Concept of Bad Bank

Introduction

• Bad bank is an idea to solve the alarming problem of Non Performing Assets (NPA) existing in Indian banks 
• NPA is a major hindrance for PSBs in India
• The current method of recapitalization will not clear off the bad debts and NPAs 
• Recapitalization has Indian financial capabilities limitations 
• RBI has suggested the idea of Bad Bank formation to solve NPA issue

What is a Bad Bank?

• Bad Bank concept was pioneered by Mellon bank in 1988 headquartered at Pittsburgh 
• Bad bank is a successful model in European nations like Sweden, Ireland and France after the financial crisis 
• Bad bank is established as a separate entity to buy NPAs from banks 
• This practice would free up the books of banks for fresh lending 
• Bad banks will then take steps to dispose off the toxic assets that are bought as NPAs from other banks 

Bad Bank Benefits

• Bad bank will clear off the NPAs of PSBs and other banks in India 
• PSBs and other banks in India will become more attractive for investors and buyers 
• Bad banks will enhance the management of NPAs 
• Segregation of NPAs to bad banks will relieve the stress from other banks to pursue their normal lending operations 
• Bad banks will help restructure the banking sector 
• NPAs will come down drastically as a result of bad bank 

Limitations of Bad Bank

• The idea of bad bank will not be relevant in India as most of the problems with NPAs in Indian banks is due to environmental clearance, governance and land acquisition problem 
• According to former RBI governor, Raghuram Rajan, these problems can be overcome by just additional funding and a restructuring of assets 
• Management of Bad banks and its composition is complex and has issues 
• The same governance and capitalization issues existing in PSBs will continue with bad bank as majority of the stake remains with the government 
• Bad bank would promote corruption and favoritism if the majority of the shareholding is given to private 

Way Forward

• The RBI suggestion of a Bad Bank must be implemented through a parliament act 
• Government must complement this RBI step by infusing more capital into the PSBs 
• Bad bank must be made the apex loan resolution authority to tackle all the bad loans of the PSBs 
• Bad banks must not be held solely responsible for bad loans but will remain as a risk diversification entity to ward off the fear about NPAs 
• Overall, Bad bank is a welcome measure to minimize impact of NPA on Indian banks especially stressed PSBs