Bad Bank for strengthening the banking sector

Synopsis: Indian banks have started to recover post the pandemic phase. Moreover, the banks will strengthen after the creation of a bad bank as promised in the budget.

Background:

• During the pandemic, NPA(Non-Performing Assets) was expected to rise. Thus, Indian banks have written off their balance sheets.
  • A write-off is an accounting term through which the book value of an asset is declared to be zero.
  • An NPA is a bank loan that is subject to late repayment or is unlikely to be repaid by the borrower in full.
• However, later at the end of the year, a positive recovery was observed. Restructuring requests were reduced and Provision Coverage Ratios (PCR) improved.
  • PCR is the ratio of provisioning to Gross Non-Performing Assets. 
  • It indicates the extent of funds a bank has kept aside to cover loan losses.
• In the recent budget 2021, the government announced a dedicated bad bank.

Reasons behind improvement in the banking system at the year-end

Before the pandemic, banks held substantial capital and built a sizable buffer for dealing with the NPAs. This prevented major degradation of their balance sheets during the pandemic. Further many other reasons were behind this performance.

1. Before the pandemic, the RBI instilled a prudent degree of financial discipline in the market. This included decreasing exposure in riskier assets and devising a system of ratings for the borrowers.
2. A surge in disposable income and spending capacity of middle-class people will be witnessed. This would cause the valuation of personal financial assets in Asia to reach $69 trillion by 2025. Therefore, bringing more business to India as well.
3. Further, the robust monetary management skills of RBI and budget announcements created a sense of positivity in the sector.  

Budget Announcements:

• A bad bank will be created under an Asset Reconstruction Company (ARC)-Asset Management Company (AMC) structure.
• National Asset Reconstruction Company (NARC) will acquire stressed assets in an aggregated manner from lenders. National Asset Management Company (NAMC) will act as a resolution manager for the acquired assets.

Benefits of Bad Bank:

• Firstly, banks will get the recovered value of the stressed asset and their balance sheet will not appear stressful. This will improve their valuations.
• Secondly, banks will get more lending leverage as:
  • Less provisioning is done for stressed assets if a robust bad bank exits 
  • Bad Banks generally pay 85% in sovereign receipts and remaining in cash. This can be used for giving more loans.
• Thirdly, it will drive the consolidation of stressed assets and help in faster decision-making.
• Fourthly, banks will get more management space as recovery work will be undertaken by bad banks. This would allow them to focus more on credit growth. 
• Finally, as per some experts, transferring Rs. 400 assets to bad banks work out to around Rs 526 for the economy (a multiplier of around 1.3). Further, benefits worth Rs 2.2 lakh can be witnessed at just a 20% recovery rate.

Way Ahead:

• The Banks have realized the growth potential of the sector. They are constantly developing new business models, rationalizing costs, and providing superior services to attract more customers.
• Along with this, the focus should on creating a favorable environment for the development of.. that includes:
  • Keeping majority ownership in the private sector
  • Putting together a strong and independent board
  • Linking AMC compensation to their performance

Source: Indian Express