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Tuesday, 2 June 2020

The Big 'BAD BANK' Amid India's Bad Banks

𝐈𝐧𝐝𝐢𝐚’𝐬 ‘𝐁𝐚𝐝 𝐁𝐚𝐧𝐤’ 𝐚𝐦𝐢𝐝 𝐭𝐡𝐞 𝐁𝐚𝐝 𝐁𝐚𝐧𝐤𝐬

The Indian Banks’ Association has rekindled an old idea which can potentially cure the banking system off its NPAs. A bad bank, very similar to an Asset Reconstruction Company, will purchase the collateral backing the NPAs of the banking system to turn it around.

While the idea sounds feasible on paper, it most like isn’t. There are multiple problems associated to successfully implementing a behemoth task like this, which includes undermining the idea of Free Markets.

As a result, this may serve as merely painting a false picture that makes things seem better than they truly are; it could create long-run problems and exacerbate risky banking in the future, while weakening the government’s financial position.

india's bank and rising npas


THE IDEA OF A BAD BANK

A Bad Bank ' refers to a structure wherein ' toxic assets ' ( distressed and illiquid assets ) of banks are moved in order to clean up their balance sheets.

The idea , not at all new , was proposed in 2015 in response to RBI's Asset Quality Review and again in 2018 by the ex - PNB Chairman led Mehta Committee.

As of late , the Indian Banks ' Association has urged the Central Government to form a ' Bad Bank ' to mitigate the problem of rising NPAs and ensure financial sector liquidity .

TRANSFER OF TOXIC ASSETS TO A ' BAD BANK '

Even though Non - Performing loans might be unserviceable to banks , the collateral backing the loan is , in most instances , worth a large amount.

The ' Bad Bank ' shall function as an Asset Restructuring Company ( ARC ) ; purchasing collaterals of NPAs from troubled banks at a discounted price , and selling it to interested parties , usually for a profit.
A ' Bad Bank ' , unlike the already existing 27 private ARCs in India , will be backed by the government .

THE NEED FOR THE NEED FOR GOVERNMENT BACKING

Like any rational consumer doesn't pay full price for a second hand good , private ARCs don't pay a price which is high enough to incentivise banks to sell the collateral to them.

As a result , both parties go home empty handed and the troubled bank continues to stay troubled.

However , this is where government backing comes in - unlike a private ARC , the Bad Bank's primary objective would not be to generate profit but infuse liquidity into the system , paying a ' fairer ' price for the collateral .

SETTING A PROBLEMATIC PRECEDENT

The Bad Bank will discount the collateral lesser than a private ARC would , implying that it would pay a higher price to purchase the asset.

The higher price for a troubled asset being paid by the state undermines the idea of a ' Free Market ' as prices are being distorted artificially , not being determined by demand and supply in the markets.

THE GOVERNMENT'S RESPONSIBILITY TO SELL ASSETS

This is where another problem lies ; while amassing distressed assets from the banking system is fairly easy , selling them isn't.

COVID - 19 and the global economic slowdown have hamstrung businesses , and private players with deep pockets would likely be averse of making big ticket purchases in the near - future.

If the government is ultimately unable to sell these assets , the government just undertook a bailout of both private and public banks , with of course a fancier name -'Bad Banks ' .

WINDOW - DRESSING THE EXISTING PROBLEM

The idea of a ' Bad Bank ' embodies what window dressing stands for ; making a problem look better than it is while not quite solving it.

While the banking system may escape scratch - free , the government's fiscal deficits could take a massive hit if the stressed assets are not sold , hampering the government's ability to borrow at a trying time with COVID - 19.

Therefore , this may result in a mere transfer of NPAs , encourage risky lending , and create an expectation of a bailout even in the future ; not truly addressing what led to massive NPAs.

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