Bad bank – Is it a good idea?

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.

Former RBI Governor Raghuram Rajan had opposed the idea of setting up a bad bank in which banks hold a majority stake. “I just saw this (bad bank idea) as shifting loans from one government pocket (the public sector banks) to another (the bad bank) and did not see how it would improve matters. Indeed, if the bad bank were in the public sector, the reluctance to act would merely be shifted to the bad bank,” Rajan wrote in his book I Do What I Do.

US-based Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany. However, resolution agencies or ARCs set up as banks, which originate or guarantee lending, have ended up turning into reckless lenders in some countries.

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Bad Banks: A few Examples

Grant Street National Bank is a well-known example of a bad bank. It was created in 1988 to house the bad assets of Mellon Bank. The recession of 2008 revived interest in the bad bank solution as some of the world’s largest financial institutions proposed to segregate their nonperforming assets. Federal Reserve Bank Chairman Ben Bernanke proposed the idea of using a government-run bad bank with the purpose to clean up private banks with high levels of problematic assets and allow them to begin lending once more.

In 2009 the Republic of Ireland formed a bad bank, the National Asset Management Agency, in response to the nation’s own financial crisis.

Bad bank is a bad idea: In no way Bad Bank is better than the existing Asset Reconstruction Companies except that there can be some Alternate Investment Fund and the bad bank may securitise the receivables through it. Transferring NPAs from banks to Bad Bank will not remove it from the financial system, though it may not be in the balance sheet of banks. This is not removal of NPAs but only transfer of NPAs, which is labeled as Resolution.

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.

Bad Bank with capital from banks: There is another suggestion in circulation to have a Bad Bank with capital contribution by various banks. When such an idea is executed, first funds will have to move from Banks to the proposed Bad Bank and when the bad debts are transferred to the Bad Bank, funds will move back from Bad Bank. This does not make any sense at all.

Bad bank cannot recover: When the financing bank, which knows the customer very well, cannot recover the dues, how can the new Bad Bank be better equipped to recover?

Resolution based on reason: NPAs arise mainly due to business failure or by willful default. There may be a number reasons for business failure. When the business unit fails, there may not be cash generation to service the debt and the borrowers expect the banks to sacrifice a part or full of the debt. If it is genuine business failure, the banks should expeditiously approve the heir cut to avoid further deterioration of assets. If there is a willful default, criminality should be established and for this we need a faster judicial system.

We do not have any effective judicial machinery to tackle the problem of willful default or diversion of funds.

The proposed Bad Bank cannot arrest sanction of loans, which may become NPAs in future. In fact it may encourage banks to reckless lending as NPAs can be transferred to Bad Bank. It cannot enable recovery of the loan in time or enhanced recovery. On the whole there cannot be any value addition. It may only help banks to camouflage the real position.

Also Read:- How To Prepare For Group Discussion Tips

1. What Group Discussion Skills Required
2. How to Start a GD
3. What Skills Are Judged In GD?
4. How to Enter a GD in the Middle of the Discussion
5. How to prepare for Group Discussion
6. Read Daily Current Affairs