What Is A 'Bad Bank' And What Are Its Functionalities?

Indian banking sector is now highly occupied with the concept of 'bad bank', after FM Nirmala Sitharaman has finally announced that the union government is going to guarantee Rs. 30,600 crore in National Asset Reconstruction Company Ltd. (NARCL), or popularly known as ARC in short - that will aid to buy bad loans from banks. NARCL will be offering a 15% of the net asset value in cash, along with issuing a security receipt (SR) for the rest 85%.

What is a bad bank?

Bad loans are referred as Non Performing assets (NPA) in banking term, which has been a major challenge in the Indian banking ecosystem. Although the Punjab National Bank (PNB) was one of the top positions, but other banks including SBI could not secure itself from the NPA trap. RBI, earlier in its Financial Stability Report mentioned that the gross NPAs on bank balance sheets could increase to 13.5% in September 2021. Additionally, it stated that the Public Sector Banks (PSBs), accounting 60% of the Indian banking sector's assets, but their gross NPAs can increase to 16.2% by September 2021 in the baseline scenario, which is nearly double in y-o-y basis. This droved FM to think strongly about the matter and form a bad bank.

In February, 2021, FM Sitharaman sounded worried about the growing NPA of both public and private sector banks, during the budget session. At that time, she had proposed to set up an Asset Reconstruction Company (ARC) for NPA management, to infuse Rs. 20,000 crore of capital into public sector banks for FY 2021-22. ARC is also called as Debt Management Company, as it will absorb the stressed debt of banks. Hence the ARC can be considered as an ICU, by RBI for the stressed banks. The ARC is commonly worded as 'bad bank' which has derived its term from 'bad loans'. The union government's bad bank will help the public sector banks to operate normally by liquidating them to recover as much money as possible, without lending pressure on the common citizens.

V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services sounded positive on bad bank as he stated, "Since the banks will remove these NPAs from their balance sheets, they can focus on lending activities that can help trigger a fresh round of credit off take that the economy badly needs. The FM's confirmation that Rs. 5 lakh crore has already been recovered during the last 5 years is a positive signal that the burden will not be as high as initially feared. Nirmala Sitaraman's track record as a reformist finance minister has been further reinforced with this NARCL announcement."

The PSBs have already identified 22 stressed assets with a total amount of Rs. 82,500 crore, which will be transferred to the NARCL in phases, and Rs. 2 lakh crore more in future. The bad bank or NARCL with more than Rs. 149.2 crore paid-up capital, has equity participations by PSBs like - Bank of Baroda, SBI, Union Bank of India, and Indian Bank, with the highest share by Canara Bank.