The ABCD of Bad Banks

Context: Budget 2021-22 recommended for setting up an Asset Reconstruction Company (ARC) Ltd and an Asset Management Company (AMC) for dealing with stressed debt, signals a green light for ‘Bad Bank’

Arguments favouring setting up of ‘Bad Banks’  

• It benefits Commercial banks: by transferring their bad loans to bad banks and thereby reducing loan book risks and provisioning losses and allows them to refocus on their core business.
• Bad banks are bad, for good: It purchases distressed loans and sell the assets at a profit and thereby returns the money with capital gains to its shareholders.

Arguments against setting up of ‘Bad Banks’ in India

• Indian distressed assets are high valued: - mostly corporate fixed assets as against smaller bad housing loans as seen in the US.
  • Bad banks have never worked where industrial, corporate- and conglomerate-level bad loans predominate. E.g. failure of bad loan resolutions in Mexico, Brazil, Argentina.
• Discounted sales of distressed asset may attract scrutiny: (Commercial banks have to provide a discount of 10-25% of book value)
  • No clarity about protection to bank’s management for providing such discounts: especially in the case of Public Sector Banks (PSBs) where gross non-performing assets (NPAs) of 15%.
  • PSBs constitute ‘the State’ under Article 12 of the constitution of India, and hence its actions will be scrutinised by the Parliament, the Central Vigilance Commission (CVC) etc.
• Bad banks are just recapitalisation schemes: thus, it cannot clean up the structure of commercial banks as previous recapitalisations of PSBs since 1992-93 failed to do so.
• Ownership issues: Government cannot own bad bank as they will be major sellers of bad debt. Hence equity holders of an entity that buys such debt should be any other party. 

Conclusion: Many reforms are needed in law, legal procedures and in freeing PSBs from debilitating State oversight and investigations before the financial system can resolve distressed loans through bad banks.