The COVID-19 pandemic saw a rise in the number of bad loans issued, especially from the public sector banks. It points to a dramatic increase in the NPA(non-performing assets ) in the banking system, therefore creating a burden on the banking sector.
The government took cognizance of the problem and to remedy the situation, the idea of bad banks was pitched in January 2021 in the form of providing a budget for ARC (Asset Reconstruction Company) and AMC (Asset Management Company) model.
However, the stand of the general public on the creation of these entities stands divided. To deal with the growing problems, one needs to understand the obstacle the Indian economy is facing.
The Crisis: What is it?
The term NPA Has become a buzzword in the business world and not for the right reasons.
Loans or advances that are in default or arrears are known as nonperforming assets (NPAs). When a principal or interest payments are late or missing, the loan is in arrears. When the lender assumes the loan arrangement has been broken and the debtor is unable to fulfill his commitments, the loan is considered in default.
NPAs are often a hindrance to a financial institution’s ability to carry out its operations. Conveying nonperforming resources, likewise alluded to as nonperforming credits, on the accounting report places critical weight on the moneylender. The delinquency of premium or chief diminishes the bank’s income, which can upset spending plans and reduce profit. Advance misfortune arrangements, which are put to the side to cover likely misfortunes, decrease the capital accessible to give ensuing credits to different borrowers. When the genuine misfortunes from defaulted credits are resolved, they are discounted against profit. Conveying a lot of NPAs on the monetary record throughout some period is a marker to controllers that the monetary soundness of the bank is in danger.
It has been predicted by the RBI that the NPAs may ascend to as high as 14.8% in one year if there should be an occurrence of a serious pressure situation, from 7.5% as of September 2020, even as Indian banks are as yet working out a rebuilding bundle for borrowers hit by the Covid 19 pandemic, hence indicating severe stress on the banking system.
The Solution: The “bad” strategy
To tackle the growing stress, the role of the “bad banks” comes into play. It is a bank set up to purchase the terrible advances and other illiquid property of another monetary establishment. The substance holding critical nonperforming resources will offer these possessions to the terrible bank at market cost. By moving such resources for the awful bank, the first foundation may clear its monetary record—even though it will, in any case, be compelled to take compose downs.
A model has been proposed by the Indian Banks Association( IBA) for the bad banks to work in two tiers.
Level 1:
- There will be an Asset Reconstruction Company (ARC) upheld by the Government which would purchase awful advances from banks and issues Security Receipts to the Banks.
- According to RBI rules, ARC will hold Security Receipts of 15%.
- Banks will get 15% of the money and will hold 85% of Security Receipts. Consequently, it is called 15:85 construction.
Level 2:
- There will be an Asset Management Company (AMC).
- AMC would be controlled by open and private bodies which incorporates banks too.
- Turnaround experts.
The Future way forward :
The NPAs have predicted to increase and it has been observed that the bad banks are currently present-focused and often lack the future vision, The proposed solution is fixated on lessening the NPA stock, which is a lot lesser issue, as opposed to containing augmentations or stream, which is a more pressing issue. The challenge is how to reduce accretion which can be done through several structural measures including, but not limited to improvement in credit underwriting skills. Hence, the focus should be on creating a holistic ecosystem to create the Bad banks which stop the creation as well as ensure a flow of capital in the banking sector to ensure credible loans.
Sources:
Bloomberg Quint
Business Today
Money Control
Times of India
Strategy Unboxed 
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