India Gets its ‘BAD BANK’

Paving the way for a major clean-up of bad loans in the banking system, the Cabinet cleared a ₹30,600-crore guarantee programme for securities to be issued by the newly incorporated ‘bad bank’ for taking over and resolving non-performing assets (NPAs) amounting to ₹2 lakh crore.

 

More Important Highlights:

  • The Reserve Bank of India is in the process of granting a licence for the National Asset Reconstruction Company Limited (NARCL), following which toxic assets worth ₹90,000 crore that banks have already fully provided for, will move to the NARCL.
  • The Cabinet’s decision to extend a five-year guarantee for NARCL-issued security receipts to banks completed the entire cycle of cleaning up India’s banking system that began with the recognition of the extent of bad loans in 2015.
  • Under the proposed mechanism, the NARCL will acquire assets by making an offer to the lead bank. Private sector asset reconstruction (ARCs) firms may also be allowed to outbid the NARCL. Separately, public and private lenders will combine forces to set up an India Debt Resolution Company (IDRC) that will manage these assets and try to raise their value for final resolution.
  • A 15% cash payment would be made to the banks based on some valuation and the rest will be given as security receipts. For those to hold on and have their value intact, there is a need for the government to give a back-stop arrangement and that is why this ₹30,600 crore has been cleared by the Cabinet.
  • The whole idea is to ensure that these assets for which this whole set-up is being created, and the value that is locked in the assets is realised and comes back to the banks; they use it as a growth capital and the banking system becomes more robust.
  • Public sector banks will have a 51% ownership in the NARCL, while their shareholding along with that of public sector financial institutions will be capped at 49% for the IDRC, with private lenders bringing in the rest of the equity capital.

  

What Is a Bad Bank?

  • A bad bank is a bank set up to buy the bad loans and other illiquid holdings of another financial institution. The entity holding significant nonperforming assets will sell these holdings to the bad bank at market price. By transferring such assets to the bad bank, the original institution may clear its balance sheet—although it will still be forced to take write-downs.
  • A bad bank structure may also assume the risky assets of a group of financial institutions, instead of a single bank.
  • Examples of bad banks include Grant Street National Bank. Bad banks were also considered during the financial crisis of 2008 as a way to shore up private institutions with high levels of problematic assets.