Moving forward with one of her main statements made during the 2021 Budget presentation, the Finance Minister, Nirmala Sitharaman has declared the creation of India’s first-ever ‘Bad Bank.’ She said the National Asset Reconstruction Company Limited (NARCL) has already been incorporated under the Companies Act and it will procure strained assets worth approximately Rs.2 lakh crore from different commercial banks in various stages. India Debt Resolution Company Limited (IDRCL), another establishment that has also been founded will attempt to dispose of the strained assets in the market. The NARCL-IDRCL configuration is the novel bad bank and to make it a reality the government has allowed the utilization of Rs 30,600 crore to be employed as a guarantee.
Many banks had experienced a progressive increase in their loans’ portfolio since the international financial disaster of 2008-2009. In India, since 2016, the level of non-performing assets (NPAs) or bad loans has climbed terrifyingly. Largely this was because the Reserve Bank of India wanting banks to precisely identify the bad loans and record them in their books of accounts. Total NPAs of Indian public sector banks stood at Rs.6.17 trillion in the financial year 2020-2021. Thus, there is now no probability of receiving payment of that amount and banks must make provision for the sick days ahead.
Moreover, the greatest troublesome fact is that a vast share of NPAs is with the public sector banks (PSBs), which are managed by the government. The government must recapitalize them to keep them in the business. To do this the government has no option besides using the taxpayers’ money to improve the financial health of PSBs so that they can carry out the function of advancing and financing economic activity. Therefore, due to the high-pitched increase in NPAs, talks of establishing a ‘bad bank’ have gained momentum.
What is ‘Bad Bank’?
A bad bank is an organization that acquires all the NPAs of a bank at a price that is below their book price. It then works to recuperate and turn around the assets by way of expert management, sale, or restructuring. The sellers of these bad credits can clear their balance sheets and hold only the good assets after canceling the bad ones. The main advantage of forming a bad bank is asset monetization. Bad assets will remain the risky zone, while the good ones stay in the other category, saving them from mixing. With this, investors are confident of its fiscal health and could pour in more funds.
Initially, the NARCL will acquire bad loans from banks and disburse 15% of the decided value in cash and the balance 85% will be in the form of ‘Security Receipts’. When the assets are disposed of by taking help from the IDRCL, the banks will be paid back the rest. If the bad bank is incapable to sell the bad loan or has to sell by incurring a loss, then the government guarantee will be evoked and the variance between what the commercial bank was supposed to receive and what the bad bank was able to nurture will be funded from the Rs 30,600 crore that has been offered by the government.
United States of America, Malaysia, Ireland, Nigeria, Sweden, and Finland have used bad banks to put an end to the financial crisis. A noticeable instance of a bad bank is Portugal’s Novo Banco. Novo Banco was started by the government of Portuguese in August 2014 as part of a rescue of the dwindling Banco Espirito Santo BES. BES was split into a ‘good bank’ covering its good assets; and a ‘bad bank’ (Novo Banco), comprising all the difficult to recover loans.
One more illustration is Grant Street National Bank. This institution was established in 1988 to accommodate the bad assets of Mellon Bank. In January 2017, the idea of setting up a ‘bad bank’ attained popularity in India, when the then RBI deputy governor, Viral Acharya recommended two models namely Private Asset Management Company (PAMC) and the National Asset Management Company (NAMC) to resolve the concerns of strained assets.
Bad bank should not be BAD forever
Now the question is whether the idea of a bad bank will help to solve the mega problem of NPAs? From the viewpoint of a bank burdened with extreme NPA levels, it will help. The bad bank will assist the banks to erase all its lethal assets which were damaging their profitability, in one quick attempt. Additionally, the bank’s position will develop when the recovery money is paid back. The NARCL will be assessed on the footing of how rapidly and how efficiently it can get settled the stressed assets that it takes over. That will depend on what type of conditions it is capable to provide to the banks whose non-performing advances it is procuring.
However, from the viewpoint of the government and the taxpayer, the scenario is more confused because whether it is recapitalizing PSBs loaded with bad loans or providing guarantees for security receipts, the funds coming from the taxpayers’ pocket. Although such actions of the government are habitually termed as “reforms”, they are a band at best. The only justifiable remedy is to develop the advancing operation in PSBs. Importantly; the strategy of bailing out banks will crumble if the bad bank cannot sell such diminished assets in the market. If that occurs, guess who will have to bail out the bad bank itself? Indeed, the taxpayer.
Now a bad bank is on the pathway and the fundamental job before the government is to guarantee that it attains a reasonable level of success in accomplishing the duty allocated. If a bad bank turns out to be a problematic establishment that is incapable to preserve a healthy balance between its assets and liabilities, then that will be extremely disastrous. The government must implement measures to ensure that the governing system permits a bad bank to carry out its tasks with rapidity and a manageable cost to itself. Then only the bad bank will become a successful venture.
The government has chosen the first move towards this by introducing the Insolvency and Bankruptcy Code (IBC) which aims to resolve the problems of NPAs and up to now it has done well but there are miles to go. The resolution procedures should be condensed and it has to assure that appeals to higher authorities are not employed as an adjourning trick by the accused parties. The government should immediately fill the many positions on the tribunals that are the medium for the resolution procedure to be carried out.
The people who will manage the bad bank should be autonomous experts so that they can perform a good job of locating buyers for strained advances with some logic and not at throwaway prices. The concept of the bad bank should not become a case of old wine in a new bottle. It is also crucial that the bank must be capable to retrieve the amenities of efficient resolution professionals who are already aiding the IBC process.
As a final point, the government should have a clear notion that a bad bank once established, should not go on endlessly. The global experience is that a bank is established after a financial system becomes laden with an overburden of NPAs due to remarkable macroeconomic changes, then it does its job with some achievement and subsequently, it is wound up. Also, the government must alter the manner it manages the financial institutions or banks it possesses. If huge credits are granted on the basis of phone calls from politicians and civil servants whose gestures senior managers follow for the good of their careers, then there is no faith.