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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?”

Conclusion

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.

The idea of setting up a bad bank to resolve the growing problem of non-performing assets (NPAs), or loans on which borrowers have defaulted, is back on the table.

Q.What is Bad Bank? Discuss how it is different from an Asset Reconstruction Company (ARC)?

Why in news?

• Commercial banks are set to witness a spike in NPAs, or bad loans, in the wake of the contraction in the economy as a result of the pandemic.
• Hence the RBI recently agreed to look at the proposal for the creation of a bad bank.
• This is in the response to a six-month moratorium it has announced to tackle the economic slowdown.

What is a Bad Bank?

• A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
• Technically, it is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
• Such bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
• The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

Global examples of Bad Bank

• US-based BNY Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
• However, resolution agencies or ARCs set up as banks, which originate or guarantee to lend, have ended up turning into reckless lenders in some countries.

Do we need a bad bank?

• The idea gained currency during Rajan’s tenure as RBI Governor.
• The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet.
• However, the idea remained on paper amid lack of consensus on the efficacy of such an institution.
• ARCs have not made any impact in resolving bad loans due to many procedural issues.

What is the stand of the RBI and government?

• While the RBI did not show much enthusiasm about a bad bank all these years, there are signs that it can look at the idea now.
• Experts, however, argue that it would be better to limit the objective of these asset management companies to the orderly resolution of stressed assets, followed by a graceful exit.

Key suggestions

Former RBI Dy. Governor Acharya suggested two models to solve the problem of stressed assets.

1. The first is a private asset management company (PAMC), which is said to be suitable for stressed sectors where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness.
2. The second model is the National Asset Management Company (NAMC), which would be necessary for sectors where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short to medium terms.

Good about the bad banks

• The problem of NPAs continues in the banking sector, especially among the weaker banks.
• The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
• The presence of the government is seen as a means to speed up the clean-up process.
• Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

Pandemic and the NPAs

• Bad loans in the system are expected to balloon in the wake of contraction in the economy and the problems being faced by many sectors.
• The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector is expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020.
• The report warned that if the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%.