Few days back our Finance Minister announced the creation of a Bad Bank.


Due to the scams and thefts during Sonia Gandhi’s tenure, the Public Sector Banks (PSBs) and even private sector banks (for e.g. YES Bank) had lent recklessly. Due to that the Non Performing Assets (NPAs) had grown up. Loans were written off to hide this theft. Say a company has taken Rs 100 crore loan, the bank would just waive off the loan by taking a token money from the borrower and close the loan account. But after NDA came to power, the NPAs were officially announced which amounted to 2,24,542 crore and the policy of writing off the loans were stopped(or greatly reduced). A new law called Insolvency and Bankruptcy Code (IBC) was passed which made it easier for Banks to auction off properties of the defaulters. We then saw many companies like Essar Steel, Bhushan Steel (and now Jet airways) got auctioned off. Existing laws like SARFAESI were also strengthened, National Company Law Tribunals were established and many other steps were taken which made it easier for banks to deal with NPAs.

IN spite of these measures the NPAs still remain high. With Bank holding the NPAs, their balance sheets have to report loss due to the NPAs and hence banks cannot lend thereby stifling the industrial growth.

What is the bad bank?

The Govt has established an asset reconstruction company. What is Asset Reconstruction Company(ARC)? An ARC is a company established after getting a license from Reserve Bank of India whose job is to purchase NPAs from banks (it can be cars, houses, land, industries, companies etc. which is mortgaged to the bank). The ARC may do some kind of repair or reconstruction. For e.g. say in case of house, it may do internal repairs, beautify it a bit before selling it off as a regular owner. The ARCs make profit by selling the asset at a higher price. The National Asset Reconstruction Company Limited (NARCL) will purchase the NPAs from Banks. Another entity — India Debt Resolution Company Ltd (IDRCL), which has also been set up — will then try to sell the stressed assets in the market.

The "NARCL+IDRCL" is "nicknamed" the bad bank as it will deal with bad assets of the Banks.

What will the bad bank do?

NARCL will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks in different phases. To make it work, the government has okayed the use of Rs 30,600 crore to be used as a guarantee. It will pay 15% of the agreed price in cash to the bank (it purchases the NPA from) and the remaining 85% will be in the form of “Security Receipts”. When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest. (NARCL + IDRCL) will keep some profit for their own.

How will this benefit the banking system?

This bank will relieve the commercial banks of their “stressed assets” and allow them to focus on resuming normal banking operations, especially lending. While commercial banks resume lending, the bad bank, would try to sell these “assets” in the market. This will not only relieve the banks of their NPAs but also revive the NPA. How? Say we have a bus or truck which is declared a NPA and is seized by the bank. Once the bus or truck is sold off to a new owner, it will get operational and start earning.

Hence, I consider this a very positive step in right direction.

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