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A Bad Bank to resolve Bad loans

A Bad Bank to resolve Bad loans

UPSC CSE Mains Syllabus: GS-3- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

In news:

State Bank of India and the Indian Banks’ Association have once again revived the proposal for a bad bank. It is imperative, if India’s broken banks are to start lending again, to fuel growth, as the economy recovers from Covid. India needs a bad bank jointly owned by the banks themselves.

What is a bad bank:

  • It is a bank which takes over, that is, buys at a discount, the non-performing loans of banksand then resolves the assets over time, leaving the banks that sell off their bad loans with clean books.
  • It brings clarity on the bank’s finances.
  • Banks would now be capable of making a fresh start, to raise capital with better ratingsand on better terms and to make loans.

Why bad bank now:

  • When a bank is already saddled with a high proportion of bad loans, its appetite for making a fresh loan is lower than when a bank has no bad loans on its books.
  • For post-Covid recovery, banks must be free of their bad-loan burden.
  • And a proper way they can do this fast is by selling them off to a bad bank.

Why not sell it to the Asset reconstruction companies:

  • For an Asset reconstruction company Bad loans have to be sold at a discount.
  • If a loan of Rs 1,000 crore has turned non-performing, the buyer will buy it for say, Rs 530 crore, depending on the likelihood of realising the money from selling off the assets with which the loan has been secured.
  • Banks are reluctant of accepting a sharp discount, because they might be accused of causing a loss to the bank, and indirectly, to the exchequer,in the case of public sector banks.
  • They might be accused of causing a notional loss to the exchequer.

What about its ownership:

  • The key to the success of a new bad bank is ownership.
  • It should be owned by all the public sector banks, which account for the bulk of non-performing assets on banks’ books, and by private sector bank that want to join in.
  • Their respective shares of ownership can be their share in the total bad loan portfolio.
  • The advantage of having a bad bank owned by the banks collectively is that when the assets underlying a bad loan is resolved, the profits will accrue to the owners,that is, the banks themselves.
  • This would make the loss they book on selling the non-performing assetsat a discount more palatable.
  • The better-quality assets would sell at a premium; say power assets that turned non-performing just because a state government went back on its power purchase agreement.

Some concerns:

  • Critics of bad banks say that the option encourages banks to take undue risks, leading to moral hazard, knowing that poor decisions could lead to a bad bank bailout.
  • The transfer will be from public sector lenders to another public sector entity, and the government will end up providing capital to both the entities.
  • There are already 20 asset reconstruction companies, competing with each other to buy bad loans. Yet, no sales are taking place because of valuation issues. It is doubtful whether bad bank can solve this valuation issue.

Examples of Bad Bank Structures:

  • A well-known example of a bad bank was Grant Street National Bank. This institution was created in 1988 to house the bad assets of Mellon Bank.
  • The financial crisisof 2008 revived interest in the bad bank solution, as managers at some of the world’s largest institutions contemplated segregating their nonperforming assets.
  • In 2009 the Republic of Ireland formed a bad bank, the National Asset Management Agency, in response to the nation’s own financial crisis.

Private ARCs would be able to compete with the bad bank to buy stressed assets and pricing would become competitive.

Bad bank experiments have worked well around the world. India could consider it after assessing the benefits and issues around it.

Source:” Economic Times“.

Possible UPSC CSE Mains Question:

To bring a post-COVID recovery, the banks must free their bad-loan burden. How useful will a bad bank be in this regard?