BAD BANK IN INDIA

Announced in the Union Budget earlier this year India’s so-called Bad Bank is beginning to take shape. Finance Minister Nirmala Sitharaman announced on September 16 that the Union Cabinet had cleared a proposal to approve ₹30,600 crore government guarantees for security receipts issued by the National Asset Reconstruction Company (NARC) as part of the resolution of bad loans. A bad bank is a bank set up to buy a bad loan and another illiquid holding of another financial institution. The entity holding significant non-performing assets will sell these holdings at a bad market price. By transferring such assets to the bad bank, the original institution may clear its balance sheet although it will still be forced to take write-downs. Padmakumar M. Nair of the State Bank of India (SBI) will be the Chief executive of the National Asset Reconstruction Company (NARC), a proposed entity for taking over the bad loan of lenders, predominantly the Public sector Banks. 

HOW BAD BANK WORKS

A bad bank is a special type of financial institution that buys a bad loan at a mutually agreed value and attempts to recover the debt or associate securities by itself. The bad bank takes over a position of the debts that are non-performing and recognized as non-performing assets (NPAs). All the rights held by the lender (the bank) in respect of the debt are transferred to the bad bank. Banks and other financial institutions are required to classify the debt owned by them into the following four categories:

i) Standard:- It is a kind of performing asset which creates continuous income and repayments as and when they become due. 

ii) Substandard:– Loans and advances which are non-performing assets for 12 months. 

iii) Doubtful:- The assets considered as non-performing for more than 12 months.

iv) Loss:- All those assets which cannot be recovered by the lending institutions. 

“Those loans are fully provided in the books of the bank. The upfront cash received 15% of the written-down value, would be reversed while the provision for the balance (value of security receipts) written renowned government unlikely to be reversed even if it is fully provided” analysts at Kotak Securities wrote in a note. “The larger release of provisions, if any would be made as and when the cash is received on sale of these receipts or redemption of security receipts. The government’s guarantee on SRs can enable trading of these securities” Kotak Securities added. The security receipts issued by NARCL are backed by the Union government guarantee. The government guarantee will cover any shortfall between the face value of the receipt and the actual realization value of the receipts and the actual realization value of the bad bank.

BENEFITS OF BAD BANKS IN INDIA

The toxic assets separation helps in generating some confidence among potential investors so that they can then clearly examine the financial health of the lender. Sour loans when transferred to the bad bank can help lender prioritize their financing business and the specialized institution deals with maximizing loan recovery. Most of the big-ticket NPAs (Non-Performing Assets) will be transferred to NARCL, thereby cleaning up banks’ balance sheets and freeing up growth capital for them to support economic activity. Some experts believe that a bad bank can help free capital of over ₹5 lakh crore that is locked in by banks as a provision against the bad loan. The governor of the Reserve Bank of India, Mr. Shati Kanta Das indicated that the RBI is considering the idea of a bad bank to tackle bad loans. Erstwhile Deputy Governor of RBI, Viral Acharya, had suggested two models of Bad banks solve the problem of stressed assets. The first is a Private Assets Management Company (PAMC) which is set to be suitable for a stressed sector where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness. The second model is the National Asset Management Company (NAMC) which would be necessary for sectors where the problem is not just one of excess capacity but possibly also of unviable assets in the short to medium terms. Commercial banks in India have been slow in selling bad assets to the existing Asset Reconstruction Company (ARC) as neither the ARC nor the banks were ready to bear the losses which prolonged the process of recovery. The bad bank could remove this flow and expedite the process of buying the bank asset and recovering the dues. 

DISADVANTAGES OF BAD BANKS IN INDIA.

Some banking and finance experts criticize the setup of Bad banks. Many experts are of the view that if states take over non-performing loans, this will encourage banks to take undue risks in lending, and in the long-run situation will not improve. Lending by the public sector banks is not constrained by the lack of capital. Banks lack the risk appetite to lend to lower-rated borrowers. While the aggregate credit by banks to commercial borrowers is growing at 5.6 percent, their investment in government securities is growing at 18.2 percent providing them to boost the level of lending. The regulation about who could buy or sell the bad loan, what will be the price, and in which form among others are poorly designed and are over-prescriptive. As such they do not help much in recovering the dues. Various options could be explored for the ownership of Bad banks:- entirely government-backed funding, private funding, or a public-private government-owned partnership (PPP). While global Bad bank models with favorable outcomes were largely government-owned, many see an advantage in having a bad bank owned by the bank collectively. This would ensure that when a bad loan is resolved, the profits would accrue to the owners, i.e the banks themselves. This would make the loss they booked on selling the non-performing assets at a discount more palatable.

CONCLUSION 

• The sovereign guarantee would allow the banks to free up the capital without the burden of additional provisioning, effectively allowing more participation from the banks to resolve their NPAs through the bad banks. However, the success of the Bad bank will depend on the implementation and management of the transferred NPAs.