TO ENSURE THAT the ‘bad bank’ mechanism proposed in the Budget takes off, the Finance Ministry is planning to provide a guarantee against security receipts to be issued by the Asset Reconstruction Company (ARC) to banks against the value of their bad assets being taken over.

The ARC, according to government officials, is likely to take over Rs 2-2.5 lakh crore of stressed assets that remain unresolved in around 70 large accounts. Stressed loan accounts of more than Rs 500 crore each are expected to be transferred to the new entity.

“Even though there will be no equity contribution by the government in the proposed ARC, the government will provide guarantee to ensure the success of this structure,” a senior government official said. The proposed ARC will provide banks 15 per cent cash and 85 per cent security receipts against the value of bad assets that will be taken over from the banks.

The ARC will be set up by state-owned and private sector banks, and there will be no equity contribution from the government. It will have an Asset Management Company (AMC) to manage and sell bad assets.

For the banks it will be a cash neutral kind of exercise, because for the capital they will contribute to the ARC, they will get some portion back as cash and rest as security receipts against transfer of the stressed assets, a source said.

“For security receipts, the regulator requires some kind of provisioning, for which the banks are asking the government to provide guarantee that the RBI (Reserve Bank of India) requires. For the 85 per cent SRs portion, banks need provisioning of around 15 per cent. Banks are seeking sovereign guarantee for that, which we will provide as we go forward. We are going to give a sovereign backing to support the banks,” the official said.

If the government guarantees the security receipts issued by the ARC, then banks can transfer stressed assets to the proposed entity without having to make additional provisions. The RBI’s 2016 guidelines require banks to make provisions for assets assigned to ARCs.

Of the existing ARCs, only 3-4 are adequately capitalised, while more-than-dozen are thinly capitalised, necessitating the need to set up a new structure to resolve stressed assets urgently. The transfer of stressed assets to the ARC will happen at net book value, which is the value of assets minus provisioning done by banks against these assets. This structure will reduce the load of stressed assets on the bank balance sheet and look to resolve the bad debt in a market-led way.

With most banks expected to be on board this company, the resolution is expected to be faster. Since most commercial loans are granted by a group of 8-10 banks, under the existing resolution mechanism some banks would typically oppose the resolution due to differences, which slowed the resolution process. The proposed structure is expected to resolve this.