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From UPSC perspective, the following things are important :

Prelims level: Bad bank

Mains level: Paper 3- Advantages of bad bank

The article explains the important role bad bank can play in cleaning up the balance sheets of the banks.

Indian banks were written off in the early days of the pandemic due to expectations of an exponential jump in non-performing assets.
Only after the banks consistently talked about the lower number of restructuring requests, and the higher provision coverage ratios that the markets began to get convinced.
What finally turned the corner were the budget announcements related to the financial sector
There are several reasons for this good performance by the banks.
First, banks in India and globally were much better capitalised prior to the pandemic.
Second, Indian banks had built up a sizeable buffer to provide for bad assets negating any surprise on balance sheets during and even after the pandemic.
Third, independent research shows that as the size of the middle class grows to about two-thirds of Asian households.
Banks in Asia, including in India, have begun to adjust for this steady growth in the size of pie by experimenting with new business models, rationalising costs and providing faster and superior customer digital experience, as was clear during pandemic.
Fourth, Indian banks and the RBI brought about financial discipline much before the pandemic.

The budget this year has the provision for reation of a bad bank.
The proposed structure envisages setting up of a National Asset Reconstruction Company (NARC) to acquire stressed assets in an aggregated manner from lenders, which will be resolved by the National Asset Management Company (NAMC).
A skilled and professional set-up dedicated for Stressed Asset Resolution will be ably supported by attracting institutional funding in stressed assets through strategic investors, AIFs, special situation funds, stressed asset funds, etc for participation in the resolution process.
The net effect of this approach would be to build an open architecture and a vibrant market for stressed assets.

Banks may first transfer those assets to the proposed bad bank with a 100 per cent provision on its book and then based on the experience they will decide on transferring assets with less than 100 per cent provisioning at a later date.
It is also being speculated that of the total amounts recovered, a specified percentage will be in the form of security receipts.
These receipts will reside in the bank balance sheets, but will carry a zero-risk weight, with full government guarantees for a specified period of time.

The benefits of this process includes the recovered value, and significant lending leverage because of three factors:
One, capital being freed up from less than fully provisioned bad assets.
Two, capital freed up from security receipts because of a sovereign guarantee.
Three, cash receipts that come back to the banks and can be leveraged for lending, also freeing up provisions from the balance sheet.
There are several international success stories of a bad bank accomplishing its mission and there is no reason to believe why India cannot accomplish its objective.
The current Indian approach will drive consolidation of stressed assets under the AMC for better and faster decision making.
This will free up management bandwidth of banks enabling them to focus on credit growth, leading to an enhancement in their valuations.
Governance of the AMC and its independence is central to its successful functioning, there are multiple suggestions to make.
These include keeping majority ownership in the private sector, putting together a strong and independent board, a professional team, and linking AMC compensation to returns delivered to investors.

Consider the question “What is a bad bank? How its creation could help the banking sector?”

The creation of a bad bank will help the banking sector contribute more in the growth of the country

Bad bank is good move

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