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Insights EDITORIAL ANALYSIS : Of what good is a bad bank

 

Source: The Hindu

  • Prelims: Monetary Policy, NARCL, RBI, NPA
  • Mains GS Paper III: Fiscal policy, Issues with NPA, Issues related to planning etc.

ARTICLE HIGHLIGHTS

  • The Finance Minister announced that the National Asset Reconstruction Company(NARCL) along with the Indian Debt Resolution Company (IDRCL) will take over the first set of bad loans from banks and try to resolve them.
  • The decision to set up a bad bank was taken by the Union government during the Budget presented last year in the aftermath of the nationwide lockdowns, and the moratorium was subsequently extended to borrowers by the Reserve Bank of India(RBI).
  • The health of the balance sheets of Indian banks has improved significantly over the last few years with their gross non performing assets (GNPA) ratio declining from a peak of 11.2% in FY18 to 6.9% in Q2FY22.

 

INSIGHTS ON THE ISSUE

Context

Bad Bank

  • The bad bank is an ARC or an Asset Management Company (AMC) that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
  • The bad bank is not involved in lending and taking deposits, but helps 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.

 

Effect of Bad Bank:

  • Commercial Banks’ Perspective:
  1. Commercial banks are saddled with high NPA (Non-Performing Assets/loans) levels, setting up of the Bad bank will help.
  2. That’s because such a bank will get rid of all its toxic assets, which were reducing its profits, in one quick move.
  3. When the recovery money is paid back, it will further improve the bank’s position. Meanwhile, it can start lending again.
  • Government and Taxpayer Perspective:
  1. Whether it is recapitalising PSBs laden with bad loans or giving guarantees for security receipts, the money is coming from the taxpayers’ pocket.
  2. While recapitalisation and such guarantees are often designated as “reforms”, they are band aids at best.
  3. The only sustainable solution is to improve the lending operation in PSBs.
  • The plan of bailing out commercial banks will collapse if the bad bank is unable to sell such impaired assets in the market. The burden indeed will fall upon the taxpayer.

 

Pros and Cons of setting up a bad bank:

Pros:

  • 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 U.S., Germany, Japan and others in the past.
  • The troubled asset relief program, also known as TARP, implemented by the U.S.Treasury in the aftermath of the 2008 financial crisis, was modeled around the idea of a bad bank.

Cons:

  • A bad bank backed by the government will merely shift bad assets from the hands of public sector banks, which are owned by the government,to the hands of a bad bank, which is again owned by the government.
  • 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.

 

How will bad banks help credit flow in the economy?

  • Some experts believe that by taking bad loans off the books of troubled banks, a bad bank can help free capital of over ₹5 lakh crore that is locked in by banks as provisions against these bad loans. This will give banks the freedom to use the freed capital to extend more loans to their customers.
  • It is important not to mistake banks’ reserve requirements for their capital position. This is because what may be stopping banks from lending more aggressively may not be the lack of sufficient reserves which banks need to maintain against their loans.

 

Demand of Indian Banks:

  • Normally, a single entity to be held accountable as owner, and for recovery of the assets, is the practice followed across geographies.
  • Possibly a ‘Principal and Agent mechanism’ or similar arrangement may evolve to resolve this issue.
  • The Indian Banks’ Association is learnt to have wanted a dual structure, with the AMC as a privately held entity, to be out of the purview of the regulatory entities.

 

 

National Asset Reconstruction Company(NARCL):

●     The NARCL has been set up and issued a license by the RBI to conduct business as an Asset Reconstruction Company (ARC).

1.      NARCL will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks in different phases.

2.      Public Sector Banks (PSBs) will maintain 51% ownership in NARCL.

India Debt Resolution Company Limited (IDRCL)

●     It will provide management and resolution of assets and also help in the operational aspects, relating to price discovery and aim at evolving the best possible recovery and the resolution process.

●     PSBs and Public Financial Institutes (FIs) will hold a maximum of 49% stake in IDRCL. The remaining 51% stake will be with private-sector lenders.

●     The NARCL is majorly owned by public sector banks with 51% ownership but in the case of the IDRCL, 51% shares are in private hands.

Non-Performing Assets(NPAs):

●     NPA refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest.

●     In most cases, debt is classified as non-performing, when the loan payments have not been made for a minimum period of 90 days.

●     Gross non-performing assets are the sum of all the loans that have been defaulted by the individuals who have acquired loans from the financial institution.

●     Net non-performing assets are the amount that is realized after provision amount has been deducted from the gross non-performing assets.

Way Forward

  • So long as Public Sector Banks’ managements remain beholden to politicians and bureaucrats, their deficit in professionalism will remain and subsequently, prudential norms in lending will continue to suffer.
  • Therefore, a bad bank is a good idea, but the main challenge lies with tackling the underlying structural problems in the banking system and announcing reforms accordingly.
  • Many public sector banks may be considered to be technically insolvent, as an accurate recognition of the true scale of their bad loans would show their liabilities to be far exceeding their assets.
  • A bad bank, inreality, could help improve bank lending not shoring up bank reserves but by improving banks’ capital buffers

 

QUESTION FOR PRACTICE

Bad banks can help consolidate all bad loans of banks under a single exclusive entity. Critically analyze. (200 WORDS, 10 MARKS)