A bad bank is a business that trades in risky and illiquid assets owned by banks, other financial institutions, or a collection of banks. By moving subpar loans, it is meant to help banks balance their books and free them up to concentrate on their main activities of accepting deposits and lending money. Let’s look at the definition of a "bad bank," the need for one, its components and structure in India, as well as its downsides, in this article.
Describe A Bad Bank:
• A financial organization known as a "bad bank" was created with the goal of buying the subprime loans and other illiquid assets of other financial institutions.
• A company with a significant amount of nonperforming assets will sell them to the bad bank at market price.
• By moving these assets to the bad bank, the original institution might be able to balance its books, but it will still be required to take write-downs.
• A bad bank structure may take on the hazardous assets of a group of financial institutions rather than just one bank.
• A well-known illustration of a poor bank is Grant Street National Bank. To hold the troubled assets of Mellon Bank, this company was established in 1988.
• In response to its own financial crisis, the Republic of Ireland founded the National Asset Management Agency, a bad bank, outside of the United States, in 2009.
Need of Bad Bank
• During Governor Raghuram Rajan's term, the Reserve Bank of India (RBI) undertook an Asset Quality Review (AQR) of banks, which revealed that many banks had concealed or repressed subprime loans in order to present a healthy balance sheet.
• To deal with the banks' increasing NPAs, he suggested creating a bad bank.
• Asset Reconstruction Companies (ARCs) have had no impact in repaying problematic loans due to a number of procedural issues.
• A "bad bank," or a bank of bad loans, would try to sell these "assets" on the open market while traditional banks continue to lend.
• During the financial crisis of 2008, it was a tried-and-true strategy of dealing with NPAs and problematic assets.
• Current ARCs have been helpful in resolving stressed assets, especially for loans with lower values.
• It has been demonstrated that the Insolvency and Bankruptcy Code (IBC) and other pertinent resolution instruments are helpful.
Bad Bank In India
• In order to address the significant NPAs (Non-Performing Assets) in the Indian banking system, the Indian government has established two new companies to purchase stressed assets from banks and then sell them on the open market.
• NARCL: National Asset Reconstruction Company Limited (NARCL) was founded in accordance with the Companies Act and has submitted an application to the Reserve Bank of India (ARC) for an Asset Reconstruction Company license.
• NARCL will gradually purchase stressed assets worth around Rs 2 lakh crore from different commercial banks.
• Public sector banks (PSBs) will own NARCL to the tune of 51%.
• The NARCL will first purchase defaulted bank loans.
• For the agreed-upon price, it will pay 15% in cash and the remaining 85% in "Security Receipts."
• When the assets are sold with the aid of IDRCL, the remaining amount will be reimbursed to the commercial banks.
• If the bad bank is unable to sell the bad loan or must sell it at a loss, the government guarantee will be activated.
• This warranty is extended for a duration of five years.
• IDRCL: After the stressed assets are sold in the market, another company, India Debt Resolution Company Ltd (IDRCL), will handle the debt.
• IDRCL will be owned by PSBs and Public Financial Institutes (FIs) up to a maximum of 49 percent.
• Lenders from the private sector will hold the remaining 51% of the company.
• This NARCL-IDRCL framework is the new bad bank structure.
• It will help bankers clean up their books and move troublesome assets to a bad bank.
• After the bad bank releases capital, banks can resume lending. It will be more focused on reaching its goals, which will make it easier to recoup debt from borrowers.
• Because it has official support, it won't be hindered by issues with governance, a sluggish legal system, or poorly written regulations, among other issues that affect ARCs.
• Overall, it will significantly improve the macroeconomic climate.
• We cannot ignore the fact that a bad bank will be powerless to stop additional NPAs. Non-performing assets (NPAs)
, which are the main reason for banks' losses and the downturn in the economy, must be eliminated.
• The majority of these problematic assets have already been fully paid and reported on bank books when it comes to the bad bank. The banks no longer hold out hope for a significant revival.
• The method by which banks value these assets before transferring them to the bad bank will be the most important consideration. The ability of the bad bank to quickly resolve these assets will be critical for any future provision write-backs by banks.
• Selling stressed assets to potential buyers while also resolving the basic problem with the system could present another obstacle.
• Finding potential buyers for distressed assets may be challenging in the present context of deteriorating economic conditions and the suspension of the Insolvency and Bankruptcy Code.
• Additionally, since public sector banks will be both stockholders and clients of the bad bank, there is a chance that it will end up serving only as a means of moving bad debt from one book to another.
• Moral Danger: Raghuram Rajan, a former Reserve Bank Governor, thinks that creating a bad bank could cause moral hazard problems among banks, allowing them to carry on with their reckless lending practices and escalating the NPA crisis.
• Unreliable Antidote: Some have argued that creating a bad bank merely shifts the issue from one place to another. Without significant changes to address the NPA issue, the bad bank is likely to turn into a place to store troubled loans with no hope of recovery.
• Poor financial standing: The difficulty to raise capital for the failing bank is another significant concern. Distressed assets are hard to sell in a pandemic-affected economy, and the government's funds are scarce.
In order to support National Asset Reconstruction Company Limited's (NARCL) Security Receipts for the purchase of stressed loan assets, the Union Cabinet has approved an Rs 30,600 crore guarantee. The engagement of the government is seen as a means of accelerating the cleanup process. Many other nations, including the US, had institutionalized processes to address the strain in the banking industry, such as the Troubled Asset Relief Programme (TARP).