BAD BANKS

BAD BANKS

Subject: Economics

Context: Finance Minister Nirmala Sitharaman in her Budget speech on Monday revived the idea of a ‘bad bank’ by stating that the Centre proposes to set up an asset reconstruction company to acquire bad loans from banks.

Concept:

• A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
• Technically, a bad bank is an Asset Reconstruction Company (ARC) or an Asset Management Company (AMC) that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
• 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 takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

Global Precedence

• US-based Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
• The Troubled Asset Relief Programme (TARP) in the US.
• In Ireland, the National Asset Management Agency was established in 2009 to respond to the financial crisis.

Previous Proposals:

• In May 2020 the banking sector, led by the Indian Banks’ Association, had submitted a proposal for setting up a bad bank to resolve the NPA problem, proposing equity contribution from the government and banks.
• In 2017 the Economic Survey suggested Public Sector Asset Rehabilitation Agency or PARA, to buy out the NPAs of high value from Indian banks.