09/07/2020 - Indian Economy | GS III

IAS Parliament 4 years

Bad bank

A bad bank buys the bad loans and other illiquid holdings of other banks and financial institutions, which clears their balance sheet.

What is the government’s view?

· While the finance ministry has not formally submitted its view on the proposal, senior officials have indicated that it is not keen to infuse equity capital into a bad bank.

· The government’s view is that bad loan resolution should happen in a market-led way, as there are many asset reconstruction companies already operating in the private space.

· The government has significantly capitalised state-owned banks in recent years and pursued consolidation in the PSU banking space.

What is the RBI view?

· The central bank has so far never come out favourably about the creation of a bad bank with other commercial banks as main promoters. Former RBI Governor had opposed the idea of setting up a bad bank with a majority stake by banks, arguing it would solve nothing.

· It is argued that a government-funded bad bank would just shift loans “from one government pocket (the public sector banks) to another (the bad bank) and did not see how it would improve matters”.

What are the alternatives to a bad bank?

· To resolve banks’ stressed assets, 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.

· 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.

· The NAMC would raise debt for its financing needs, keep a minority equity stake for the government, and bring in asset managers such as ARCs and private equity to manage and turn around the assets.