NARCL–IDRCL (Bad Bank Framework)

In recent years, India’s banking sector has grappled with a large stock of NPAs, especially in public sector banks. To tackle legacy bad loans, a new “bad bank” structure was created, consisting of the National Asset Reconstruction Company Limited (NARCL) and the India Debt Resolution Company Limited (IDRCL). Announced in the Union Budget 2021 and established in 2021, NARCL–IDRCL is a two-entity setup where one entity acquires bad assets and the other resolves them.

Objectives

NARCL’s main objective is to aggregate and clean up bad loans from banks’ balance sheets. It purchases large NPAs (particularly those over ₹500 crore from multiple banks) so that banks can focus on normal lending again.

IDRCL’s objective is to professionally manage and resolve these assets to maximize recovery. In essence, this “bad bank” will isolate toxic assets and work on getting the best value out of them over time, which individual banks struggled to do. This is expected to strengthen the banking system by speeding up recovery and freeing banks’ capital for fresh credit.

Structure

NARCL is set up as an Asset Reconstruction Company (ARC) under the Companies Act. It is majority-owned by Public Sector Banks (PSBs) (collectively holding 51% stake). It started operations with a capital of around ₹6,000 crore contributed by shareholders (mostly PSBs). IDRCL, on the other hand, is a service company/operational entity. Its ownership is the inverse – majority held by private lenders (51%) and up to 49% by PSBs and public financial institutions.

The reason for this split ownership is to bring in private sector efficiencies in resolution (IDRCL’s domain) while having the government-backed public banks pool the bad assets (in NARCL). The two entities work in tandem through a ‘Principal-Agent’ partnership: NARCL is the principal that buys and owns the bad loans, and IDRCL acts as agent or asset manager to resolve them.

Operational Flow

The process for NARCL–IDRCL working can be summarized in steps:

Identification and Offer

Banks identify bad loans to sell to NARCL (in initial phases, about ₹2 lakh crore of stressed assets were identified for transfer). NARCL will make an offer to the lead bank of a lending consortium for these assets. The price offered is based on some valuation of expected recovery. To ensure transparency, a Swiss Challenge method may be used – after NARCL offers a price, other ARCs are invited to bid higher, and NARCL can match the highest bid.

Acquisition by NARCL

Once the price is agreed, NARCL acquires the NPA from the banks. Crucially, NARCL pays only 15% of the agreed price upfront in cash, and for the remaining 85% it issues Security Receipts (SRs). These SRs are like trust certificates redeemable when the loan is resolved. The Government of India provides a guarantee on these SRs up to ₹30,600 crore for five years. This government guarantee gives confidence that even if recoveries fall short, the SRs have backing, making banks willing to swap their bad loans for NARCL’s SRs.

Resolution by IDRCL

After acquisition, the IDRCL takes charge of resolving the asset. It will analyze the distressed asset, decide the best resolution strategy (sale of business, change of management, restructuring of debt, liquidation of collateral, etc.), and employ turnaround experts and professionals to execute it. Since IDRCL is privately managed, it is expected to have specialized skills and agility in resolving bad loans which banks might lack. Throughout this stage, NARCL remains the owner (“principal”) and approves resolution plans, while IDRCL is the operating partner.

Recovery and Pay-out

Once IDRCL resolves or sells the asset (for example, sells the underlying collateral or finds a buyer for the defaulter’s business), the proceeds are used to pay the holders of the Security Receipts. The cash recovered essentially goes back to the banks (who hold the SRs) as redemption. If the recovery is equal to or more than the SR value, banks get full payment. If there is a shortfall, the government guarantee can be invoked to cover the gap between the realized value and the face value of the SRs (up to the limit of ₹30,600 crore aggregate). This guarantee is invoked only if resolution occurs within 5 years; it provides a safety net to buyer banks against extreme losses.

Wind-down

After the asset is resolved and payouts made, NARCL can wind down that account. Over time, as large NPAs are resolved one by one, the banking system’s gross NPAs should reduce correspondingly, with losses absorbed by the provisions and any government-guarantee if needed.

Timeline

NARCL was incorporated in July 2021 and received its ARC license from RBI in October 2021. By early 2022, it had lined up initial accounts for transfer (around ₹50,000 crore worth in Phase 1), though regulatory and procedural clarifications caused some delays. The government’s guarantee on SRs was approved in September 2021 (for five years). Actual transfers of some large NPAs began in 2022 and 2023, albeit at a slower pace than initially envisaged.

NARCL’s Managing Director is a seasoned SBI official, and the entity is backed by 16 PSBs. As of mid-2023, NARCL had acquired a handful of large accounts to demonstrate the model, and plans to progressively take over more NPAs in tranches.

The NARCL–IDRCL “bad bank” is expected to significantly speed up the clean-up of legacy NPAs, complementing existing mechanisms like IBC. Its success will depend on how efficiently IDRCL can resolve assets and recover value. The presence of sovereign guarantee and majority government ownership signals strong commitment to address the NPA problem. If successful, the bad bank could substantially reduce NPAs on banks’ books and improve overall asset quality in the sector.