Concept of Bad Banks in India

 Introduction

India is introducing the idea of bad banks, which has been effective in nations like the USA. India recommended creating a public sector asset rehabilitation agency (PARA) as part of the 2017 economic report. It became more well-known as non-performing assets (NPAs) increased, particularly during the COVID-19 epidemic.

In this article, we’ll learn about the idea of bad banks, why India needs them, how they developed, their benefits, and their drawbacks.

Let’s start by defining non-performing assets.

When loan payments have not been made for 90 days, an asset is said to be a non-performing asset. Substandard, doubtful, and loss are three further categories that are separated from these.

The Idea of Bad Banks

The non-repayment of loans by both individual and corporate borrowers results in non-performing assets (NPAs). Loans, restructuring, utilizing and improving insolvency and resolution frameworks, and operationalizing bad banks are some of the policies used globally to deal with NPAs. Bad banks continue to be one of the successful approaches to do so systematically out of all the tried concepts by different governments.

The term Bad Bank is simply a financial organization established during a financial crunch with the goal of purchasing non-performing assets or bad loans or toxic assets of regular banks as a consequence of non-repayment of loans by individual and corporate borrowers. 

It is anticipated that taking on their bad assets at a price lower than the book value of their loans and managing them properly, will aid regular banks. Both on and off-balance sheet models can be used for NPA structuring.

Despite being named banks, they don’t operate like a typical banking system. If a bad bank is able to sell toxic assets or bad loans for more money than they cost to buy them from a bank, they will have made a profit from their operations. Profitability, however, is not a bad bank’s guiding principle.

Why India needs bad banks?

The consideration of the concept of a bad bank raises the question of whether one is required in India. Various steps have been implemented on a regular basis in our country to limit the detrimental impact of NPAs on profitability and financial stability. Despite the fact that various steps have already been put in place, the situation remains dire, which has been worsened by the start of COVID-19.

Development of bad banks

The notion of establishing bad banks in India was proposed in 2017 during an economic review of India, which suggested a public sector asset rehabilitation agency (PARA). The Indian Banking Association (IBA) proposed establishing a bad bank for the Reserve Bank of India (RBI) and the Government of India (GOI).

The IBA estimated that a bad bank would require Rs.10000 crores in capital, which would eventually be confirmed by the RBI and the GOI.

India’s Finance Minister announced in the budget 2021, the setting up of a bad bank to manage the toxic assets or bad loans of public sector banks. The bad bank will work as a two-in-one institution, Asset Management Company, and Asset Reconstruction Company.

Two-Tier Structure of Bad Banks

Advantages of Bad Banks

• Once non-performing assets are shifted to bad banks, regular banks may focus on core businesses that will continue longer.
• When non-performing assets are shifted from ordinary banks to bad banks, the external users benefit.
• This technique increases the rise of earnings while decreasing the demand for regular banks’ capital.
• When normal banks’ non-performing assets are transferred to a new venture or bad bank, the regular banks’ performing assets are less risky than previously.
• Bad banks have specific powers, such as accelerating loan recovery and disposing of non-performing assets.

Challenges on the path of Bad banks’ development

• The source of funding for the establishment of bad banks is the first and primary problem in their growth. Capital injection by the private sector alone will lead to capitalism, however, the government is already giving capital assistance to individual banks, so it is hesitant to infuse capital in bad banks.
• The capacity of bad banks to sell stressed or non-performing assets in the market is critical to their success.
• Because there is no securitization market in India to sell NPAs, bad banks simply become a warehouse for bad loans.
• It must confront the difficulty of building a sustainable and distinctive business model; and
• Its establishment may prompt banks and financial institutions to make impulsive choices and incur unnecessary risks.

Conclusion

Based on the success of the bad bank idea in European nations and the USA, we can infer that it is a one-time exercise that will aid in the reduction of non-performing assets. As a result, an in-depth study and systematic technique must be established in order to identify important contrasts in the approach of bad banks in India.

Banks would benefit greatly from the transfer of NPAs off their books, which will aid in credit expansion in the country. The successful application of the Bad banks’ idea will contribute to the restoration of customer trust in the banking industry. With the passage of the Insolvency and Bankruptcy Code in 2016 and the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act in 2002, it is pretty fascinating to learn how bad banks resolve bad loan settlements.