NARCL has been incorporated under the Companies Act which is there to acquire stressed assets in order to clean balance sheets of banks.  Stressed assets worth Rs 2 lakh crore will be acquired from various commercial banks in different phases.

Another entity, India Debt Resolution Company Limited (IDRCL) has been set up to manage and sell stressed assets in the market. 

This NARCL-IDRCL structure is basically the new bad bank and the government has ensured Rs 30,600 to be used as a guarantee.

There is a need for such a structure due to the fact that NPAs have risen significantly over the past few years. It is important to clean the balance sheet of the banks by transferring NPA to some entity.

The business model of a bank is based on the fact that it will earn money on the interest paid when borrowers take a loan. If a borrower fails to pay back the loan, it is a loss for a bank. Further, more the NPAs, more the bank is required to keep money as provisioning and the bank can not use that money for giving loans. Therefore, to prevent major losses, this structure is created. 

The NARCL will first purchase bad loans from banks by paying 15% of the agreed price in cash and the remaining 85% in the form of “Security Receipts”. Once the assets are sold, where IDRCL will play a major role, NARCL will pay back the rest of the agreed amount to the bank.

In case the bad bank is unable to sell the bad loan or sell it at a loss, the government guarantee will be invoked in that case and the difference between what the commercial bank was supposed to get and what the bad bank was able to raise will be paid from the Rs 30,600 crore provide by the government.

This will help a bank in getting rid of all the toxic assets which are eating its profits. It will also improve the position of the bank as it can start lending again without any need of provisioning.

Looking from the lens of the government and the taxpayer, the situation is a bit complex as it is the taxpayer’s money which is used to give guarantees for security receipts or recapitalising the public sector banks loaded with bad loans.

Hence, the only sustainable solution is to improve the lending operations in PSBs such that NPAs number reduce significantly. 

Further, the plan of bailing out commercial banks will collapse if the bad bank is unable to sell impaired assets in the market. In such a case, it will be interesting to see who will have to bail out the bad bank itself.

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