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what is a bad bank?

what is a bad bank?

 high debt has been a concern for Indian banks for years. finance ministry has finally come up with a solution.
July 4, 2021
3 min read
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what is a bad bank?

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what is a bad bank?

it is hard to get debt. so hard, in fact, that most small businesses get rejected on their first attempt. there are no complex reasons for this. it isn’t about business models or cash flow problems. it is just that banks are sitting on a mountain of debt and don’t have any risk appetite left. 

you must have heard of non-performing assets (NPAs). it’s been part of the common parlance for 14 years. NPAs are loans where the customer has defaulted on loan payments for over 90 days. as of March 31, 2021, the total bad loans of the banks stood at a whopping ₹8.53 lakh crore. so, India has a big NPA problem. 

now, the finance ministry is setting up a National Asset Reconstruction Company (NARCL) that will take over bank NPAs worth about  ₹2 lakh crore.

NARCL is a mouthful. it is also difficult to explain, which is why it is called a bad bank. a bad bank is a company that takes over problematic loans of banks. so, it actually is a good bank. 

bad bank: the saviour

banks will sell their bad loans — ₹90,000 crore initially — to NARCL for 15% cash up front and the rest in government-backed receipts. these receipts are a written promise by the government that the final settlement will be paid on time. 

the government has set aside a  ₹30,600 crore guarantee fund for this. the guarantee will stay for five years, by when the assets would need to be sold. 

India Debt Resolution Company (IDR), bad bank’s sister entity, will handle the sales part of the loans. it will find investors for the asset, sell it, and hand over the settlement to NARCL. 

after this hand off of sorts is complete, banks will be free of their NPAs and will have a risk appetite once again. this will mean more credit to small businesses and more money in the market. which in turn will mean more jobs, more spending, and a vibrant economy. 

why do we need a bad bank?

when banks give loans to clients, it is on the promise that the money will be paid back with interest in a certain number of years. but not everyone keeps the promise. in cases where there is an inordinate delay and the client is unable to repay, the loans are written off. 

in the second quarter of FY22, these assets forced banks to keep 60% of their operating profits as provisions. this left bankers with little money and time to improve their core business. 

according to a report, banks have written off loans worth ₹10.83 lakh crore in the last eight years. just between January and March 2021, bad loan writeoff was ₹70,000 crore.  

if you think about this carefully, in a larger sense, bad banks don’t really alleviate India’s NPA problem, but they do consolidate some of those debts. that frees up capital for business.