NARCL that i.e. NATIONAL ASSET RECONSTRUCTION COMPANY LTD will be India’s first bad bank which will buy out Rs 2 lakh crores bad debt from the banks.
These will be of the high value of NPAs of more than Rs 500 crores. NARCL will give 15% cash for these assets, which are to be paid to banks; for the rest, the NARCL will issue securitization receipts.
About the idea
Almost around 7 months earlier, the finance minister of India, Mrs. Nirmala Sitharaman, in her budget speech reviewed the idea of establishing a bad bank which the center proposes to set up an asset reconstruction company that will acquire bad loans from banks, and this is how the govt is goona deal with the problem of bad loans or NPAs.
NPA, which is non-performing assets, has always been a problem for commercial banks, especially private banks. On top of that, covid 19 has triggered it further as more NPAs have been reported since the arrival of the covid. The concept of a bad bank is to consolidate all the NPAs under one roof and then start the process of revival or recovery.
Now to understand the bad bank concept, it is very important to understand what NPA or bad loan is.
What is NPA?
NPA or non-performing assets are loans or advances that are at default, which means if the customer is not able to repay the principal amount and the interest thereon. Then such loans are categorized as NPA or bad loans within 180 days.
The concept of bad bank
A bad bank is a type of financial entity set up to buy such NPA or bad loans from the bank. Now here is what one needs to understand; the aim behind setting bad banks is to ease the burden on banks by taking the bad loans from the bank, so that the balance sheets of such commercial banks will look more impressive and less risky.
Earlier, banks used to show bad loans to write it off from their balance sheet or show them as abnormal losses which the bank had suffered in a particular financial year, but with time, NPAs started increasing, and now it has become a major problem. Writing off them from the balance sheet is not a solution as it will go against the accounting principle of full discloser, and at the same time, harm the interest of the customers as well.
What do these bad banks do with bad loans?
After purchasing the NPAs or bad loans, these bad banks may reconstruct or sell these NPAs to the interested investors. Whosoever will buy this NPA will pay a certain amount to these bad banks and that will be its profit out of it. Further, these bad banks will try to reinvest these NPAs in some markets. Since the team in such bad banks will be the experts in the finance sector, it would not be wrong to say that some part of NPA could be recovered at least.
Why there is a need for a bad bank?
If we go by the general definition of a bank, the main working of the bank is to collect deposits and lend money to the customers but over some time, the problem of NPAs scams, default in loans, etc. banks are busier in solving problems of financial crisis and recovery of NPAs.
This diverts the bank from its main function in the fund flow system of the economy.
Here, a big question arises – can bad banks solve the problem of NPA?
According to RBI, the total size of bad loans in the balance sheet of Indian banks was around 9 lakh crores on March 31st, 2020. There has been a reduction in the number of NPAs but it is not because they were recovered by the bank. The major portion has been written off due to slowdown or no recovery of bad loans to present a pleasant balance sheet and stop the reduction of capital. Incase these sink, The government tries to revive units of financial sectors majorly through the tax payer’s hard earned money.
Impact of the bad bank on the financial sector
Former governor Mr. Raghuram Rajan argued that bad banks backed by the government would merely shift bad assets with little success rates. The actual problem of how to recover the bad loans will remain as it is. So what’s the point of this concept where just a shift in the liability of some entity happens?
Financial institutions or commercial banks will benefit from this concept as they can focus on their core problems of functioning rather than the recovery process, which is itself a complex and technical task to be done.
With the government’s aim of privatizing and disinvestment policy, the losses are majorly transferred to private companies. They handle everything right from the operational level to the executory level till the working environment. There has always been an extra burden on these companies to perform well.
The people are at a loss. When a sink unit is officially declared, the revival process is very difficult as well as complex. Also somewhere, the process needs financing, which is nothing but the hard-earned money of the taxpayers; whether it is adding additional capital in the capital structure of a sink unit or introducing revival packages, the taxpayer’s money is the main source.
One good thing with the introduction of a bad bank is it will increase the credit flow in the economy. The bad bank can release the pressure on the capital of the bank as there will be less write off and the lending process can be increased to the customer.
The success rate of the bad bank depends upon its recovery process of bad loans; otherwise it is just a transfer of liability from one entity to another, because solving the problem of bad loans is something very challenging and full of complexities.