‘BAD BANK’ TO SOLVE THE NPA CRISIS
- Finance Minister in her Budget speech revivedthe idea of a ‘bad bank’ by stating that the Centre proposes to set up an asset reconstruction company to acquire bad loans from banks.
- With banks expected to report even more bad loansthis 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 bankis 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 investorswho might be interested in purchasing it.
- A bad bank makes a profit in its operations if it manages to sell the loan at a price higher than what it paid to acquire the loan from a commercial bank.
- However, generating profits is usually not the primary purpose of a bad bank the objective is to ease the burden on banks, holding a large pile of stressed assets, and to get them to lend more actively.
ADVANTAGES OF SETTING UP A 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.
- The Troubled Asset Relief Program, also known as TARP, implemented by the U.S. Treasury in the aftermath of the 2008 financial crisis, was modelled around the idea of a bad bank.
- Under the program, the U.S. Treasury bought troubled assets, such as mortgage-backed securities, from U.S. banks at the peak of the crisis, and later resold them when market conditions improved.
- According to reports, it is estimated that the Treasury through its operations earned nominal profits.
DISADVANTAGES
- Former RBI governor Raghuram Rajan has been one of the critics, arguing that 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.
- There is little reason to believe that a mere transfer of assets from one pocket of the government to another will lead to a successful resolution of these bad debts, when the set of incentives facing these entities is essentially the same.
- 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.
WILL IT REVIVE CREDIT FLOW?
- 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, they say, will give banks the freedom to use the freed-up capital to extend more loans to their customers.
- This gives the impression that banks have unused funds lying in their balance sheets that they could use if only they could get rid of their bad loans.
- It is, however, 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.
- Instead, it may simply be the precarious capital position that many public sector banks find themselves in at the moment.
- In fact, 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 as far exceeding their assets.
- So, a bad bank, in reality, could help improve bank lending not by shoring up bank reserves, but by improving banks’ capital buffers.
ALTERNATIVES
- Instead of creating a Bad Bank, infusing the capital that would be given to the bad bank directly into the public sector banks is an option.
- The enactment of Insolvency and Bankruptcy Code (IBC) has reduced the need for having a bad bank, as a transparent and open process is available for all lenders to attempt insolvency resolution.
- According to RBI, banks recovered on average more than 40% of the amount filed through the IBC in 2018-19, against just over 20% in total through the SARFAESI, Lok Adalats and Debt Recovery Tribunals.
- A model of Private Asset Management Company (PAMC) which would be suitable for sectors where the stress is such that assets are likely to have economic value in the short run, with moderate levels of debt forgiveness, can be set up.
- National Asset Management Company (NAMC) for sectors where the problem is not just of excess capacity, but possibly also of economically unviable assets in the short- to medium-term, such as in the power sector can also be set up.
WAY FORWARD
- The Economic Survey of 2016-17said the RBI had hoped ARCs would buy bad loans of commercial banks but that didn’t happen.
- In FY15 and FY16, Asset Reconstruction Companies bought up just 5% of the total NPAs and found it “difficult to recover much from the debtors”.
- To the extent that a new bad bank set up by the government can improve banks’ capital buffers by freeing up capital, it could help banks feel more confident to start lending again.