Easing credit: To fund growth cycle, a bad bank and a DFI

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Sitharaman also proposed a development financial institution (DFI) to enable long term funding worth Rs 5 lakh crore in 3 years for infrastructure projects.

With non-performing assets (NPAs) set to rise in the wake of the economic slowdown induced by the pandemic, Union Finance Minister Nirmala Sitharaman Monday announced the creation of an asset reconstruction company/ asset management company (ARC/AMC) — popularly known as a “bad bank” — to clean up the books of banks.

Sitharaman also proposed a development financial institution (DFI) to enable long term funding worth Rs 5 lakh crore in 3 years for infrastructure projects.

The purpose of a “bad bank” is to park the bad assets of commercial banks and later sell those assets at a discounted price in the market. This will help clean up the balance sheets of commercial banks. A good chunk of gross NPAs totalling Rs 899,803 crore as of March 2020 is expected to be transferred to the “bad bank”.

The move comes as a relief for banks hit by soaring bad assets and a sluggish loan off-take amid the pandemic. But several experts sounded a note of caution, saying that the move will encourage banks to continue with “reckless lending practices”.

“The proposed takeover of banks’ stressed assets by the ARC will help the banks to free their books of bad loans and thereby make available more funds for lending. Besides it will help fetch better value for the asset by aggregating debt,” said Padmaja Chunduru, MD & CEO, Indian Bank.

The Government and RBI are worried over a spike in bad loans as many borrowers are expected to delay repayments in the wake of the economic slowdown. The NPAs in the banking sector are expected to shoot up to 13.5 per cent of advances by September 2021 from 7.5 per cent in September 2020 under the baseline scenario.

The Finance Minister has not announced a formal structure for the proposed “bad bank”. But banking sources say the Government is likely to fund the institution with public sector banks also pitching in. However, private banks are unlikely to join the structure initially. “The creation of an ARC/AMC to manage stressed assets can be built upon in the years and made into a bigger entity,” said Waqar Naqvi, CEO, Taurus Mutual Fund.

The banking sector, led by the Indian Banks’ Association (IBA), had last year submitted a proposal for setting up a “bad bank”, proposing equity contribution from the Government and commercial banks. The proposal was based on an idea proposed by a panel headed by former PNB chairman Sunil Mehta on faster resolution of stressed assets in public sector banks.

IBA chairman Rajkiran Rai G said: “Incidentally, IBA had proposed the creation of a bad bank during the course of the pandemic when the banking sector was expecting a hike in stressed assets. Taking over the bad loans reduces the provisioning requirements and enhances the ability of the banks to lend to the productive sectors of the economy to spur growth.” Rai is also the MD and CEO of Union Bank of India.

On the DFI, Sitharaman said: “A professionally managed Development Financial Institution is necessary to act as a provider, enabler and catalyst for infrastructure financing. Accordingly, I shall introduce a Bill to set up a DFI.The ambition is to have a lending portfolio of at least Rs 5 lakh crore for this DFI in three years time.”

The proposed DFI will be used to finance social and economic infrastructure projects identified under the National Infrastructure Pipeline (NIP), which was launched with 6,835 projects and has expanded to 7,400 projects. Around 217 infra projects worth Rs 1.10 lakh crore have been completed.

A Bill for the creation of a DFI — the National Bank for Financing Infrastructure and Development Bill, 2021 — has been listed for the ongoing Budget session of Parliament.

The earlier DFIs, like ICICI and IDBI, later converted into universal banks to get access to public deposits. But with banks finding it difficult to finance long-gestation projects and given the general decline in long-term infra funding after the collapse of IL&FS, a need has been felt to set up a government-backed DFI.

The high-level task force on NIP had earlier recommended that the capacity of banking and financial institutions, including IIFCL and SBI, be ramped up to provide long-term infrastructure finance.

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