Banking Sector Reforms

It’s better to stop the creation of bad debt than set up a bad bank


From UPSC perspective, the following things are important :

Prelims level: Bad Bank

Mains level: Paper 3- Creation of Bad Bank is right idea at wrong time

The article argues that instead of creating the Bad Bank, several steps taken by the government and the bank regulator could deal with the problem of NPAs and also improve the performance of the banks.

Challenge of NPA: Is Bad Bank and answer to it?

  • Recently, RBI governor said that the RBI was open to considering setting up of a “bad bank”.
  • India’s economic growth, unless pandemic risks resurface, should be good enough to largely take care of its non-performing assets (NPAs) in the coming years.
  • It was the high economic and credit growth of the 2003-08 period that whittled down the NPA ratio.
  • The provision coverage ratio at banks had gone up from 42% in 2016 to 72.4% in September 2020, and that net NPAs were down to 2.8% in March 2020.
  • The bad loan legacy is almost done with.
  • Consequently, the bad bank is a right idea at the wrong time.

Steps the government and RBI should take

1) Resume the operation of IBC

  • The government should reinstate the operation of the Insolvency and Bankruptcy Code (IBC).
  • The code had improved the recovery rate from NPAs in the banking system.
  •  There is a need to create disincentives for deliberate delaying tactics, so that the original timeline of 270 days is honoured more in its observance than in breach.

2) Recapitalisation of banks

  • The government should provide more than adequate capital to the strong banks it owns, and adequate capital to the not-so-strong ones, with well-defined performance criteria for them to receive more.
  • If they don’t deliver, then the government should consolidate them or begin diluting its stake below 51% in such banks.

3) Level playing field improvement in compliance culture

  • The government should level the regulatory playing field between private-sector and government-owned banks.
  • The risk management and compliance culture in public-sector banks must improve.
  • However,  public sector banks should not be subject to excessive oversight by government investigative and audit agencies.

4) Plug the sources of NPAs through policy changes

  • More than these, there are two other important things that constitute the fountainheads of NPAs.
  • The government should evolve a framework for passing on explicit development goals of the state for banks to achieve through the credit mechanism.
  • The government should provide for them in the budget and compensate banks rather than direct credit by diktat.
  • The cost of directed lending is not just the creation of NPAs, but morale and market-value erosion as well.
  • In any case, recapitalization needs mean that the fiscal costs are not avoided. It is self-defeating.
  • Then, governments (Union and states) should plug the other underlying sources of NPAs.
  • Among things, they should ensure economic pricing of utilities, honour power purchase contracts and raw material purchase agreements, pay arrears to private counterparties, and stop being reflexive litigants.

Consider the question ” What is the Bad Bank? Do you agree with the view that India needs Bad Bank?”


The above measures would greatly help the country achieve high growth and sustain it. Setting up a bad bank may be unnecessary.

Back2Basics: Provisioning Coverage Ratio (PCR)

  • Banks usually set aside a portion of their profits as a provision against bad loans.
  • Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning to gross non-performing assets (NPA) and indicates the extent of funds a bank has kept aside to cover loan losses.
  • A high PCR ratio (ideally above 70%) means most asset quality issues have been taken care of and the bank is not vulnerable.

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