Bad Bank Concept and History
In May 2020, the Indian Banks Association (IBA) had suggested: "Financial Minister" and "RBI" to set up a BAD BANK.
How does BAD BANK work?
Before we explain how it works, we need to understand the term Non-Performing Assets (NPA). NPA means the Assets which stop giving a return on investment. NPA can be understood more clearly with an explain
Explain: XYZ Bank has given a loan to ABC PVT LTD COMPANY of Rs 1,00,000 and tells them to pay ten equal installments of Rs 10,000 each. After four installments, ABC COMPANY fails to pay the remaining six installments. The remaining 60,000Rs will be treating as Non-Performing Assets (NPA).
Bad banks purchase Non-Performing Assets (NPA) from banks, financial institutions, and other financial bodies at a discount rate and recover them from Companies.
History of Bad Bank
Bad Bank is not a new concept that has been used since 1988. The first bank to used Bad Bank is Mellon Bank which created an entity in 1988 to hold $ 1.4 billion of a bad loan.
Also, the financial crisis of 2007-2010 leads to the creation of a bad bank. For example, a bad bank was suggested as part of the Emergency Economic Stabilization Act of 2008 to help address the subprime mortgage crisis in the US. In the Republic of Ireland, a bad bank, the National Asset Management Agency was established in 2009, in response to the financial crisis in that country. You can check more detail on Wikipedia.
Why such an idea introduced now?
As per RBI Financial Stability Report that gross non-performing assets (NPAs) on bank balance sheets could rise from 7.5 percent in September 2020 to 13.5 percent in September 2021 in the baseline scenario. In a medium stress scenario, RBI projects that Gross NPAs of all banks may rise from 7.5 percent as of September 2020 to 14.1 percent by September 2021. If the macroeconomic environment worsens even more, then gross NPAs of banks may rise to at least a two-decade high of 14.8 percent by September 2021 under the severe stress scenario.
RBI Financial Stability Report clearly shows that's banks and financial institutions are unable to manage NPAs efficiently.
There is no single law in India to deal with Insolvency and bankruptcy provisions and they were dealt with under the Sick Industrial Companies (Special Provisions) Act, 1985 (since repealed in 2016), The Recovery of Debts and Bankruptcy Act 1993 (RDB Act), The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and Companies Act, 2013 which were not effective and efficacious.
Hence, it was considered to be inadequate, and to have an effective and adequate framework for insolvency and bankruptcy, the Central Government enacted the Insolvency and Bankruptcy Code, 2016 (IBC) to facilitate effective implementation of the Code to resolve problems and issues and recovery of non-performance assets
Bad bank pros and cons
Some expert believes that a bad bank can free capital that is locked in banks which will help banks to focus on core activities.
NPAs are clear from Banks Balance-sheet.
Bad banks can make profits as they usually keep a high margin before acquiring bad loans.
Speed of recovery will be more.
Moving a loan from one pocket to another pocket may not work.
Other banks may not concentrate on the quality of loans.
Due to pressure, bad banks may employ some unethical ways to recover loans.
Other banks may not show the actual position of loan accounts by doing window dressing.
Bad Bank in Union Budget
Finance Minister Nirmala Sitharaman has announced New 'bad bank' and Rs 20,000 crore recapitalization plan for lenders. Check out the announcement ↓