Recently, the Finance Ministry said that the National Asset Reconstruction Company Ltd. (NARCL), set up to take over large bad loans of more than 500 crore from banks, will pick up the first set of such non-performing assets (NPAs) in July.
- It is a special purpose asset reconstruction company for taking over the large value NPA accounts (above 500 crore) from banks.
- Its formation was announced in the Union Budget for 2021-22, is intended to resolve stressed loans amounting to about 2 lakh crore, of which fully provisioned assets of about 90,000 crore are expected to be transferred to it from lenders in the first phase.
Need for a bad bank:
- A bad bank can take over the bad loans of the bank, thereby freeing up the bank from the provisioning requirements. This means since the banks are not required to provision for the bad loans, the same money can be utilised for lending purposes.
- A bad bank would be specialised in maximising the recovery out of a bad loan, as this would be its primary task. In contrast, banks are not in the business of recovery; therefore, their capability to resolve the loans is minimal.
- Reports have pointed to a potential increase in stressed assets due to economic slowdown in India. Combined with the COVID-induced lockdown, this may create a situation in which the NPAs might increase to an unsustainable limit.
- Industry needs to come out of the crisis it is facing if India is serious about its stated goal of a $5 trillion economy. This requires a bullish sentiment in the economy. A bad bank can provide such an impetus to the industry by freeing up the books of banks.
- With the formation of a bad bank, it is expected that this amount can be utilised elsewhere, including towards public welfare and infrastructure creation.
- It can help consolidate all bad loans of banks under a single exclusive entity. The idea of a bad bank has been tried out in countries such as the U.S., Germany, Japan and others in the past.
- Shifting the problem: A bad bank is expected to take over the debts of commercial banks under it. However, to what extent it will be successful in resolving the NPA crisis is not clear.
- Since there would be pressure on the bad bank to perform, it is possible that the employees might turn towards unethical practices to boost recovery out of a bad loan. This has been a continuing problem earlier as there have been reports of harassment of the banks’ clients, who were unable to pay their dues.
- Without governance reforms, the Public sector banks (accounted for 86%, of the total NPAs) may go on doing business the way they have been doing in the past and may end up piling-up of bad debts again.
- The price at which bad assets are transferred from commercial banks to the bad bank will not be market-determined and price discovery will not happen.
- So long as Public Sector Banks’ managements remain beholden to politicians and bureaucrats, their deficit in professionalism will remain and subsequently, prudential norms in lending will continue to suffer.
- Therefore, a bad bank is a good idea, but the main challenge lies with tackling the underlying structural problems in the banking system and announcing reforms accordingly.
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