Bad Bank, good idea?

It is reported that the former RBI Governor D Subbarao made a strong case for setting up a bad bank saying it is not just necessary but unavoidable in the present circumstances when NPAs are likely to balloon and much of the resolution will have to take place outside the IBC framework. He has also advocated something similar to the Malaysia model. It seems that he was not sure whether the funds for the proposed bank has to come from private sector or public sector banks or the government.

It was earlier reported that the Indian Banks’ Association had also mooted the idea of a Bad Bank, received comments from member banks and firmed up a proposal.

By IBA’s estimates, the Bad Bank would require approximately ₹10,000 crore of capital initially, which it proposes to be fully provided by the government. There seems to be proposals of three stages of resolution including an Asset Reconstruction Company, Asset Management Company and an Alternate Investment Fund. The Bad Bank is proposed for resolution of stressed assets of both public and private banks.

Over the years, many measures had been suggested to contain the problem of NPA of banks. Often it is discussed as if the NPA problem has arisen due to poor appraisal by banks or inefficiency of banks. But the problem mostly lies outside the banking industry and the perennial problem of NPA of banks has not been contained.

None of the proposed solutions has become successful, as no solution has forced the borrowers to pay back bank dues and all directions were touching the problem only at peripheral level and year after year stressed assets of banks are galloping.

If an NPA has to become a performing asset for the bank, there should be actual recovery and not some cosmetic adjustment. Instead of ‘recovery’ of stressed assets, all the efforts are made for ‘resolution’ of stressed assets. In no way the proposed bad bank can make the banks recover the amount.

Bad bank is a bad idea: In no way Bad Bank is better than the existing Asset Reconstruction Companies except that there can be some Alternate Investment Fund and the bad bank may securitise the receivables through it. Transferring NPAs from banks to Bad Bank will not remove it from the financial system, though it may not be in the balance sheet of banks. This is not removal of NPAs but only transfer of NPAs, which is labeled as Resolution.

Bad Bank with capital from banks: There is another suggestion in circulation to have a Bad Bank with capital contribution by various banks. When such an idea is executed, first funds will have to move from Banks to the proposed Bad Bank and when the bad debts are transferred to the Bad Bank, funds will move back from Bad Bank. This does not make any sense at all.

Bad bank cannot recover: When the financing bank, which knows the customer very well, cannot recover the dues, how can the new Bad Bank be better equipped to recover?

Resolution based on reason: NPAs arise mainly due to business failure or by willful default. There may be a number reasons for business failure. When the business unit fails, there may not be cash generation to service the debt and the borrowers expect the banks to sacrifice a part or full of the debt. If it is genuine business failure, the banks should expeditiously approve the heir cut to avoid further deterioration of assets. If there is a willful default, criminality should be established and for this we need a faster judicial system.

We do not have any effective judicial machinery to tackle the problem of willful default or diversion of funds.

The proposed Bad Bank cannot arrest sanction of loans, which may become NPAs in future. In fact it may encourage banks to reckless lending as NPAs can be transferred to Bad Bank. It cannot enable recovery of the loan in time or enhanced recovery. On the whole there cannot be any value addition. It may only help banks to camouflage the real position.

The government must put down the proposal.

The writer is a retired banker

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