Why the IBA’s proposal to have government-backed bad banking could hit a wall

Mumbai: The initiatives to create one bad bank may hit a wall, as the banking regulator and the government, which is expected to sponsor it, are unlikely to accept two key proposals made by the banking lobby group.

The Indian Banks’ Association wants to transfer accounts where fraudulent activities have been discovered to the new entity that will possess their risky assets. It is also proposed to sell bad loans at book value to the asset reconstruction company (BOW).

A government official involved in assessing the IBA’s proposal asked how the government could pay for loans where a fraud had been declared. “There’s a moral hazard here,” he said.

According to the proposal submitted to the Government and the Government Reserve Bank of India, fraudulent accounts could be considered on a case-by-case basis, with the approval of the regulator, to sell to the band bank. However, lenders selling these loans will have to deal with all inquiries related to fraud investigation.

The current rules do not allow the sale of such loans. The banks cannot sell bad loans that have been fraudulent or have been classified as fraud as at the date of a planned sale, RBI said in an April 2011 announcement to all scheduled commercial banks.

Banks have a plan to transfer $ 70,000 crore of bad assets to the proposed ARC.

According to data from the Finance Ministry, between April and December 2019, banks and financial institutions had reported fraud worth $ 1.43 lakh crore.

Another dispute is the transfer of assets to the bad bank at book value less minimum regulatory provisions. Banks say that avoiding time-consuming valuation process and due diligence is avoided. But even ARCs do not buy bad assets from banks at the book value.

“In almost all bad loan sales, banks have taken haircuts from 20% to 90%, so how can this sale be done at book value without determining the true valuation of the underlying asset and its recovery opportunity, “asked the CEO of an ARC while talking about the condition of anonymity .

Data with RBI shows that the asset values ​​have been inflated in bank books. When an ARC bought a loan from a bank, the recovery rate was more than 40% for 10 years in the 15-year period until 2019. In some years, such as 2009 and 2010, it was more than 90%.

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