Lesson from China on bad banks

Relevance: There is a debate going on in India to open bad bank for solving the NPA problem with banks. 

Synopsis – To address stressed assets [nonperforming loans (NPLs), a bad bank must have a fixed term and a narrow mandate with clear aims. 

What are bad banks? 

A ‘bad bank’ is designated financial institutions that purchase and resolve nonperforming assets (NPAs) from banks and help banks to help clear their balance sheets.  

NARCL- National Asset Reconstruction Company Ltd, the proposed bad bank for taking over stressed assets of Banks, was announced in the Budget for 2021-22. 

Lesson for India from China’s bad banks 

• First, Bad banks should have a finite tenure – The bad bank should resolve these bad assets within a fixed period of time.  
• Second, Bad banks should have narrow mandate with clearly defined goals and clear resolution strategy to resolve NPAs. 
• Third, Policymakers must ensure that the NARCL’s establishment has no influence on RBI’s initiative to reduce bank holding in security receipts (SRs). 
• Forth, NPAs resolution should take place through a market mechanism and not through a multitude of bad banks. 

• The regulatory arbitrage between ARCs and AIFs must stop with the establishment of NARCL as a centralized bad bank. 

• AIFs should be allowed to purchase bad loans directly from banks and have enforcement rights under the SARFAESI Act. 
• ARCs should be allowed to purchase stressed assets from mutual funds, insurance companies, bond investors and ECB lenders.  
• ARC trusts should be allowed to infuse fresh equity in distressed companies, within IBC or outside of it. 
• The manager/sponsor of ARCs shall maintain the same level of interest as AIFs, i.e., at least 2.5 percent in each scheme or Rs 5 crore, whichever is lower. 

Way forward- 

The policymaker should learn from China’s mistake and should limit the mandate and tenure of NARCL while facilitating market-based mechanisms for bad loan resolution in a steady state. 

Read more: 

• Establishment of Bad Banks – associated Issues and Significance 

Source- The Indian Express