How Bad Bank works? Can bad bank or solve NPA issue of India?

Bad Bank
  • Finance Minister Nirmala Sitharaman in her Budget speech revived the idea of a ‘bad bank’ by stating that the Centre proposes to set up an asset reconstruction company to acquire bad loans from banks.
  • While the problem of bad loans has been a perennial one in the Indian banking sector, the COVID-19 pandemic-triggered lockdown last year and the moratorium subsequently extended to borrowers by the RBI have worsened the crisis. With banks expected to report even more bad loans this year, the idea of a ‘bad bank’ has gained particular significance.

What is a ‘ Bad Bank’ :

  • A bad bank is a financial entity set up to buy non-performing assets (NPAs), or bad loans, from banks. The aim of setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints.
  • After the purchase of a bad loan from a bank, the bad bank may later try to restructure and sell the NPA to investors who might be interested in purchasing it.

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What is the extent of crisis faced by the banks:

  • According to the latest figures released by the RBI, the total size of bad loans in the balance sheets of Indian banks at a gross level was just around 9 lakh crore as of March 31, 2020, Down significantly from over 10 lakh crore two years ago.
  • While the size of total bad loans held by banks has decreased over the last few years, Analysts point out that it is mostly the result of larger write-offs rather than due to improved recovery of bad loans or a slowdown in the accumulation of fresh bad loans.
  • The size of bad loan write-offs by banks has steadily increased from around $70,000 crore in 2015-16 to nearly *2.4 lakh crore in 2019-20. Further, due to the lockdown imposed last year, the proportion of banks’ gross non-performing assets is expected to rise sharply from 7.5% of gross advances in September 2020 to at least 13-5% of gross advances in September 2021.

Pros and Cons of setting up bad bank :

  • A supposed advantage in setting up a bad bank, it is argued, is that it can help consolidate all bad loans of banks under a single exclusive entity. The idea of a bad bank has been tried out in countries such as the United States, Germany, Japan and others in the past.
  • Other analysts believe that unlike a bad bank set up by the private sector, a bad bank backed by the government is likely to pay too much for stressed assets. While this may be good news for public sector banks, which have been reluctant to incur losses by selling off their bad loans at cheap prices, It is bad news for taxpayers, who will once again have to foot the bill for bailing out troubled banks.

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Will ‘Bad Bank’ help to ease bad loan crisis?

  • A key reason behind the bad loan crisis in public sector banks, some critics point out, is the nature of their ownership. Unlike private banks, which are owned by individuals who have strong financial incentives to manage them well, public sector banks are managed by bureaucrats who may often not have the same commitment to ensuring these lenders’ profitability. To that extent, bailing out banks through a bad bank does not really address the root problem of the bad loan crisis.
  • Further, there is a huge risk of moral hazard. Commercial banks that are bailed out by a bad bank are likely to have little reason to mend their ways. After all, the safety net provided by a bad bank gives these banks more reason to lend recklessly, and thus, further exacerbate the bad loan crisis.
  • Some experts believe that by taking bad loans off the books of troubled banks, A bad bank can help free capital of over 75 lakh crore that is locked in by banks as provisions against these bad loans. This, they say, will give banks the freedom to use the freed-up capital to extend more loans to their customers.
Sodhi Gautam

Sodhi Gautam

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