What is “bad bank”?

0
38
The proposed ‘bad bank’ would be a centralised agency that would take over the largest and most difficult stressed loans from public sector banks in order to help clean their balance sheets, and would take politically tough decisions to reduce debt.

India’s Chief Economic Advisor Arvind Subramanian on Wednesday said there is an urgent need for India to create a ‘bad bank’ that could buy up bad debts from lenders to restructure them, echoing the views of Reserve Bank of India’s newly-appointed Deputy Governor Viral Acharya, who yesterday had called for a new approach to tackle the problem of high NPAs (non performing assets).

The proposed ‘bad bank’ would be a centralised agency that would take over the largest and most difficult stressed loans from public sector banks in order to help clean their balance sheets, and would take politically tough decisions to reduce debt, providing an impetus to further lending to spur economic activity.

Problem

India has been trying to solve its ‘Twin Balance Sheet’ (TBS) problem — overleveraged companies and bad-loan-encumbered banks, which is a legacy of the boom years in mid-2000s, when companies launched several new projects worth lakhs of crores of rupees, and stepped up hiring with the help of credit from banks.

It has now become imperative to tackle record stressed loans of $133 billion held by Indian banks by last September, or about 12.34% of their total loans, as the burden constrains lending and delays private investment. The Economic Survey, released before the Union Budget, had said that now a “decisive resolution is urgently needed before the TBS problem becomes a serious drag on growth”.

Current approach and drawbacks

  • Thus far, decisions to solve individual stressed loans have been left to banks themselves, who find it difficult to resolve these cases for many reasons. Banks are required to to recognise the true extent of bad loans but have flexibility to restructure them.
  • The current framework leaves banks with too much discretion in solving the problems. In most cases, banks simply refinance the debtors, making it costlier for the government as it means the bad debts keep rising, increasing the ultimate recapitalisation bill for the government.
  • Further, the decision to refinance the banks to continue their lending has also not worked out quite as well, as banks hesitate to lend even with adequate capital in hand till they can’t assess the future impact of bad loans on their books, the economic survey had said. Moreover, private asset reconstruction companies (ARCs) too haven’t proved any more successful than banks in resolving bad debts.

You may also like to watch:

New approach

It is now time to consider a different approach, the economic survey had said, outlining how could the problem of the Twin Balance Sheet — banks and corporate — be solved.

  1. PARA (Public Sector Asset Rehabilitation Agency) would purchase specified (large) loans from banks and then work them out, either by converting debt to equity and selling the stakes in auctions or by granting debt reduction. Once the loans are off the books of the public sector banks, the government would recapitalise them, restoring their financial health and allowing them to get back to making new loans.
  2. Similarly, once the financial viability of the over-indebted enterprises (such as the large, over-indebted infrastructure and steel firms) is restored, they will be able to focus on their operations, rather than their finances. And they will finally be able to consider new investments.

You may also like to watch:

Merits and demerits

  • The creation of the proposed ‘bad bank’ also has its own critics, including former RBI Governor Raghuram Rajan, who felt such an approach would simply shift the soured debt from banks to another firm. Rajan has said the focus needed to be on how to restructure the bad loans.
  • Further, even if the government and the RBI agree on creating an institution to tackle bad debt, the differences in structures under the existing plans would need to be ironed out.
  • However, a spin off into a ‘bad bank’ the bad assets are moved to a separate entity altogether, cleaning up the balance sheet and ensuring maximum risk transfer.

Leave a Reply