Article on “Decoding Bad Banks A Palliative or A Cure” by Mr. Adwait Venkitachalam, Director, Bizsolindia Financial Services Pvt. Ltd. (May 2021)

The Indian banking system has been reel- ing under the stress of Non Performing Assets (NPA) well before Covid reached our shores last year. Especially with re- spect to Public Sector Banks, where NPAs have risen at an alarming rate over the past half-decade. NPAs have now become a na- tional financial crisis & a matter of consid- erable worry. The RBI has, in its bi-annual Financial Stability Report (FSR), informed that gross NPAs were expected to jump to 13.5% of advances by September 2021, from 7.5% the previous year. What is worse is that the RBI no longer has the where- withal to bail out banks anymore. Post the pandemic & resultant lockdown, the RBI had announced the halting of repayment of loans for six months, which provided relief not only to borrowers but also to banks as potential loan defaults didn’t have to be recognised and bank balance sheets would remain stable. It is unlikely that the RBI would continue with this strategy this year. Hence, cleaning up of NPAs is not only prudent but now essential. To help assuage this situation, FinMin Nirmala Sitaraman proposed the idea of a Bad Bank in the last budget. Contrary to its name, a bad bank is an Asset Restructuring Company (ARC) that could be a good proposition to relieve our beleaguered financial institutions of these toxic assets from their books.

What is a Bad Bank?

A bad bank is in all honesty not a bank at all. It is actually a company formed for acquiring NPAs from financial in- stitutions with the idea to turn those assets around with the goal to realise maximum value out of the same over a period of time. A bad bank helps financial institutions clean up their books thereby increasing liquidity as lower provisions need to be allocated towards bad loans. The idea of a bad bank gained traction in India after the RBI, under then Governor Raghuram Rajan, conducted an Asset Quality Re- view of commercial banks. The review found banks having concealed bad loans under a variety of structures. With the economy submerged in the Covid deluge, the RBI is once again worried that despite the 6-month moratorium reprieve, NPAs could see a startling rise this year. Hence, calls for a bad bank have risen again.

The concept of a bad bank has been implemented with ranging success all over the globe over the past few de- cades; from the US, Sweden, Finland, Germany & France in the western world to Korea in Asia.

A Bad Bank is a Special Purpose Ve- hicle (SPV) serving as an ARC/AMC to whom banks would transfer their NPAs at net book value. The assets would then be handle by dedicated professionals having experience in dealing with bad asset management to resolve the NPA. They would then operate the asset for a limited period of time till it can be offloaded to a suit- able investor. This would allow banks

to focus on their primary business of lending without having to divert vi- tal resources towards NPAs. The bad bank concept would ideally be fund- ed by the government initially, with financial institutions and other inves- tors investing in due course.

The Benefits of a Bad Bank
  • Logical Conclusion to NPAs The fact that our banking sys- tem has such high NPAs goes to show that, for a myriad num- ber of reasons, we are unable to clean up this mess A professional approach through a Bad Bank could help reduce the stress on the financial system & unlock additional value from some of the assets that can be recovered eventually.
  • Internationally Proven As I have mentioned above, a number of countries have, over the past decades, successfully created Bad Banks to help banks stem the problem of growing NPAs. Such a track record goes to further allay any doubts about its efficacy.
  • Increased Credit Flow With banks transferring their NPAs to a Bad Bank, credit flow would increase considerably due to reduction in provisions for bad loans & also in the form of a percentage of recovered val- ue of the NPAs
The Disadvantages of a Bad Bank
  • Not a definitive solution Although a bad bank would ide- ally help resolve the problems of existing NPAs for banks, it can- not be seen as the go-to solu- tion The very need to establish a Bad Bank points to a deeper problem; tolerance & ac- ceptance by banks for such high NPAs. The financial eco-system needs a fundamental overhaul to ensure reduction in creation of NPAs in the first place.
  • Blatant dissociation Many, including ex RBI Gov- ernor Rajan, feel that a shift of such assets from banks to the Bad Bank is just shunting the asset from one pocket to anoth- er & is not a solution. Addition- ally, the presence of a Bad Bank could give such banks, who are already unable to gauge bad loans, even higher incentive to care less about the quality of the borrowers.
  • Structural Lacuna Without robust systems in terms of pricing mechanisms for pur- chase & subsequent sale of the NPAs, the Bad Bank would only end up as the garbage pile for financial institutions. Also, bu- reaucratic intervention could lead to major delays in deci- sion-making.
  • Financial Stability Concerns A Bad Bank requires immense capital to operate. With the econ- omy in shambles, new money would be required to shore the coffers. Due to the fears regard- ing government interference, this new money might not be easy to obtain. Foreign investors might be uncertain to invest where major political oversight is mandatory, bringing its own share of inflexibility.

In conclusion, a Bad Bank no longer seems like a possibility but an inevita- bility to deal with the bad loans float- ing around in our financial eco-system. That said, it cannot be the solution to our ever-goring pile of NPAs. That re- quires monumental changes in per- ception of banks & the government. Also, for a Bad Bank to work in In- dia, the powers that be must ensure an organisation that moves fast, with negligible red tape & professional de- cision-making. To sum it up I shall borrow a phrase from our Honorable Prime Minister – Minimum Govern- ment, Maximum Governance

 

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