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What’s good about a ‘bad bank?’

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September 17, 2021

Why in news?

The government has set up the new bad bank structure (NARCL-IDRCL) to acquire stressed assets from banks and then sell them in the market

What are bad banks?

  • Technically, a bad bank is an asset reconstruction company (ARC) or an asset management company 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.
  • It just 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.
  • US-based Mellon Bank created the first bad bank in 1988.

What is the recent new bad bank structure about?

  • India’s first-ever bad bank, National Asset Reconstruction Company Limited (NARCL) will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks
  • It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of Security Receipts.
  • The rest will be paid when the assets are sold by IDRCL
  • The other entity, India Debt Resolution Company Ltd (IDRCL), will then try to sell the stressed assets in the market
  • To make it work, the government has granted the use of Rs 30,600 crore to be used as a guarantee.
  • If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then this government guarantee of RS.30,600 crore will be invoked.

What is the need for bad banks?

  • According to RBI’s Financial Stability Report, the gross non-performing assets (GNPA) ratio of banks may rise to 9.8 per cent by March 2022 from the 7.48 per cent in March 2021
  • Within the bank groups, public sector banks' (PSBs') GNPA ratio is 9.54 per cent in March 2021
  • To improve the financial health of PSBs, the government was forced to recapitalise them using taxpayers’ money
  • So bad banks are needed to relieve the commercial banks of their stressed assets.
  • It also improves the bank’s position and help them resume their normal banking operations, especially lending.

 

Source: The Indian Express

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