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Bad Bank

The Topic covers GS paper 3 [Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.]

From worse to bad - Talk of a bad bank in India | Leaders | The ...

Context

  • Indian lenders want the government to provide up to $2 billion to set up a “bad bank” at a time when their heavy pile of soured debt is expected to double in size due to the COVID-19 pandemic, according to media reports. 

  • The banks have proposed that the government set up an asset reconstruction company (ARC) to initially buy non-performing loans worth up to a total of 1 trillion rupees. 

  • The Indian Banks’ Association (IBA) has drafted the proposal and sent it to the government and the Reserve Bank of India for their approval, according to the same media reports.

What is a bad bank?

  • The Central government has revived the idea of setting up an asset reconstruction or asset management company, a sort of ‘bad bank’ first mooted by Chief Economic Adviser Arvind Subramanian in January 2017. 

  • Mr. Subramanian had envisaged a Public Sector Asset Rehabilitation Agency that would take on public sector banks’ chronic bad loans and focus on their resolution and the extraction of any residual value from the underlying asset.

  • This would allow government-owned banks to focus on their core operations of providing credit for fresh investments and economic activity.

  • Unlike a private asset reconstruction company, a government-owned bad bank would be more likely to purchase loans that have no salvage value from public sector banks. 

  • It would thus work as an indirect bailout of these banks by the government.


How will it be capitalised?

  • The bad bank will require significant capital to purchase stressed loan accounts from public sector banks. 

  • The size of gross NPAs on the books of public sector banks is currently over ₹10 lakh crore. 

  • The chances of private participation are low unless investors are allowed a major say in the governance of the new entity.

  • Private asset reconstruction companies have been operating in the country for a while now, but have met with little success in resolving stressed loans.

  • The CEA had proposed a significant part of the bad bank funding to come from the Reserve Bank of India, which is likely to be a tricky proposition.

  • That means the government, which is already committed to recapitalising state-run banks, will have to be the single largest contributor of capital even if private investors are roped in.


How will it help solve the NPA problem?

  • Hiving off stressed loan accounts to a bad bank would free public sector bank balance sheets from their deleterious impact and improve their financial position.

  • As the quality of a bank’s assets deteriorates, its capital position (assets minus liabilities) is weakened, increasing the chances of insolvency.

  • Some analysts believe that many public sector banks are effectively insolvent due to their poor asset quality. Consequently, banks have turned risk-averse and credit growth has taken a hit. If managed well, a bad bank can clean up bank balance sheets and get them to start lending again to businesses.

  • But it will not address the more serious corporate governance issues plaguing public sector banks that led to the NPA problem in the first place.


Conclusion

The idea of Bad Bank is not new. Currently this is in the news due to the problem caused by COVID-19. Earlier the topic of Bad Bank was a matter of debate in the banking and finance circles when former Interim Finance Minister Piyush Goyal had put forward the idea when a committee headed by Sunil Mehta was formed to study the feasibility of National Asset Reconstruction Company. Even in 2017 Economic Survey had mooted the idea by suggesting creation of Public Sector Asset Rehabilitation Agency (PARA). Even former RBI governor Raghuram Rajan had started a debate on Bad Banks in 2015 as a possible solution to the problems of Non Performing Assets.



 
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