Can a ‘bad bank’ solve the growing NPA crisis?

In News: Union Budget revived the idea of Bad Bank and Asset Reconstruction Company for dealing with the NPA crisis.

What is a Bad Bank?

A bad bank is a financial entity set up to buy non-performing assets (NPAs), or bad loans, from banks.

• Also known as Asset Reconstruction Company (ARC)
• Bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
• Aim of setting up a bad bank
  • to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints.
  • After the purchase of a bad loan from a bank, the bad bank may later try to restructure and sell the NPA to investors who might be interested in purchasing it.

Need for Bad Bank:

• It will clean the balance sheet of Banks thus solving Twin Balance Sheet Problem of Indian Economy.
• It will aid the expansionary policy of the Government after Pandemic.
• Promote specialisation in dealing with Asset Reconstruction.
• It allows companies a graceful exit under Insolvency and Bankruptcy Code.
• PNB Chairman Sunil Mehta Panel also proposed setting up of Bad Bank for speedy and efficient management of Bad Loans.

Challenges before Bad Banks:

• Chief Economic Advisor, K Subramanian has expressed his concern over pre-existing non-functional 28 ARCs.
  • Banks were unable to sell their bad loans to these entities.
• NPAs are expected to rise after COVID Pandemic
  • Impact of Covid-19 and the associated policy response is likely to result in an additional Rs 1,67,000 crore of debt from the top 500 debt-heavy private sector borrowers turning delinquent between FY21 and FY22
• Former RBI governor Raghuram Rajan argued that a bad bank will merely shift bad assets from the hands of public sector banks, which are owned by the government, to the hands of a bad bank, which is again owned by the government.
• Inefficient way to deal with bad loans as government owned Bad banks will end up paying more than real worth of stressed assets.

Way Forward:

The Bad Bank can be a good measure but not panacea. Different models which can be helpful in ensuring efficiency with minimal load on government has been discussed below.

• RBI Deputy Governor Viral Acharya has proposed two models
  • Private Asset Management Company (PMAC): suitable for stressed sectors where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness.
  • National Asset Management Company (NAMC): necessary for sectors where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short to medium terms
• Further, institutional mechanisms like the Troubled Asset Relief Programme (TARP) of the US may be deployed to deal with stress in the financial system.

Source: TH