Context: Former RBI Governor Raghuram Rajan suggested that the government should privatise select public sector banks, set up a bad bank to deal with NPAs and dilute the Department of Financial Services’ role.
What is a ‘bad bank’?
- The concept of ‘bad bank’ was first mooted by Chief Economic Adviser Arvind Subramanian in January 2017.
- No, it is not a wicked or a corrupt bank or any of those things. A bad bank is termed so simply because it houses bad loans, or in financial parlance – non-performing assets (NPAs).
- It is basically a Public Sector Asset Rehabilitation Agency that would take on public sector banks’ chronic bad loans and focus on their resolution and the extraction of any residual value from the underlying asset.
- This would allow government-owned banks to focus on their core operations of providing credit for fresh investments and economic activity.
- Unlike a private asset reconstruction company, a government-owned bad bank would be more likely to purchase loans that have no salvage value from public sector banks. It would thus work as an indirect bailout of these banks by the government.
- The CEA had proposed a significant part of the bad bank funding to come from the Reserve Bank of India.
How will it help the NPA problem?
- Hiving off stressed loan accounts to a bad bank would free public sector bank balance sheets from their deleterious impact and improve their financial position.
- As the quality of a bank’s assets deteriorates, its capital position (assets minus liabilities) is weakened, increasing the chances of insolvency.
- Some analysts believe that many public sector banks are effectively insolvent due to their poor asset quality. As a result, banks have turned risk-averse and hesitate to provide loans.
- (As a result, no new institution/company/organization- no new jobs – no increase in GDP)
- If managed well, a bad bank can clean up bank balance sheets and get them to start lending again to businesses.
- However, it will not address the more serious corporate governance issues plaguing public sector banks that led to the NPA problem in the first place.
- The bad bank model was first proposed in the 1980s in the U.S.
- Subsequently, Sweden, Finland, France, Germany, Indonesia, and several other countries implemented the idea.
- On paper the idea is simple, but its implementation is more complicated — perhaps the reason why this idea has only been toyed with and not actually implement by policymakers in India.
- There are both pros and cons to this idea. Those in favour of the idea have argued that aside from cleaning up the banks’ balance sheets and making them financially healthy, separation of good and bad assets allows the bank to focus on its core activity of lending, and leaves the resolution to experts.
- Aside from this, a government-led initiative may perhaps make it more palatable or even attractive an opportunity for investors to invest their money- both domestic and foreign.
- One of the key challenges with such a bad bank is also capital, which has been tough to mobilise in the past.
- Those against the idea argue that a one-size-fits-all approach towards resolution via this bank may not be feasible.