Bad Bank And The NPA Crisis

Bad Bank is a financial entity which buys bad loans from banks and tries to recover the money by selling those bad loans.

what is a bad loan?

In simple term, NPAs(Non Performing Assets) are the bad loans. These are loans taken by companies/individuals who fail to return the money.
These loans sit on a Bank’s balance sheet and makes it weak. At a stage Bank’s feel they can not recover the money.
But Banks can decide to transfer these bad loans from their balance sheet to the bad bank and make their own balance sheet clean.

The Concept of Bad Bank is to achieve

Cleaning up financial system

Financial risk mitigation
Targeted approach to solve the problem
Having a robust mechanism in place to deal with losses in Financial system.

More info About Bad Bank

A bad bank conveys the impression that it will function as a bank but has bad assets to start with.

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, but 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, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
However, resolution agencies or ARCs set up as banks, which originate or guarantee lending, have ended up turning into reckless lenders in some countries.

Do we need a bad bank?

The idea gained currently during Rajan’s tenure as RBI Governor. The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet. However, the idea remained on paper amid lack of consensus on the efficacy of such an institution. ARCs have not made any impact in resolving bad loans due to many procedural issues.

Former RBI Governor Raghuram Rajan had opposed the idea of setting up a bad bank in which banks hold a majority stake. “I just saw this (bad bank idea) as shifting loans from one government pocket (the public sector banks) to another (the bad bank) and did not see how it would improve matters. Indeed, if the bad bank were in the public sector, the reluctance to act would merely be shifted to the bad bank,” Rajan wrote in his book I Do What I Do.

Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium it has announced to tackle the economic slowdown.

How serious is the NPA issue in the wake of the pandemic?

Bad loans in the system are expected to balloon in the wake of contraction in the economy and the problems being faced by many sectors.

The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector are expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020, under the baseline scenario, as “a multi-speed recovery is struggling to gain traction” amidst the pandemic.
The report warned that if the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%. Among bank groups, the NPA ratio of PSU banks, which was 9.7% in September 2020, may increase to 16.2% by September 2021 under the baseline scenario.

Can Bad Banks completely solve the NPA problem ?

No one Knows about it now. But in the present pandemic scenario when there is a high chance of accumulation of NPA, government have to take step whatever it is, which gives positive signal in the matket.

Then, how can the NPA problem be solved?

May be with a better mindset shift and understanding between lenders and Borrowers.
Government should be cautious enough before giving the lending target. Lending target should be based on merit rather than for political advantage.
Banking management system should have sector based expert who can analyse the risk of that project.
There is a very narrow line, because if banks are reluctant to lending then there is a crunch of money in the market and if banks are giving freehand to lending then there are chances of NPA.
Reforms are needed in different departments at different level. Because, it is seen that clearances are not given on time and hence the whole project is delayed and at last it created NPA.

Also refer: