Challenges Associated with Bad Banks
- Changing the issue: A bad bank is anticipated to assume the obligations of the commercial banks that it is owed. It’s unclear, though, how much it will help to resolve the NPA crisis. This is due to the fact that the current commercial banks have tried practically all of the viable treatments. Therefore, it is only reasonable to anticipate that the bad bank will add to the issue rather than alleviate it.
- Losses incurred by banks: Similar to the previous argument, the banks’ haircuts would impact their profit and loss account and profitability. This could cast doubt on the bank’s management and the choices it made in the past and now about haircuts.
- Concern over unethical behavior: Employees at the bad bank might use unethical methods to increase the recovery on a bad loan because they would be under pressure to succeed. As there have been complaints of consumers of banks who were unable to pay their dues being harassed, this issue has persisted in the past.
- Not addressing the root problem: If governance reforms are not made, the public sector banks, which accounted for 86% of the total NPAs, may continue operating as they have in the past and wind up piling up bad debts once more. Additionally, the bad bank concept is equivalent to transferring debts from one government pocket (the public sector banks) to another (the bad bank).
Bad Bank
A company that deals in risky and illiquid assets are known as a bad bank. These assets are owned by banks, financial institutions, or a group of banks. It was set up to assist banks to remove troublesome debts from their balance sheets. It enables them to focus on their main tasks, which include receiving deposits and extending credit. Depositors typically do not lose money from this arrangement, but stockholders and bondholders typically do. The process can result in the insolvency of banks, which can then be liquidated, nationalized, or recapitalized.
India’s bad bank would be known as National Asset Reconstruction Ltd. (NARCL). This NARC will function as a firm that reconstructs assets. It will purchase defaulted loans from banks, relieving them of their Non Performing assets (NPA) obligations. After that, NARC will try to sell the stressed loans to companies that buy distressed debt. India Debt Resolution Company Ltd. (IDRCL) will make an effort to advertise and sell them. After the stressed asset is sold, the involved bank will receive partial payment. The government guarantee will be used if the bad bank in India is unable to sell the stressed loan for a profit or at all. It’s significant to note that the government has made a guarantee available for this purpose in the amount of Rs 36,000 crores. If a bad bank is able to sell a loan for more than it paid for it when it bought it from a commercial bank, it will turn a profit from its activities. The main goal of a bad bank is typically not to make money; instead, it is to relieve banks of the burden of holding a significant amount of stressed assets and encourage them to lend more aggressively.