The Indian Banks’ Association (IBA) has begun identifying bad loans which can be transferred to the Centre’s proposed bad bank.
- The IBA has written to banks asking them for a list of all bad loans worth Rs 500 crore and above to “identify magnitude of the problem” and “get clarity over initial capital required for the entity”.
- Finance Minister Nirmala Sitharaman had proposed setting up of a bad bank during her Union Budget 2021 speech on February 1. She said the proposed entity would take over stressed loans from banks to sell to alternative investment funds (AIF).
- Formed on 26 September 1946 as a representative body of management of banking in India operating in India – an association of Indian banks and financial institutions based in Mumbai.
- With an initial membership representing 22 banks in India in 1946,
- IBA currently represents 249 banking companies operating in India.
- IBA was formed for development, coordination and strengthening of Indian banking, and assist the member banks in various ways including implementation of new systems and adoption of standards among the members.
- Indian Banks’ Association is managed by a managing committee, and the current managing committee consists of one chairman, 3 deputy chairmen, 1 honorary secretary and 26 members.
Bad Bank – Origin of Concept
The concept of a bad bank was pioneered at the Pittsburgh-headquartered Mellon Bank in 1988. Bad Bank would set up as a separate entity that would buy the Non-Performing Asset from other banks to free up their books for fresh lending. It is focused on the task of recovery.
How Does ‘Bad Bank’ Work?
- Banks will be able to demarcate their assets into good assets and toxic or bad assets.
- Good assets are ones in which loans are repaid as per schedule, and defaulted ones are classified as toxic assets or bad assets.
- Toxic assets can be removed from Banks books and transferred to Bad Bank which has the sole purpose of aiding the recovery of risky assets.
- Hence the banks will clean up and reduce their exposure to risky assets.
- Bad Bank will absorb all the toxic assets of banks at a price below the book value of these loans.
What is the Need for a Bad Bank?
Investors would see large NPA’s as a sign of Banks ill-health or financial weakness. If the NPA’s are high, then the Bank loses its ability to borrow, lend or conduct business.
Bad Bank Structure – IBA Proposal
The ‘Bad Bank’ will be a 2 tiered structure.
- There will be an Asset Reconstruction Company (ARC) backed by the Government which would buy bad loans from banks and issue Security Receipts to the Banks.
- As per RBI guidelines, ARC will hold Security Receipts of 15%.
- Banks will get 15% of the cash and will hold 85% of Security Receipts. Hence it is called 15:85 structure.
- There will be an Asset Management Company (AMC).
- AMC would be run by public and private bodies which includes banks as well.
- Turnaround professionals.
Why be concerned about bad loans?
- Indian banks’ pile of bad loans is a huge drag on the economy.
- It’s a drain on banks’ profits. Because profits are eroded, public sector banks (PSBs), where the bulk of the bad loans reside, cannot raise enough capital to fund credit growth.
- Lack of credit growth, in turn, comes in the way of the economy’s return to an 8% growth trajectory. Therefore, the bad loan problem requires effective resolution.
- This helps banks or FIs clear-off their balance sheets by transferring the bad loans and focus on its core business lending activities.
- Large debtors have many creditors. Hence bad bank could solve the coordination problem, since debts would be centralised in one agency.
- It can effect speedier settlements with borrowers by cutting out individual banks.
- It can drive a better bargain with borrowers and take more stringent enforcement action against them.
- It can raise money from institutional investors rather than looking only to the Government.
What are the Concerns or demerits of such banks?
Suppose, say for example, a bank sells bad loans. Then, it has to take a haircut because when Rs 100 goes bad, the actual amount that can be expected is lower than Rs 100 and that leads to haircut. When it takes haircut that will impact the P&L (Profit & Loss).
So, till that particular aspect is not addressed, creating a new structure may not be as potent in addressing the problem.
Past Debates on Bad Banks
The idea of Bad Bank is not new. Currently, this is in the news due to the problem caused by COVID-19. Earlier the topic of Bad Bank was a matter of debate in the banking and finance circles when former Interim Finance Minister Piyush Goyal had put forward the idea when a committee headed by Sunil Mehta was formed to study the feasibility of National Asset Reconstruction Company. Even in 2017 Economic Survey had mooted the idea by suggesting the creation of Public Sector Asset Rehabilitation Agency (PARA). Even former RBI governor Raghuram Rajan had started a debate on Bad Banks in 2015 as a possible solution to the problems of Non Performing Assets.
The K V Kamath Committee, has said companies in sectors such as retail trade, wholesale trade, roads and textiles are facing stress.
- Sectors that have been under stress pre-Covid include NBFCs, power, steel, real estate and construction.
- Setting up a bad bank is seen as crucial against this backdrop.
Source: The Hindu