The Indian banking sector has been saddled with high levels of non-performing assets (NPAs) in recent years. According to a report by the Reserve Bank of India (RBI), the gross NPA ratio of banks increased from 5.43% in March 2015 to 10.97% in March 2019. In order to tackle this problem, the government set up a Bad Bank. A Bad Bank is a special purpose vehicle (SPV) that takes over the bad loans of commercial banks. The SPV then tries to recover the money by selling off the assets attached to the loan or by restructuring the loan itself. The setting up of a Bad Bank is a welcome move by the government as it will help ease the burden on commercial banks and allow them to focus on their core business activities. It will also help in faster resolution of bad loans and release of capital for new lending.
What is bad bank?
The term ‘bad bank’ is used to refer to a specialised financial institution that is created to take over the non-performing assets (NPAs) of another bank. The main objective of setting up a bad bank is to clean up the balance sheet of the parent bank by transferring the NPAs to the bad bank. This enables the parent bank to focus on its core banking activities and improve its financial performance.
The bad bank typically raises funds through asset sales, debt issuance or equity investment. These funds are then used to purchase NPAs from the parent bank. The parent bank receives cash for the NPAs and relief from having to manage these problem assets. The bad bank is responsible for managing and disposing of the NPAs.
Bad banks can be set up as standalone entities or as units within the parent bank. They can be publicly owned or privately owned. There are a number of different models for bad banks, but all share the common goal of transferring NPAs off the balance sheet of the parent bank.
The concept of a bad bank has been around for many years and was first implemented in Sweden in the early 1990s. Bad banks have also been used in other countries, including Ireland, Greece and Spain. In India, the Reserve Bank of India (RBI) has been encouraging banks to set up bad banks as a way to deal with their mounting NPAs.
Evolution of bad bank in India
The concept of bad bank was first mooted in the early 2000s in the US and Europe as a way to deal with the high levels of non-performing assets (NPAs) on banks’ balance sheets. The idea was simple: create a new entity, funded by the government or private investors, that would take over the NPAs from the banks and then try to recover as much money as possible through asset sales or other means.
The bad bank concept gained traction in India in the wake of the global financial crisis, as NPAs started to rise sharply on Indian banks’ balance sheets. In 2012, the Reserve Bank of India (RBI) set up a working group to study the feasibility of setting up a bad bank in India. However, nothing concrete came out of it.
In 2016, RBI Governor Raghuram Rajan proposed setting up an asset reconstruction company (ARC) to take over NPAs from banks. The proposal was met with some resistance from within RBI, but it was eventually agreed to by the government. In February 2017, RBI issued guidelines for setting up ARCs in India.
So far, two ARCs have been set up in India: National Asset Reconstruction Company (NARCL) and Asset Management Company (AMC). NARCL is owned by a consortium of banks, while AMC is owned by SBI Capital Markets Ltd., a subsidiary of State Bank of India (SBI).
Why do we need bad bank?
Banks are the lifeblood of any economy and when they are not functioning properly, it can have a ripple effect on the entire economy. Non-performing assets (NPAs) are one of the biggest problems facing Indian banks today.
Bad banks are usually set up to deal with NPAs in a more efficient manner. They are typically given a large amount of capital by the government to help them deal with the toxic loans.
The hope is that by dealing with NPAs quickly and efficiently, bad banks will help to restore confidence in the banking sector and get the economy back on track.
How can it help reduce NPAs?
The Bad Bank concept is simple. It involves the creation of a separate entity, called a ‘bad bank’, which will take over the bad loans from the existing banks. The bad bank will then work on resolving these loans and eventually selling them off.
The main advantage of this concept is that it can help reduce NPAs in a number of ways. First, it would provide much-needed relief to the existing banks by taking off their hands the burden of dealing with non-performing assets. Second, it would create a dedicated entity whose sole purpose would be to resolve these loans, which should help increase the chances of successful resolution. Finally, by selling off the resolved loans, the bad bank can generate some income which can be used to offset its losses.
There are certain risks associated with this concept as well, but overall it seems to be a viable option for tackling the problem of NPAs.
What are the challenges associated with setting up a bad bank?
The challenges associated with setting up a bad bank are numerous and varied. Firstly, there is the challenge of finding the right buyer for the bad bank. This can be difficult, as many buyers may be reluctant to take on a bad bank, due to the inherent risks involved. Secondly, there is the challenge of ensuring that the bad bank is adequately capitalised. This is essential in order to protect the interests of shareholders and creditors. Finally, there is the challenge of ensuring that the bad bank is run effectively and efficiently. This can be difficult, as bad banks can often be complex and unwieldy organisations.
Conclusion
The Bad Bank model is a sensible and practical way to deal with the problem of NPAs in the Indian banking sector. By setting up a separate entity to manage NPAs, banks can focus on their core business activities, while at the same time providing a specialized resolution mechanism for problematic assets. While the Bad Bank model is not a panacea for all ills in the banking sector, it is certainly an important step in the right direction and one that can help to restore confidence in the Indian banking system.