Herald: GOOD NATURED ‘BAD BANK’

GOOD NATURED ‘BAD BANK’

Neetant D Sinai Shirodkar

The banking sector in recent times has been in the news for all the wrong reasons, starting with the PNB Bank scam, followed by the PMC Bank debacle, and then the multi thousand crore Yes Bank scam. It’s not just the private banks which are guilty of misappropriation but also the PSU Banks which were otherwise considered more secure and dependable are also facing the heat. Adding fuel to fire was the lockdown due to COVID-19 which has further worsened the financial position of many banks owing due to economic slowdown (GDP of the first quarter was down by 23% year on year), and the loan moratorium which was extended as part of relief during the lockdown period. The RBI in its financial stability report has warned that the gross NPA ratio may increase from 7.5% in Sept 2020 to 13.5% in September 2021.

Recently the finance minister (FM) has stated that an asset reconstruction company (ARC) and an asset management company (AMC) would be set up to consolidate and take over the existing NPAs of the banks and then manage and sell the NPAs to alternate investment funds (AIFs) and other potential investors for eventual value realisation. The ARC/AMC taking over the existing stressed NPAs of public sector banks (PSBs) has been described as Bad Bank (BB).

What is a Bad Bank and how does it work?

A bad bank conveys the impression that it will function as a bank but has bad assets to start with. Technically, a bad bank is an asset reconstruction company (ARC) or an asset management company (AMC) that takes over the bad loans (NPAs) of commercial banks, manages them and finally recovers the money over a period of time by selling collateral assets mortgaged to the respective loan. 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.

Do we need a bad bank?

The idea gained momentum during Raghuram Rajan’s tenure as RBI Governor. The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet. However, the idea remained on paper amid lack of consensus on the efficacy of such an institution. ARCs have not made any impact in resolving bad loans due to many procedural issues. Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium it had announced to tackle the economic slowdown.

Will a bad bank solve the problem of NPAs?

Despite a series of measures by the RBI for better recognition and provisioning against NPAs, as well as massive doses of capitalisation of public sector banks by the government, the problem of NPAs continues in the banking sector, especially among the weaker banks. As the COVID-related stress pans out in the coming months, proponents of the concept feel that a professionally run bad bank, funded by the private lenders, and supported the government, can be an effective mechanism to deal with NPAs. The bad bank concept is in some ways similar to an Asset Reconstruction Company but is funded by the government initially, with banks and other investors co-investing in due course. The presence of the government is seen as a means to speed up the clean-up process. Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

If the Government does go through with the idea of setting up bad bank to clear the previous NPAs affecting the financial condition of various public sector banks, it still does not address the malice of the increasing amount of bad loans suffered by the PSU banks. If loans which are issued from public deposits by the…