7 PM Editorial |Tackling NPA crisis by establishing a bad bank| 5th June 2020

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Tackling NPA crisis by establishing a bad bank

What has happened:

COVID 19 has caused a slowdown in the economy due to lockdowns and movement restrictions. It also has an impact on financial health of banks. As of December 2019, banks have 9.7 lakh crore Non performing Assets – NPA’s. Estimates suggest fresh 5.5 lakh crore assets will become NPA’s. Considering such impact of COVID, Insolvency and bankruptcy code(IBC) provisions for initiating insolvency against defaulters are suspended for 1 year. However, India needs a strategy to tackle the inevitable rise in NPA’s due to economic slowdown.

Indian Banks Association(IBA) has asked RBI to set up a bad bank to tackle the looming NPA(Non performing Assets) crisis in India. Economic survey of 2016-17 too proposed such a bad bank. Let us understand bad bank, its need, its merits and demerits.

Failure of ARC’s and need for bad bank:

Currently banks can sell their stressed assets to private owned ARC’s – Asset Reconstruction companies. Intention of ARC’s is reconstruction where the economic value of stressed assets is increased.

But ARC’s have failed in reconstruction of companies. They merely collect pending dues. Even this recovery is low at around 9.5% of total stressed loans amount.

In addition, public sector banks(PSB’s) sell these stressed assets at low rates. CVC report on assets sold between 2013-14 and 2017-18 by PSB’s highlighted low prices in at least 48 cases. It also highlighted how prices do not factor in stocks and equipment of these stressed assets. Such reports have reduced asset sales by banks to ARC’s in fear of adverse CVC/CBI/CAG reports.

A bad bank can overcome these issues and help faster resolution of stressed assets

Understanding a bad bank:

Bad bank is an autonomous banking institution which solely deals with NPA’s and their recovery. Other traditional banks will sell their NPA’s to bad bank. Such stressed assets are then managed by experts who maximize their economic value by reconstruction.

For example, consider a steel plant has become a stressed asset with SBI. Bad bank purchases this stressed asset from SBI. Then bad bank appoints experts in this domain to manage the affairs of the plant in order to maximize revenues and cut losses. This is called reconstruction and increases the economic value of the plant. When bad bank sells this plant, they will recover more money.

Merits of bad Bank:

1. Traditional banks lack expertise in reconstruction of stressed assets. Bad banks manned by experts are more suited for the reconstruction.
2. Improve credit in economy: NPA’s was one of the reasons for lack of monetary transmission in India. Banks have not reduced lending rates even though RBI has reduced policy rates. After traditional banks sell their NPA’s to bad bank, their financial health will improve. This can lead to greater lending in the economy. For growth recovery post COVID, credit growth is crucial for investments
3. Price at which NPA’s are sold comes under preview of CVC,CBI and CAG. Banks become hesitant in fast disposal of stressed assets fearing adverse reports by these institutions. A bad bank which can maximize recovery due to professionalism and hence will be less prone to hesitancy.
4. Higher prices for stressed assets can be realized by bad banks. Case of Jhabuau power below is example

Arguments against bad bank in India:

1. Bad assets currently don’t have many purchasers and hence a bad bank will not help.
2. Considering there is no demand for bad assets, bad bank will have to be capitalized by the government. With the stressed fiscal condition of government it will be difficult. In addition, bad bank with government majority will have the same constraints as current public sector banks in terms of scrutiny by CVC/CAG/CBI.
3. Price at which a bad bank buys bad assets from traditional banks will not be market determined. This increases losses to traditional banks and for government(in case of Public sector banks-PSB’s)
4. Private ARC’s are already present for transferring bad assets from banks. Hence bad bank will not be needed

Let us see how these issues can be overcome:

1. When bad assets don’t have many purchasers, it is better to have experts manage them rather than traditional banks. Hence bad bank would be better
2. While government resources need to be invested for setting up band bank, as seen in case of Jhabua power above, loss to the government from NPA’s can be reduced by a professional price discovery. Hence overall balance sheet can be improved in long term
3. In case of low selling price of bad assets from banks to bad bank is considered low by banks, provision to retain the bad asset by banks need to be included.
4. ARC’s have failed in reconstruction as discussed earlier. Bad bank can ensure reconstruction

International experience:

US, UK, Malaysia, France etc have had bad banks to successfully combat the NPA crisis. UK Asset Resolution(UKAR), a bad bank has recovered nearly 50 billion pounds of loans. Hence these models can be studied for framing India’s bad bank.

Going ahead:

Sunil Mehta committee recommended an Asset Management Company to resolve bad loans above 500 crores. This can be implemented to improve financial health of banks and reduce NPA’s

Mains Question:

1. What are NPA’s and stressed assets? Can a bad bank tackle the NPA crisis in India. Critically analyze?