‘Bad bank’ idea finds more takers amid pandemic blues

'Bad bank' idea finds more takers amid pandemic blues

© Ophelio Roel Almeida
‘Bad bank’ idea finds more takers amid pandemic blues

The idea of creating a ‘bad bank’, a single entity which will house all bad loans in the banking system, is back on the discussion table. Two former central bankers, Raghuram Rajan and Viral Acharya and former State Bank of India (SBI) Chairman, Rajnish Kumar, have strongly supported the idea.

Days after a jointly-authored paper by Rajan and Acharya pitched the bad bank idea, outgoing SBI Chairman too said this is the best time to create a bad bank.

“In my view, this is the best time to create a bad bank,” said Kumar in an exclusive interview to Moneycontrol on Wednesday.

A ‘bad bank’ is a bank set up to buy the bad loans and other illiquid holdings of another financial institution. Once toxic assets are transferred to this entity, attempts for an early resolution by experts begins while originating banks can focus on their business. Banks can transfer NPAs to a bad bank at a discount. The price discovery can happen later.

Rajan and Acharya too wrote in favour of the bad bank plan.

“The national public sector “bad bank” could serve as a vehicle to aggregate loans, create management teams for distressed firms, and possibly buy and hold distressed assets in a sector like power till demand returns,” the paper said.

Further, private asset management and national asset management “bad banks” should be encouraged in parallel to the online platform for distressed loan sales. Private players could aggregate and recover on loans in sectors where government intervention isn’t necessary, the paper said.

In April-May this year, the idea of bad bank was in active discussions when the Indian Banks Association (IBA) mooted the idea with the government by submitting a formal proposal.

The IBA proposed that bad bank will have an ARC-AMC model and an alternative investment fund (AIF) will be set up to buy the stressed assets from the banking system. But, the idea didn’t find many takers then on account of then.

Time more ideal

But, Kumar said the time is different now since bet value of NPA assets with banks have fallen dramatically. Explaining his logic, Kumar said a bad bank was not created before because the net book value of NPAs was very high.

“Today, the net book value of NPAs is very low—hardly 15 per cent in many cases. The point is if there are people specialising on resolution, and if all NPAs are brought to one place, bank managements can focus on the rest of the business,” Kumar said.

Also, this will speed up resolution, Kumar said. “Right now, if there is a large corporate NPA, one needs to go to 10-15 banks for resolution. Whether you are making a bad bank or not, the resolution process is very slow. It needs to be faster,” the former SBI Chairman said.

Who will fund?

Regardless of the model with which the bad bank is created, the bigger debate has always been who will put in the initial capital required to get the bad bank up and running. In May this year, when the IBA submitted its proposal, it had requested the government to put in an initial capital of Rs 10,000 crore.

Kumar, who was IBA Chairman at that point, said the government which is the majority owner in the Indian banking industry, needs to invest in the bad bank.

“PSBs own 60 percent of the banking system. We can’t transfer (bad loans) to any other entity other than a government-owned company. This is the logic (of saying government has to fund the project),” said Kumar.

Kumar’s successor at SBI Dinesh Kumar Khara, didn’t give a specific answer at a press conference on Wednesday to a question on whether he supports the idea of a bad bank. Khara said various options are being looked at by lenders, bad bank being one of them.

“The central concept behind all these options is aggregation of stressed loans…we have to see which is the best way,” said Khara.

Not a new idea

The idea of a bad bank is not new. In 2018, the government had announced a plan for PSBs called ‘Project Sashakt’, which had a five-point plan for bad loan resolution in public sector banks.

The government then spoke of a model, with the guiding principles of an Asset Management Company (AMC) resolution approach, under which an independent AMC would be set up to focus on asset turnaround, job creation and protection. The functions of this new company will be aligned with Insolvency and Bankruptcy Code (IBC) process and IBC laws, the government had said.

The government did not call it a bad bank then and made it clear that it won’t get involved in the bad asset resolution process and the process will be led by banks.

With this, an alternative investment fund (AIF)-based resolution approach for loans above Rs 500 crore was also discussed under which an AIF would raise funds from institutional investors. Banks, too, will have an option to participate, if they wish to participate on the upside. The idea could not be executed for various reasons.

The talk about ‘bad bank’ bears a resemblance to ‘Project Sashakt’, albeit in a different avatar. The idea is good and more workable now since banks have already made 70-80 percent provisions on the NPAs after the mega clean-up exercise. They can remove the remaining by transferring the assets to a different entity, experts argue.

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