Bad bank ready, 15 cases adding up to Rs. 50000 cr to be shifted by March 31

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Last Updated29/01/2022

Government banks will hold majority in ARC; private banks will own 51% or more in debt resolution company
With just three days for Union Budget 2022-23, a proposal by Finance Minister Nirmala Sitharaman February 1 last year to set up a ‘bad bank’ has been cleared.
The proposed ‘bad bank’ has “now” received all necessary permissions including from the Reserve Bank of India.

A bad bank is a company that acts as an aggregator of bad loans or non-performing assets (NPAs) and buys them at a discount from banks all over the country, then attempts to recover and resolve them.
These loans are classified as non-performing and are either about to fail or have already done so. Bad loans have a detrimental influence on a bank's balance sheet.
The bad bank functions similarly to an Asset Reconstruction Company (ARC), in that it absorbs bank debts and manages them to recover as much money as possible.

Economic Upheavel: With the epidemic affecting the banking industry, the RBI is concerned about combating the economic downturn which could result in an increase in bad loans.
Role of Government: Professionally administered bad banks, supported by the government and funded by private lenders, can be an excellent tool for dealing with non-performing assets (NPA).
Rising NPAs: According to the RBI's latest Financial Stability Report, gross NPAs in the banking industry are predicted to rise to 13.5 percent of advances by September 2021, up from 7.5 percent in September 2020.
International Examples: Many other countries had put in place institutional mechanisms to deal with the financial system's stress.

The government of India has established two new firms to acquire stressed assets from banks and then sell them in the market in order to resolve large NPAs (Non-Performing Assets) in the Indian banking sector.
The NARCL-IDRCL structure is the new bad bank structure.

NARCL was established under the Companies Act and has applied for an Asset Reconstruction Company licence from the Reserve Bank of India (ARC).
In different phases, NARCL will buy stressed assets totaling roughly Rs 2 lakh crore from various commercial banks.
NARCL will be owned by public sector banks (PSBs) to the tune of 51 percent.

The stressed assets will subsequently be sold in the market by another firm, India Debt Resolution Company Ltd (IDRCL).
IDRCL will be owned to a maximum of 49 percent by PSBs and Public Financial Institutes (FIs).
Private-sector lenders will own the remaining 51 percent of the company.

The NARCL will buy bad loans from banks first.
It will pay 15% of the agreed price in cash and the rest 85% in "Security Receipts."
The commercial banks will be paid back the remainder when the assets are sold with the help of IDRCL.
The government guarantee will be activated if the bad bank is unable to sell the bad loan or has to sell it at a loss.

Mobilising Capital: Finding buyers for bad assets in a pandemic-affected economy will be difficult, especially when governments are grappling with the issue of fiscal deficit reduction.
Not Addressing the Underlying Issue: Shifting loans from one government pocket (public sector banks) to another.
Market determined Prices: Price discovery will not occur since the price at which bad assets are transferred from commercial banks to the bad bank will not be market-determined.
Moral Hazard: Former RBI Governor Raghuram Rajan stated that a bad bank might create a moral hazard, allowing banks to pursue risky lending practises without any commitment to eliminate nonperforming assets (NPAs).

So long as public sector bank managements are subservient to politicians and bureaucrats, they will continue to lack professionalism, and prudential lending standards will suffer.
As a result, while having a bad bank is a fine concept, the primary challenge is addressing the underlying structural problems in the banking sector and proposing appropriate adjustments.