Updated: Oct 4, 2021
Understanding the bad bank
A bad bank is a bank set up to buy the bad loans and other illiquid holdings of other financial institutions. The entity holding significant non-performing assets will sell these holdings to the bad bank. By transferring such assets to the bad bank, the original institution may clear its balance sheet. Bad banks if designed with a good business model may address the twin balance sheet problem in India and capital adequacy concern too.
Bad bank abroad
The idea of a bad bank has been there since the 1980s. US and Sweden was the early adopters. Bad banks have been institutionalized and considered a success in several countries including the US, Sweden, Finland, Belgium and Indonesia.
Countries like Malaysia created a bad bank sponsored by the government, the US launched the Troubled Asset Relief Program (TARP) in 2008, Ireland, too, had set up a National Asset Management Agency (NAMA) in 2009. But conditions in these countries were far different from what is being tried in India.
Bad bank in India
A National Assets reconstruction company Limited (NARCL), effectively a bad bank is incorporated that isolates risky assets held by the banks in separate entity. NARCL also called as bad bank is established to buy non-performing loans existent in the balance sheet of banks and to structure them.
The government of India has announced that it will provide INR 30,600 crore guarantees to the NARC to buy bad loans from banks. NARCL, through its operational entity, India Debt Resolution Company (IDRC), will be tasked with the resolution of stressed assets.
The main objectives of creation of the bad bank are (a) to clean the balance sheets of banks in India, (b) to enable the banks to reach the required level of capital adequacy by mobilising fresh capital from the market, and (c) to focus on credit growth to boost investment and ultimately economic growth. Essentially a bad bank would help the Indian banks to trim losses and concentrate on their core business of lending.
How bad bank benefit the Indian economy?
The majority of the bad loan pile in India is stuck with the state-owned lenders. The pandemic has made the crisis worse. Public sector banks account for the majority of loans generated in the Indian economy and because their capital has been stuck in providing for the large amount of bad loans, their ability to lend has been constrained. Credit growth in India has been largely dormant in the past three years due to low appetite in the corporate sector.
"Since the banks will remove these NPAs from their balance sheets, they can focus on lending activities that can help trigger a fresh round of credit off take that the economy badly needs,” said VK Vijayakumar, chief investment strategist at Geojit Financial Services.