Bad Bank - What is it? How will it operate?

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What is a 'bad bank'?

  • It is a financial entity set up to acquire NPAs from banks & resolve them
  • The bank, which sells the stressed assets to the bad banks, is now relieved of the burden of the bad loans & can instead focus on growing its business by advancing fresh loans to borrowers requiring credit
A bad bank is also called NARCL = National Asset Reconstruction Company Ltd.

Is bad banks the way forward for improving banking sector in India?

  • Yes, if they combine recapitalisation with asset segregation then bad bank segregations are effective in cleaning up balance sheets & promoting bank lending, according to Jan 2020 BIS working paper (BIS = Bank for International Settlements)

Critics of bad banks

  • government's role in guaranteeing some part of NPAs could lead to laxity on the part of bankers in assessing risk & thus creating fresh dodgy loans

How will NARCL operate?

  • the bad bank will acquire assets by making an offer to the lead bank of a group of lenders of n NPA
  • NARCL would make 15% cash payment to the banks based on a valuation & the rest (85%) would be given as security receipts
  • These security receipts would be guaranteed by Rs.30,600-crore backstop facility.
  • To assist NARCL, public & private banks together would set up IDRCL that would manage the acquired assets & try to improve their value for final resolution  (IDRCL = India Debt Resolution Company Ltd.)
  • And on completion of resolution, the balance 85% of value, being held as security receipts, would be given to the banks
  • the guarantee of these security receipts is 5 years. It can also be invoked either at the time of resolution or liquidation to cover the shortfall (if any) b/w the face value of the security receipts & actual realisation
  • These security receipts are tradable.

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