Growing NPA’s & Bad Bank

UPSC CSE MAINS SYLLABUS– GS – 3- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Growing NPA’s & Bad Bank

In news:

The idea of setting up a bad bankto resolve the growing problem of non-performing assets (NPAs), or loans on which borrowers have defaulted, is back on the table.
With commercial banks set to witness a spike in NPAs, or bad loans, in the wake of the contraction in the economy as a result of the Covid-19 pandemic, Reserve Bank of India (RBI) Governor Shaktikanta Das recently agreed to look at the proposal for the creation of a bad bank.

What’s a bad bank and how does it work?

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.

Huge NPA’s:

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.
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.
The K V Kamath Committee, which helped the RBI with designing a one-time restructuring scheme, also noted that corporate sector debt worth Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress before the pandemic.
This effectively means Rs 37.72 crore (72% of the banking sector debt to industry) remains under stress.
This is almost 37% of the total non-food bank credit.
The panel led by Kamath, a veteran banker, has said companies in sectors such as retail trade, wholesale trade, roads and textiles are facing stress.
Sectors that have been under stress pre-Covid include NBFCs, power, steel, real estate and construction.
Setting up a bad bank is seen as crucial against this backdrop.

Is bad bank necessary:

The idea gained currency 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.
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.

Will a bad bank solve the problem of NPAs?

Despite a series of measures by the RBI for better recognition and provisioning against NPAs, as well as massive doses of capitalisation of public sector banks by the government, the problem of NPAs continues in the banking sector, especially among the weaker banks.
As the Covid-related stress pans out in the coming months, proponents of the concept feel that a professionally-run bad bank, funded by the private lenders and supported the government, can be an effective mechanism to deal with NPAs.
The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
The presence of the government is seen as a means to speed up the clean-up process.
Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

Source:”Indian Express”.

POSSIBLE UPSC MAINS QUESTION:

Owing to the rise in Non-Performing Assets, do you think there is a need for a bad bank? Examine.