Proposal To Setup Bad Bank – Burning Issues

Table of Contents

WHAT IS A BAD BANK?

A bad bank is termed so simply because it houses- Bad loans, or Non-performing assets (NPAs).
As time goes by, these loans accumulate, interest keeps getting accumulated.
Bank X keeps providing more money against the bad exposure it took, because it realises that chances are it may never get this money back.
One could argue that these bad loans, or NPAs could just continue sitting in Bank X’s books and that would be that.
In practice, however, these NPAs could really hurt the bank.
Investors, or any other counterparties, see large NPAs as a sign of the bank’s ill-health or financial weakness.
The higher the NPAs, the more impaired the Bank X’s ability to borrow, lend, or conduct business in general.

Bad loans can be taken out of the bank’s books and transferred to a bad bank.
Bad banks would only serve the purpose of aiding in recovery of these risky assets.
As a result, Bank X will clean up or deleverage its own balance sheet, reduce its exposure to risky assets, and thereby ringfence itself.

BENEFIT TO BANK X?

A bad bank, therefore, is expected to help the banks by absorbing all their bad assets, usually at a price below the book value of these loans, and
Manage them, in an attempt to finally recover the money over a period of time.

On paper the idea is simple,
But its implementation is more complicated – perhaps the reason why this idea has only been toyed with and not actually implement by policymakers in India.
Though first pioneered in the US in 1988,
The idea of forming a ‘bad bank’ in India was initially floated in January 2017 when the Economic Survey of India suggested setting up a-
Public Sector Asset Rehabilitation Agency (PARA).
The central bank RBI, too, came up with a suggestion to form two entities to clean up the bad loan problems ailing PSBs –
PAMC (Private Asset Management Company)
NAMC (National Assets Management Company).

Those in favour of the idea have argued that-
Aside from cleaning up the banks’ balance sheets and making them financially healthy,
It also allows the bank to focus on its core activity of lending, and leaves the resolution to experts.
Former RBI Governor Raghuram Rajan was against the bad bank concept saying that-
It created a moral hazard, enabling banks to continue with their reckless lending practices.

As per IBA’s estimates, the ‘Bad Bank’ would require approximately Rs 10,000 crore of capital initially, which it proposes be fully provided by the government of India.