What is a bad bank?
A bad bank (also referred to as Asset management Company or AMC) is a corporate structure which isolates illiquid and high risk assets (typically non-performing loans) held by a bank or a financial organisation, or perhaps a group of banks or financial organisations. The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course. The presence of the government is seen as a means to speed up the clean-up process. Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.
This is not a new concept. This remained on tables for a while. Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium that it has announced to tackle the economic slowdown.
Bad banks aim at speedy recovery of loans at lesser price as compared to IBC. Economists have hailed this concept.
The proposed bad bank is better than the existing Asset Reconstruction Companies as it will be owned by the government. Once the NPAs are transferred to the bad bank, PSBs need not resort to higher provisioning and would be better placed to mobilise capital from the market. Since there has been a steep rise in discount rates from 30 to 60 per cent of the book value of bad loans due to regulatory norm of upfront cash payment of 15 per cent by ARCs, the timing of bad bank is apt.
Banks in India have been very slow in selling assets to the existing ARCs as neither the ARCs nor the banks were ready to bear the losses which prolonged the process of recovery.
This will allow banks to focus on giving fresh loans. (A big plus)
Some economists say, the question of recovering the bad loans still remains. Shifting the bad loans from one balance sheet to other won't make much of a difference.
The Question here is simple: Is it poor governance to move a bad loan from one account to another entity which the government has invested the funds in?