13/05/2020 - Indian Economy

KEY POINTS

·         A “bad bank” is reportedly being planned to deal with the fallout of the non-performing assets crisis, which has constrained commercial bank credit growth for years.

·         It is understandable why this idea is returning to the forefront of policy now — reviving credit growth is a necessary condition for emerging from the sudden sharp stop that the economy has been subjected to as a consequence of the pandemic and efforts to contain it.

·         The plan now, is that banks will transfer about Rs 60,000 crore worth of stressed assets to a new asset reconstruction company (ARC), which will seek to turn them around. The ARC, having taken the troublesome assets off the balance sheets of the bank, would then allow them to resume normal operations and lending.

·         Any state-controlled ARC would be forced to deal with the same questions that the heads of nationalised banks are asking themselves .

·         The adherents of a bad bank are yet to answer why these issues will be solved differently by calling the new public-sector institution an ARC instead of a bank.

·         Indeed, such an organisation would have less of an ability to deal with other creditors than the banks, since its bargaining power would be reduced.

·         The very creation of a bad bank would require the banks to make decisions they have so far been unwilling to make — namely, decide a value for the assets that they will have to pass on to the bad bank.

·         The pandemic must not be used as an excuse to brush the crisis of state-controlled banking under the carpet. Many in public-sector banks see a bad bank simply as another way to evade responsibility for the crisis.

·         Reform of the banking system, and independence from the government, is the only way to revive effective banking and move on. The bad bank achieves neither of those goals.

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The government of India is planning to set up a Bad Bank to rescue the banking system from the rising non-performing assets. The total stress in the Indian banking system is about Rs. 14 lakh crore.

>>> What is Bad Bank:

- A Bad Bank is an Asset Reconstruction Company (ARC). 

- Once it is formed, banks divide their assets into two categories;

(a) one with non-performing assets and other risky liabilities, and 

(b) others with healthy assets, which help banks grow financially.

- ARC or Bad Bank buys bad loans from the commercial banks at a discount and tries to recover the money from the defaulter by providing a systematic solution over a period of time. 

- The bad bank will manage these Non-Performing Assets in suitable ways, some may be liquidated, others may be restructured, etc.

>>> Benefits of setting up a bad bank :

The major benefit of forming a bad bank is asset monetization. It’s the process of turning a non-revenue-generating item into cash.

Bad assets would stay in the risky category, while the good one stays in the other category, saving them from mixing together. 

Bad bank specializes in loan recovery, and it is expected to perform better than commercial banks, whose expertise lies in lending.

>>> Challenges with Bad Bank:

A banking institution has to keep in mind its choices of assets to be transferred into the risky category, and healthy category.

Each of these choices must be made while considering the impact on funding, capital relief, cost, feasibility, profits, and timing. 

Once the NPA problem is settled, the Bankers may become complacent and again resume reckless lending.

A one-size-fits-all approach to designing a bad bank can be very expensive and less effective. 

At least Rs. 25,000 to Rs. 30,000 crore of capital will be required to set up a bad bank in the initial stages.

>>> Way Forward:

Bad Bank should be based on a set criterion as any such exercise creates a moral hazard that should be eschewed.

There have to be strict performance criteria for the banks selling such assets. 

The criteria for buying assets should be transparent.

A competitive approach should prevail among the banks so that they work hard to qualify for the sale of bad assets to the bad bank. This, in fact, will ensure better governance standards too.

Set up a bad bank to deal with NPAs at some of the weaker PSBs, instead of stronger one.

>>> Conclusion :

The resolution of bad loans and restoring the health of PSBs is among the biggest challenges the economy faces today. It’s a challenge that requires a response on multiple fronts. A bad bank cannot be the sole response. The most efficient approach would be to design solutions tailor-made for different parts of India’s bad loan problem and use Bad Bank only as a last resort once all other methods fail. 

The most important step that govt needs to take is better regulation, monitoring, and functioning of PSBs, capital infusion and structural reforms in the economy to tackle the NPA problem.