[Answered] What is a ‘bad bank’? What are the pros and cons of setting up a bad bank?

A bad bank is a financial entity set up to buy non-performing assets (NPAs), or bad loans, from banks. 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. Generating profits is usually not the primary purpose of a bad bank – the objective is to ease the burden on banks, of holding a large pile of stressed assets, and to get them to lend more actively.

Pros:

• It can help consolidate all bad loans of banks under a single exclusive entity.
• Bad loans bring government regulations on the activities of banks. Their lending activities are curtailed in some cases. They could use their idle funds only if they could get rid of their bad loans.
• Many public sector banks may be considered to be technically broke. In reality, their liabilities are far exceeding the assets they have.  So, a bad bank could help them reduce their liabilities by purchasing bad loans.

Cons:

• Bad banks are backed by the government. The government will pay the high cost for stressed assets (to make bad bank profitable). It is not good for fiscal health of the country.
• There is a bad loan crisis in PSUs because they are managed by the bureaucrats. Bureaucrats are not like private banks andcannot offer the same commitment to lenders and ensure profitability. If a Bad bank is allowed to manage by bureaucrats, then there is no point to create a bad bank at all.
• Bad banks do not address the root problem. The reason behind the bad loan accumulation is lack of focus on the quality of credit provided by banks. Establishing a bad bank might create a mindset that there is a system in place to recover the loans. This can lead to careless lending by banks in a larger manner and worsen the present bad loan crisis.

The Problem of NPA is huge in India. Without reducing the problem of NPA India cannot become a trillion-dollar economy. The UK Asset Resolution (UKAR), a bad bank has recovered nearly 50 billion pounds of loans in UK. So, the Bad Banks is key to reduce the NPAs.