A critique of the national asset reconstruction company, India’s bad bank

This study aims to provide a critique of the institutional framework of the National Asset Reconstruction Company Limited (NARCL), India’s “bad bank.”

The approach followed is the development of an economic model of the gains to trade of an Asset Reconstruction Company.

Using an economic model, the paper shows that the rules of the game create an uneven playing field and are likely to lead to a systematic overpricing of nonperforming loans (NPLs). While this might increase the upfront cash received by the bank, it will come at the cost of higher liabilities for the government on account of the sovereign guarantee that is part of the proposed structure. The overpricing is also likely to act as an obstacle to efforts aimed at the revival of the distressed company. The NARCL could become a warehouse for NPLs subverting the objective of reconstruction.

Solutions to create a vibrant market for NPLs are proposed.

The Indian case is unique in the sense that a bad bank backed by the government has been introduced after almost two decades of the existence of similar entities in the private sector. To the best of the author’s knowledge, this paper is the first that addresses the design of such a market using economic modeling.