The bad loan problem is bigger in India.
What Happened?
We all know that India has a huge problem with non-performing assets (NPAs) and the problem being the continued rise of NPAs in banks. For the past years, the government has been infusing a lot of capital in public sector banks (PSBs) to help them come out of this problem.
Meanwhile, sources told newspapers that the Indian Banks Association is reconsidering the option of bringing back the bad bank concept to settle the existing legacy of stressed assets, writes, Livemint. Banks are looking at the possibility of transferring loans under restructuring or those undergoing resolution in the National Company Law Tribunal (NCLT) to the bad bank.
But What Is A Bad Bank?
It might sound like a bank that is really bad at being a bank but it is actually not. A bad bank is a bank which will buy out all toxic loans from banks. This will help the other banks get on with their business while the bad bank will focus on recovering the loans or releasing cash from selling the underlying assets.
In 2018, Interim Finance Minister Piyush Goyal said that the government has established Project Sashakt to consider the possibility of forming a bad bank. So, India has dabbled into the concept of creating a bad bank before as well.
Advantages Of Having A Bad Bank
Asset monetisation. Once banks have transferred all of their bad loans to the bad bank (which is basically like Marie Kondo-ing their balance sheet), banks can prevent the assets from mixing together.
Once the bad loans are out of the picture, one can see the actual financial health of the bank, which will help the lender in raising capital, borrow and lend money to other companies.
Were They Any Bad Banks Before This One?
YES! The bad bank model was first proposed in the 1980s. U.S-based Mellon Bank set up a bad bank in 1988 to hold its toxic assets by spinning off its own capital and five of its own board members into the Grant Street National bank.
So, Grand Street National Bank is the bad bank here and it did not take deposits from the public like normal banks do and it wasn’t a member of the Federal Reserve System. Once the bank served its purpose of resolving or liquidating bad debt to recover as much money as it can, it was eventually liquidated a few years down the line.
Following in the footsteps of the US, Sweden, Finland, France, Germany, Indonesia and many other countries also deployed the same idea.
Challenges With A Bad Bank
It is very complicated to bring this to life. A McKinsey & Company report, says that a banking institution has to keep in mind its choices of assets to be transferred into the risky category, business case, portfolio strategy, and the operating model. The report added that each of these choices must be made while considering the impact on funding, capital relief, cost, feasibility, profits, and timing.
In conclusion, the rising NPAs are a problem and we can’t ignore it any longer. With the cash drying up from the system and the economy slowing down due to the pandemic, the government has to come up with a solution to deal with this crisis as soon as possible.
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