Everything You Wanted To Know About Bad Bank

A ‘bad bank’ is a bank that buys the bad loans of other lenders and financial institutions to help clear their balance sheets. The bad bank then resolves these bad assets over a period of time. When the banks are freed of the NPA burden, they can take a more positive look at the new loans. Ideally, such a bank should be owned by the banks which have the most of NPAs.

A paper co-authored by Raghuram Rajan and former RBI deputy governor Viral Acharya, noted that the government obtains enormous power from directing bank lending. This power is sometimes exercised for larger pblic interests such as promoting financial inclusion or infrastructure finance.

“Re-privatisation of select PSBs can then be undertaken as part of a carefully calibrated strategy, bringing in private investors who have both financial expertise as well as technological expertise; corporate houses must be kept from acquiring significant stakes, given their natural conflicts of interest,” the paper said.

  • The bad bank is not involved in lending and taking deposits.
  • Bad banks are supposed to help commercial banks clean up their balance sheets and resolve bad loans.
  • The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.
  • Bad banks can also include unwanted assets that are no longer core to a firm’s strategy.

Need For a Bad Bank in India

The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector are expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020, under the baseline scenario, as “a multi-speed recovery is struggling to gain traction” amidst the pandemic. The report warned that if the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%.

Proposal of Bad Bank In The Budget

The Union Budget 2021-22 proposed the creation of a bad bank under an Asset Reconstruction Company (ARC)-Asset Management Company (AMC) structure, wherein the ARC will aggregate the debt, while the AMC will act as a resolution manager.

The proposed structure envisages setting up of a National Asset Reconstruction Company (NARC) to acquire stressed assets in an aggregated manner from lenders, which will be resolved by the National Asset Management Company (NAMC).

Main Objective Of The Bad Bank

The main objectives of creation of the bad bank are

  • to clean the balance sheets of banks in India,
  • to enable the banks to reach the required level of capital adequacy by mobilising fresh capital from the market, and
  • to focus on credit growth to boost investment and ultimately economic growth.

Arguments In Favour Of Bad Bank

  • In May 2020, the Indian Banks Association (IBA) had suggested to the finance ministry and RBI to set up a bad bank.
  • The Confederation of Indian Industry (CII) requested government to set up “multiple bad banks” to address the NPAs of public sector banks (PSBs).
  • It is argued that bad banks will act as alternative investment funds (AIFs) to buy bad loans.
  • Bad bank helps expedite the pace of debt restructuring by reducing the number of lenders who must agree to a proposed deal.
  • Placing non-core assets in a separate division can help make restructuring more efficient and transparent.

Arguments Against Bad Bank

Not all experts support bad banks. Chief economic adviser (CEA) KV Subramanian does not support the idea of bad bank. According to him, “setting up of a bad bank may not be a potent idea as there are already many asset reconstruction companies (ARCs) in operation and banks have failed to sell bad loans to them. Also, when a bank sells bad loans it has to sell it at a discount and hence take a haircut”.