Bad Bank
Source: The Hindu
1.Context
The Finance Minister announced that the National Asset Reconstruction Company (NARCL) along with the India Debt Resolution Company (IDRCL) will take over the first set of bad loans from banks and try to resolve them.
2.What is a bad bank?
A bad bank is a financial entity set up to buy non-performing assets or bad loans, from the banks.
The aim of Setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and getting them to lend again to customers without constraints.
3.Key points
- While the problem of bad loans has been a perennial one in the Indian banking sector.
- The Union government decided to set up a bad bank during the Budget, in the aftermath of the nationwide lockdowns.
- The moratorium was subsequently extended to borrowers by the Reserve Bank of India.
- It should be noted that the health of the balance sheets of Indian banks has improved significantly over the last few years with their gross non-performing assets (GNPA) ratio declining from a peak of 11. 2 Per cent in Financial year 18 to 6.9 Per cent in Q2 FY 22.
4. Pros and Cons of setting up a bad bank?
Pros |
Cons |
|
It is argued that it can help consolidate all bad loans of banks under a single exclusive entity.
|
Several problems with the idea of a bad bank to deal with bad loans.
|
|
The idea of a bad bank has been tried out in countries such as the U.S., Germany, Japan and others in the past.
|
Former RBI governor Raghuram Rajan criticised the idea, arguing that a bad bank backed by the government will merely shift bad assets from the hands of the public sector banks, which are owned by the government, to the hands of a bad bank, which is again owned by the government.
|
|
The troubled asset relief program (TARP) was implemented by the U.S.
|
There is little reason to believe that a mere transfer of assets from one pocket of the government to another will lead to a successful resolution of these bad debts when the set of incentives facing entities is essentially the same.
|
|
Treasury in the aftermath of the 2008 financial crisis was modelled around the idea of a bad bank.
|
Unlike a bad bank set up by the private sector, it is backed by the government and is likely to pay too much for stressed assets.
|
|
Under the program, the U.S. Treasury bought troubled assets such as mortgage-backed securities from U.S. banks at the peak of the crisis and later resold them when market conditions improved.
|
These have been reluctant to incur losses by selling off their bad loans at cheap prices.
It is bad news for taxpayers who will once again have to foot the bill for bailing out troubled banks. |
|
It is estimated that the Treasury through its operations earned a nominal profit of anything between $11 billion to $30 billion, although some contest these figures.
|
5.Will a bad bank help ease the bad loan crisis?
- A key reason behind the bad loan crisis in public sector banks nature of their ownership.
- Unlike private banks, which are owned by individuals who have strong financial incentives to manage them well.
- Public sector banks are managed by bureaucrats who may often not have the same commitment to ensuring these lenders' profitability.
- To that extent, bailing out banks through a bad bank does not address the root problem of the bad loan crisis.
- There is a huge risk of moral hazard.
- Commercial banks that are bailed out by a bad bank are likely to have little reason to mend their ways.
- The safety net provided by a bad bank gives these banks more reason to lend recklessly and thus further exacerbates the bad loan crisis.
6.Will it help revive credit flow in the economy?
- A bad bank can help free capital of over five lakh crore that is locked in by banks as provisions against these bad loans.
- This, they say, will give banks the freedom to use the freed-up capital to extend more loans to their customers.
- This gives the impression that banks have unused funds lying in the balance sheets that they could use if only they could get rid of their bad loans.
- It is important not to mistake banks' reserve requirements for their capital position.
- This is because stopping banks from lending more aggressively may not be the lack of sufficient reserves which banks need to maintain against their loans.
- It may simply be the precarious capital position that many public sector banks find themselves in at the moment.
- Many public sector banks may be considered to be technically insolvent as an accurate recognition of the true scale of their bad loans would show their liabilities to be far exceeding their assets.
- In reality, it could help improve bank lending not by shoring up bank reserves but by improving banks' capital buffers.
- To the extent that a new bad bank set up by the government can improve banks' capital buffers by freeing up capital, it could help banks feel more confident to start lending again.
