The idea of the bad bank in itself is not new. It has been discussed extensively over several years. But, it has gained prominence after being announced in the budget of 2021.
Effective tool to handle NPA crisis:
In simple terms, a bad bank can be defined as an entity that absorbs the existing pile of Non-Performing Assets (NPAs) in the banking system. And, attempts to resolve it through a professional approach.
The bad bank will go a long way to free the banks from the mounting burden of the NPAs. It could take these stressed assets under its wing and find its resolution.
At present, NPAs in the Indian banking system is the worst in the world. More than Rs 2.25 lakh crore lies unresolved in the Indian banking system. Current gross NPAs stand at around 7%. Led by the Covid-19 disruptions, the RBI expects it to rise to 15% by September 2021 in a worst-case scenario.
Focus on reviving credit growth:
Due to the lack of clarity about the actual stress in the system, banks continue to remain cautious on fresh lending. Hence, credit growth has failed to kick off post lockdown. Despite the several monetary measures from RBI, credit growth has remained abysmally low at ~6%.
With bad bank taking away the stressed assets, the bankers are likely to shift their focus on their primary task of lending.
Beneficial for PSU Banks:
Shifting the stress assets off the balance sheet could do wonders for PSU Banks. It is likely to speed up the divestment process as PSU Banks without stressed assets offer a far more attractive proposition to the bidders.
Devil is in the details :
No doubt, a bad bank is an efficient tool to resolve the stressed asset issue. However, setting it up is going to be a challenging task. As per the emerging details, the government is not going to put any capital. It has distanced itself from having any shareholding in the Bad Bank.
Rather, it wants the banks to infuse fresh capital to establish the bad bank. It is a significant development and brings the whole matter down back to square one. With onus lying on banks, larger private banks, considering their superior asset quality, are likely to opt-out of the process altogether. They would rather choose to handle the crisis on their own.
In this situation, the bulk of the responsibility is likely to fall on the PSU Banks who possesses the majority of these stressed assets. They are already capital-starved. And, accumulating fresh funding without the government's help will not be an easy task for them.
Banks have made excess provisioning in recent quarters to mitigate any unforeseen covid related stress. The government is expecting banks to utilize this fund to fulfill their capital requirements. Apart from that, the banks could also accumulate necessary capital by selling these assets to ARC.
But, the whole concept would be left self-defeating in absence of the government participation. Banks are anyways handling the crisis on their own. In this light, setting up a bad bank would not make any difference to their ground reality.
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