India’s Union Cabinet has given the go-ahead to government guarantee of $4.1bn (INR306bn) to back security receipts to be issued by the ‘bad bank’.

This guarantee is valid for a five-year period and the guarantee fee that NARCL pays to the government will keep on increasing each passing year.

The government guarantee would be invoked in case of loss against the threshold value, finance minister Nirmala Sitharaman announced while addressing the media.

Banks transferring their stressed assets will receive 15% of the value in cash and 85% as tradable security receipts.

The bad bank National Asset Reconstruction Company (NARCL) will take up $27.2bn (INR2trn) worth of bad loans from stressed lenders, of which INR900bn will be transferred in phase one.

“For the SRs to hold on and to have their value intact, there is a need for government to give the backstop arrangement and that’s why Rs 30,600 crore has been cleared by the cabinet yesterday,” Sitharaman noted.

The bad bank will aggregate NPAs in banks’ balance sheets and offload them, cleaning up banks’ balance sheets and freeing up growth capital.

“The SRs are getting the backstop through government funding only in as much as to pay the gap between the realised value (resolution/liquidation) and face value of SRs and this will hold good for five years,” Sitharaman further stated.

Public sector banks will have 51% ownership of the NARCL, which will have an operational entity India Debt Resolution Company to manage stressed assets and find potential acquirers.

Last month, Indian Banks’ Association (IBA) moved an application to the Reserve Bank of India (RBI) seeking a licence for NARCL.

Sitharaman said that the licence is in the process of being approved and “should happen sooner than later”, without specifying a timeline.

In June this year, it was reported that Punjab National Bank (PNB) will transfer around $1.1bn (INR80bn) worth of NPAs to NARCL.