Bad Bank- Everything You Need to Know

Bad Bank

The name ‘Bad Bank‘ itself intimate that it deals with something bad in the financial sector. The idea of starting a bad bank by the government was recently projected in the Economic Survey presented in January under the name ‘Centralized Public Sector Asset Rehabilitation Agency’ (PARA) that could take charge of the largest, most difficult cases, of non-performing assets (NPAs) in the banking system. The need for a government-owned bad bank has been felt for some time as the commercial banks are finding it difficult to deal with NPA or bad loan.

The Financial Stability Report, produced by the RBI, had said that the gross non-performing advances ratio increased to 9.1 per cent from 7.8 per cent between March and September 2016, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent.

India’s NPA ratio is higher than any other major emerging market, except Russia, the Economic Survey said. High NPAs have weighed down the Indian banking system’s capacity to lend money to the corporate sector, resulting in a drag on the country’s growth.

According to the Economic Survey, banks’ credit to the corporate sector till November 2016 in FY17  was minus 8 per cent. A downbeat growth in corporate lending means the industry will not be able to invest in new projects to generate jobs.

Even as the government has not charted out any guidelines on the structure of a bad bank, such an institution would be largely based on the principles of an asset restructuring company (ARC), which 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. Since a bad bank specialises in loan recovery, it is expected to perform better than commercial banks, whose proficiency lies in lending.

At current, there seems to be a consensus building up on the need of creating a government owned bad bank, though former Reserve Bank of India Governor Raghuram Rajan was not in favour of such an entity.

“It is not clear (if) India needs a so-called “bad bank” to deal with non-performing loans, adding that it would be preferable to push banks to clean up balance sheets themselves” Mr Rajan had said. As the head of the central bank, Mr Rajan was more in favour of capitalising the banking system.

With the change of guard at the central bank, there has been a change of attitude towards dealing with the bad loan dilemma in the Indian economy.

“We have to remain open to all solutions at this point because I think the problem is quite big,” RBI Deputy Governor Viral Acharya had said.

“The hassle in our banking sector must be extinguish to allow the system to lend to small businesses and other rising sectors of economy. And the present strength of our public sector banks do not allow them to do so. “Therefore, a national bad bank is a good idea,” said Kotak Mahindra Bank’s chief, Uday Kotak.

However, economists in the country are separated in their opinion whether a bad bank can facilitate resolve the bad loan problem of the Indian IT industry.

Pinaki Chakraborty, a professor at National Institute of Public Finance & Policy, said, “When we talk about the dilemma of NPAs, it is not a sudden phenomenon. NPAs were there in the 1980s as well but the structure of those NPAs was very different. Structure of today’s NPAs need a public debate whether a bailout is necessary.”

“Why would taxpayers’ money be used to buy bad loans of private sector? It would be socialisation of the losses of the private sector” who can pay but are not willing to pay,” he added.

R Nagraj, a professor at Indira Gandhi Institute of Development Research, said one needs a greater clarity on what these bad loans are about.

“Part of the bad loans are genuine business risks. Cyclical downturn after the financial crisis in 2008-09, and the Great Recession were unexpected events accentuating the risks, hence the government needs to “socialise” these risks.”

“There is the other part which includes wilful defaults of some big business houses and that needs to be separated and dealt with strictly. If government does not make the distinction and bails out all big defaulters, then it could lead to moral hazard problem, which should be avoided,” he adds.

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