The good idea of a ‘Bad Bank’

The good idea of setting a ‘Bad Bank’

In Budget 2021, the finance minister has announced to set up a bad bank, that will take over the existing stressed assets of the banks. The Asset Reconstruction Company (ARC) and the Asset Management Company (AMC) will be set up as bad banks to manage the bad debts of the banking companies.

NPA loans are the assets from which interest and principal are not recovered and are ‘past due’. In the last few years, banks have gradually increased the figures of stressed assets in their balance sheet. Corporate loans constitute a large portion of NPAs in the banking industry. Further, the state-owned banks have a high share of NPA loans in their books compared to that of the private banks. The banks have failed to provide loans in such hands, which are credible in channelising the borrowed funds in generating sufficient profit and eventually repay the loans. The piling up of NPA loans has affected the growth of the economy as well.

The idea of cleaning up banks’ sour debts by transferring them to the bad bank, will allow the banks and financial institutions to focus on their core business of lending. Once the bad loans are transferred to ARC and AMC, they will pool and manage the existing stressed debts. The bad loans will then be transferred to other potential investors at discounted value. A lot more depends on how the plan of the bad bank is executed. 

The changes may bring financial stability and reduce future requirements of capital in the banking sector. It will also enable restarting lending activities without fear. 

However, the banks should improve organisational processes to ensure funding for good credit proposals. The credit underwriting process must be improved simultaneously by defining proper approval stages for various kinds of loans. This will ensure disbursing loans to quality customers and reduce further chances of piling up the doubtful loans. 

For any clarifications/feedback on the topic, please contact the writer at namita.shah@cleartax.in