What is Bad Bank and How Government Will Tackle Increasing NPAs: Budget 2021?

What is Bad Bank and How Government Will Tackle Increasing NPAs Budget 2021 (1)
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Finance Minister Nirmala Sitharaman announces that the government will set up Asset Reconstruction Company (ARC) and Asset Management Company (AMC) to manage the stressed assets of Indian Banks. For recapitalization, the government will infuse Rs. 20,000 crore into PSBs (Public Sector Banks) to improve the credit growth that has been hit hard by the pandemic and lockdown in 2020.

Gita Gopinath, Chief Economist, IMF has also supported the Bad Bank idea implementation and will help in reviving the financial institution of the country.

“The Bad Bank is certainly a reasonable idea but right now I would encourage the banks and the NBFCs to raise capital given how easy the financial conditions are at this point,” Gopinath said while speaking to News18 in an interview.[1]

What is Bad Bank?

Bad banks are implemented in the time of crisis like Covid-19 pandemic when long-standing financial institutions are trying to recover the bad loans of the banks. A bad bank is set up to buy the bad loans of another financial institution. The asset management and reconstruction companies holding non-performing assets will sell these NPA holdings to the bank at the market price. The insolvent banks or banks which are holding NPAs can be liquidated, nationalized, or recapitalized through the bad bank.

Four Bad Bank Models Outlined by Mckinsey

  • Special Purpose Entity (SPE): The bank transfers the bad assets or NPAs to another entity i.e. backed by the government.
  • Internal Asset Restructuring: A bank creates a separate unit to manage and hold the bad assets.
  • Bad Bank Spinoff: The bank establishes a new and independent bank that will hold the bad assets, through this the original bank will isolate itself from the risk of bad loans and assets.
  • On balance sheet guarantee that bank uses to protect the bank’s portfolio against losses.

Asset Reconstruction Company

ARC is a specialized financial institution that buys the bad assets or NPAs from banks so that the bank can have clean balance sheets. Selling bad assets to the ARC help in saving time and money and avoid wasting time and effort in going after the defaulters to recover the loan. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the provision of reconstruction of assets without the intervention of courts.

Economist and Experts’ Opinion on Bad Banks

Leading economists believe that the bad bank could be a good idea for reducing the burden of NPAs from banks.

The Indian Banks Association (IBA) had also suggested to the RBI and Finance Ministry.

“Covid-19 impact is expected to exacerbate the non-performing assets problem, affecting the credit cycle. Facilitating multiple bad banks, by allowing alternative investment funds (AIFs) to buy bad loans.” suggested by Uday Kotak, CII Presidents.

“The government should privatize select Public Sector Banks (PSBs) and set up a bad bank to deal with non-performing assets and dilute the role of department of financial services.” suggested Raghuram Rajan, Former RBI Governor.



Written by Hardik Tokas

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