NARCL and China Huarong’s NPA management lessons for India

China is battling with one of its largest bad banks, China Huarong Asset Management Co. Ltd., as India prepares to launch a new bad bank, the National Asset Reconstruction Company Ltd. (NARCL) (Huarong). The Hong Kong-listed corporation, which has the Chinese government as a major stakeholder, recently sparked fears about financial stability by avoiding a potential bond default.

Its former Chairman, Lai Xiaomin, was executed earlier this year for soliciting bribes, corruption, and bigamy. While such strong punishment in global banking is hoped to remain an outlier, the Chinese example should guide Indian policies on failed banks.

Following the Asian financial crisis, China established separate bad banks for each of its four major state-owned commercial banks. These bad banks were supposed to buy those banks’ non-performing loans (NPLs) and resolve them within ten years. Their contract was extended indefinitely in 2009. China allowed the formation of one local bad bank per province in 2012.Chinese bad banks efficiently help conceal NPLs, according to recent research by Ben Charoenwong of the National University of Singapore and others. Over 90% of NPL transactions are financed by banks through direct loans to bad banks or indirect financing vehicles. Over 70% of NPLs are resold at inflated prices by bad banks to third parties that happen to be debtors of the same bank.

Chinese bad banks efficiently help conceal NPLs, according to recent research by Ben Charoenwong of the National University of Singapore and others. Over 90% of NPL transactions are financed by banks through direct loans to bad banks or indirect financing vehicles. Over 70% of NPLs are resold at inflated prices by bad banks to third parties that happen to be debtors of the same bank.Third, Indian banks, like Chinese banks, are still exposed to problematic loans once they are transferred to asset reconstruction businesses (ARCs). According to the RBI Bulletin (2021), ARCs’ funding sources have primarily been bank-centric. Similarly, the same banks continue to hold about 70% of all security receipts (SRs). The RBI has tightened bank provisioning to address this issue, while liberalizing the rules for foreign portfolio investment. Bank holdings in SRs have decreased from 80.5 percent in March 2018 to 66.7 percent in March 2020, according to the RBI’s action. Policymakers must make certain that the NARCL does not reverse this trend.

Bad loan settlement should take place through a market process rather than a slew of bad banks. The Narasimham Committee (1998) in India considered a single ARC to be a failing bank. Yet, the SARFAESI Act, 2002 ended up creating multiple, privately owned ARCs. As a result, regulations have treated ARCs like bad banks, although functionally they are closer to stressed asset funds registration (AIFs). The regulatory arbitrage between ARCs and AIFs must stop with the establishment of NARCL as a centralized bad bank.

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