Bad Banks – Boon or Bane?

Introduction

One of the major problems that Indian banks face is of STRESSED ASSETS and amid Covid 19 the fear
of non-recovery of debts amongst banks has increased as businesses are being shut down or are
working at very low capacities since the lockdown.

In order to overcome the above crisis, Indian Bank Association (“IBA”) has brought back the idea of
‘Bad Bank’ on the discussion table to revive the banking system. The same was discussed earlier in
2015 during the Asset quality review conducted by RBI and was subsequently discarded as the banks
had inadequate provisioning.

What exactly is a Bad bank?

Bad banks are the institutions set up to absorb and manage the bad assets of banks for which
provisions have already been made (usually at a price below the book value of these bad assets) with
the aim of recovery over a period of time. They are set up with a view to clean up the books of the
banks.

The basic objective of the IBA for setting up a bad bank is so that all the bad assets go under one
entity and selling them can become easier.

How will Bad bank revive the banking system?

Transferring the bad assets to the bad bank will clean up the bank books and fuel up economic
growth with new lending capacities.

The next question that pops into our minds is “why not sell the non-performing assets to the existing
Asset Reconstruction Companies (“ARCs”) that perform almost similar functions?”

The primary answer to this question is the issue of ownership. According to the plan pitched by the
IBA, proposed bad bank should be owned by the Indian Government (“GoI”) and a consortium of
banks. The advantage of above plan is that when the bad loans are recovered the profits will accrue
to the owners i.e. the banks themselves or the GoI, which will help in boosting the economy and
reduce the losses of the banks. Secondly the existing ARCs bargain for steep discounts which are
likely to cause huge losses to the banks.

Current development by authorities

 The proposal was simultaneously sent to both, the Finance ministry as well as the RBI.
 The key items of the proposal were as below:

Structure A 3 tier structure including:

Asset Reconstruction Company (ARC) – owned by GoI
Asset Management Company (AMC) – public and private sector participation (body of professionals)
Alternate Investment Fund (AIF) – for creation of secondary market for security receipts to be issued
Targeted IBA estimates approximately Rs 70,000-75,000 crore NPAs (at book value) to be housed through this bad
NPA bank.
Capital Initial seed capital expected from GoI is Rs 10,000 crores.
requirement
Note: The above proposal is pending to be finalised
Issues hindering success of bad bank

 Serious distortion in pricing of stressed assets (as bad bank will be controlled by the GoI and
also majority banking system is governed by the GoI, bad bank will be forced to take the
stressed asset at the prices desired by the banks)
 Anticipating that bad banks will back them up in cleaning their books, banks may overlook
the problem of NPAs and emphasis only on increasing their lending portfolio .
 Current situation of Covid 19 makes it difficult to find potential buyers for the underlying
stressed assets.

Conclusion

Many countries have implemented the idea of bad banks however there are very few countries that
have actually tasted success in their implementation. In order to succeed, proper resolutions
including changing of laws and reforms are necessary along with creation of bad bank.

Sources

CNBC TV 18
Economic times
Money control