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What are the arguments for and against a bad bank?

  • Posted By
    10Pointer
  • Categories
    Economy
  • Published
    20th Jan, 2021

Context

  • As the problem of non-performing assets persists in a sector stressed by the pandemic, the RBI Governor has agreed to look at a proposal for creating a bad bank.

What is the concept of ‘bad bank’?

  • A bad bank will function as a bank but has bad assets to start with.
  • ARC: Technically, a bad bank 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.
  • Balance sheet cleaning:The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
  • Recovery of 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.

Do we need a bad bank?

  • Dismal performance of ARCs:ARCs have not made any impact in resolving bad loans due to many procedural issues.
  • COVID- 19:Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium it has announced to tackle the economic slowdown.
  • High rate of NPAs: The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector are expected to shoot up to 13.5% of advances by September 2021.

Assessing the impacts

Pros

  • The major benefit of forming a bad bank is asset monetisation.
  • Bad assets would stay in the 'risky' category, while the good one stays in the other category, saving them from mixing together.
  • The real benefit for a bank comes when its investors are sure of its financial health, which helps it in the long run in raising capital, borrow, and lend money to other companies.

Cons

  • Shifting of loan: It is considered as mere a shifting of loans from one government pocket (the public sector banks) to another (the bad bank).
  • Lack of functioning guidelines: It did not see how it would improve matters.

Global practice of bad bank

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