‘Bad Bank’

The government has set up the new bad bank structure (NARCL-IDRCL) to acquire stressed assets from banks and then sell them in the market

Bad banks

A bad bank is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.

The bad bank is not involved in lending and taking deposits.

It just helps commercial banks clean up their balance sheets and resolve bad loans. The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently. US-based Mellon Bank created the first bad bank in 1988.

New bad bank structure:

• India’s first-ever bad bank, National Asset Reconstruction Company Limited (NARCL) will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks
• It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of Security Receipts.
• The rest will be paid when the assets are sold by IDRCL
• The other entity, India Debt Resolution Company Ltd (IDRCL), will then try to sell the stressed assets in the market
• To make it work, the government has granted the use of Rs 30,600 crore to be used as a guarantee.
• If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then this government guarantee of RS.30,600 crore will be invoked.

Need for bad banks

• According to RBI’s Financial Stability Report, the gross non-performing assets (GNPA) ratio of banks may rise to 9.8 per cent by March 2022 from the 7.48 per cent in March 2021
• Within the bank groups, public sector banks’ (PSBs’) GNPA ratio is 9.54 per cent in March 2021
• To improve the financial health of PSBs, the government was forced to recapitalise them using taxpayers’ money
• So bad banks are needed to relieve the commercial banks of their stressed assets.
• It also improves the bank’s position and help them resume their normal banking operations, especially lending.

NARCL-IDRCL functioning:

The NARCL will first purchase bad loans from banks. It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of government-guaranteed security receipts. When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest.

If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then the government guarantee will be invoked and the difference between what the commercial bank was supposed to get and what the bad bank was able to raise will be paid from the Rs 30,600 crore that has been provided by the government.

The value of bad loans being carved out of bank books for transfer to the NARCL is around Rs 2 lakh crore. About Rs 90,000 crore in bad loans will be transferred in the first phase. The guarantee of Rs 30,600 crore will cover the entire pool of Rs 2 lakh crore.

The government guarantee will be valid for a period of five years. To disincentivise delay in resolution, NARCL has to pay a guarantee fee which increases with the passage of time.