A bad bank is a financial entity set up to buy non performing assets (NPAs), or bad loans, from banks. It is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.It buys bad debtors of a bank at a mutually agreed value and attempts to recover the debts or associated securities by itself.
The aim of setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints. After the purchase of a bad loan from a bank, the bad bank may later try to restructure and sell the NPA to investors who might be interested in purchasing it. A bad bank makes a profit in its operations if it manages to sell the loan at a price higher than what it paid to acquire the loan from a commercial bank. A supposed advantage in setting up a bad bank is that it can help consolidate all bad loans of banks under a single exclusive entity. The one time transfer of assets out of the balance sheets will relieve banks of their assets out of bank’s balance sheets will relieve banks of their stressed assets and allow them to focus on their core business of lending. Banks with clean balance sheets can mobilize fresh capital from the market and improve their credit growth, which is crucial for spurring investments. Bad banks would also give an impetus to India’s economic growth , which has been affected by heightened risk aversion arising from the unbridled growth in NPAs . And the bad bank will unlock trapped capital, which will be a net positive for the economy in the long term. The idea of a bad bank has been tried out in countries such as the U.S.,Germany, Japan and others in the past. Some experts believe that by taking bad loans off banks, a bad bank can free capital of over ₹ 5 lakh crore that is locked in by banks as provisions against these bad loans. This will give banks the freedom to use the freed customers.
It is argued that creating a bad bank is just shifting the problem from one place to another.Without fundamental reforms to solve the NPA problem, the bad bank is likely to become a warehouse for bad loans without any recovery taking place. An important concern is regarding mobilizing capital for the bad bank. In an economy hit by the pandemic, it is hard to find buyers for distressed assets and the Government is also in a tight fiscal position. There is no clear procedure to determine at what price and which loans should be transferred to the bad banks.
Sources : The Hindu, Drishti IAS , Wikipedia
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