Bankable Idea

Context: Setting up of Bad bank is a good move as it will help in recovering value from stressed assets and allow banks to increase lending.

Factors that helped the Indian financial sector to sustain the shocks of pandemic

• Better capitalization: banks in India were much better capitalized prior to the pandemic.
• Sizeable buffers: to provide for bad assets and thus negates any surprise on balance sheets.
• Increase in demand for financial services: due to steady rise in disposable income and personal financial assets in Asia (It will reach about $69 trillion by 2025).
• Financial discipline: displayed by Indian banks and the Reserve Bank of India (RBI). E.g.  Units with high leverage were advised to reduce their debt levels in a time-bound manner.
• Prudent monetary management by the RBI.

Features of the proposed Bad bank

• Proposed Structure:
  • Aggregation of the debt: A National Asset Reconstruction Company (NARC) to acquire stressed assets.
  • Resolution management: by the National Asset Management Company (NAMC).
• Proposed process:
  • Transfer of assets: Initially transfer assets with 100 % provision on its book and the remaining on a later date based on the experience.
  • Nature of the recovered amount:  85 % will be in the form of security receipts that will reside in the bank balance sheets.

Benefits associated with setting up a Bad bank

• Provide zero-risk weight to banks: As according to the proposal, 85% of the recovered amount will be in the form of security receipts with full government guarantees for a specified period of time.
• High recovered value and significant lending leverage: because
  • The capital will be freed up from less than fully provisioned bad assets and from security receipts because of a sovereign guarantee.
  • Cash receipts that come back to the banks can be leveraged for lending, also freeing up provisions from the balance sheet. 
• Consolidation of stressed assets under the AMC: which may result in better and faster decision making and free up management bandwidth of banks - Thus, they can focus on credit growth.

Way forward: Ensure good governance and independence of AMC by-

• Keeping majority ownership in the private sector.
• Putting together a strong and independent board.
• Linking AMC compensation to returns delivered to investors.