Finance Minister Nirmala Sitharaman’s budget announcement instilled instant market confidence as she announced the proposal to set up ‘Bad Bank’ that will directly improve credit flow. Indian banks are plagued with nearly 7.5% bad loans, which consumes extra resources, paperwork, and time for recovery. These ‘bad loans’ are often termed as Non-Performing Assets (NPAs), which signifies that the asset is not generating income for the bank.
In layman terms, the task of a bad bank is to purchase NPAs from the bank and work towards its resolution over a period of time. By this, bad banks increase transparency quotient in balance sheets of main banks and help to manage and strip the assets for sale to potential investors such as Alternative Investment Funds (AIFs).
That said, the idea of a bad bank isn’t new. In 2004, the government helped IDBI Ltd by setting up a Stressed Asset Stabilization Fund (SASF) that specifically dealt with bad loans on behalf of the bank. Again, in 2018, Sunil Mehta, then Non-Executive Chairman of Punjab National Bank, advised establishing a stress management company with a dedicated AIF for asset sale.
Internationally, the bad bank concept became commercial after the success of Malaysia’s Danaharta that continues handling NPAs for banks for two decades.
While most economic and financial experts (including Raghuram Rajan) agree to the bad bank setup, there are a few repercussions to the process. During the sale of NPA to a bad bank, the owner bank has to sell it at a discounted price. The balance amount is deducted from the main bank’s pocket.
KV Subramanian, Chief Economic Advisor, said that the banks have failed to sell bad loans to the pre-existing Asset Reconstruction Companies (ARCs) and introduction of bad bank might not prove fruitful.