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Daily News Analysis

Explained: What is a bad bank, and why is a proposal to set it up being floated?

9th July, 2020 Editorial

About Bad bank:

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

- This was based on an idea proposed by a panel on faster resolution of stressed assets in public sector banks headed by former PNB Chairman Sunil Mehta.


Need for Bad Bank:

- Adverse effects of Covid-19 on economic activity.

- Slump in earnings of companies and individuals could lead to a jump in non-performing assets.

- Various analysts suggest that in a couple of years, the proportion of stressed assets in the banking system could jump to as high as 18 per cent from around 11 per cent at present.


Government Opinion:

-  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.

- In the last three financial years, the government has infused equity of Rs 2.65 lakh crores into state-owned banks.

- Insolvency resolution under the Insolvency and Bankruptcy Code (IBC) is adequate to the tackle the challenge of bad loans. Thus, Government argues that there is no need for Bad bank.


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 Raghuram Rajan had opposed the idea of setting up a bad bank with a majority stake by banks, arguing it would solve nothing.

- Rajan 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”.

- If the bad bank were to be in the private sector, the reluctance of public sector banks to sell loans to the bad bank at a significant haircut would still prevail.

-So, according to banking experts, Bad bank will not achieve anything.

Way Forward:

-  Enactment of IBC has reduced the need for having a bad bank, due to it being transparent and open process.

-  Banks recovered on average 42.5% of the amount filed through the IBC in 2018-19, against 14.5% through the SARFAESI, 5.3% through Lok Adalats and 3.5% through Debt Recovery Tribunals.

- Private Asset Management Company: It 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: 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.

Reference: https://indianexpress.com/article/explained/explained-what-is-a-bad-bank-why-proposal-to-set-it-up-is-being-floated-6496725/