October 23, 2021
  • October 23, 2021
  • Home
  • Asset Risk
  • Asset rebuilding: tackling the post office mess: how does a bad bank work and does it involve risks?

Asset rebuilding: tackling the post office mess: how does a bad bank work and does it involve risks?

By on September 18, 2021 0

Minister of Finance Nirmala Sitharaman. | Photo credit: PTI

Highlights

  • Simply put, a bad bank is a financial institution created for the sole purpose of taking over non-performing assets from lenders, allowing them to refresh their books, focus on lending, build confidence in the financial sector, and, ultimately, lenders. ultimately, stimulate economic activity.
  • Banks, non-financial banking corporations and similar institutions are essential components of the economy as they represent formal lines of credit
  • Although bad banks are helping these lenders get rid of their failed loan books, concerns remain about such proposals.

On Thursday, Finance Minister Nirmala Sitharaman followed through on the central government’s pledge to address the growing unproductive asset (NPA) crisis in the country, announcing the formation of the National Asset Reconstruction Company Ltd (NARCL) .

The Minister of Finance noted that around Rs 2 lakh crore of stressed assets will, over time, be transferred from the books of public sector banks. In the first phase of asset reconstruction, a total of Rs 90,000 crore of stressed assets had been allocated to the transfer to NARCL.

In addition, she also announced the formation of the India Debt Resolution Company (IDRCL) which, in tandem with NARCL, will form the Bad Bank of India. The government has also authorized the use of Rs 30,600 crore in cash to be deployed as collateral to banks.

How does a bad bank work?

The concept of bad bank is not new but prevailed during the global financial crisis between 2007 and 2009. At the time, Citigroup reportedly transferred loans worth around $ 900 billion to its unit. reconstruction of assets (bad bank) Citi. Barclays and Bank of America have also chosen to create failing banks to ease financial strains.

Simply put, a bad bank is a financial institution created for the sole purpose of taking over non-performing assets from lenders, allowing them to refresh their books, focus on lending, build confidence in the financial sector, and, ultimately, lenders. ultimately, stimulate economic activity.

In such a scenario, banks are required to separate their bad assets from their good assets in a transparent manner, which allows them to raise capital through debt or equity issuances. Bad debts or toxic assets are transferred to the failing bank which focuses on their recovery and maximization of recovery.

Banks, non-financial banking corporations and similar institutions are essential components of the economy as they represent formal lines of credit. The precarious state of the economy is currently seeing most of the toxic debt concentrated in public banks.

In an environment that continues to be plagued by economic uncertainty, these lenders have taken risk averse positions, refusing to lend amid growing concerns about rising NPAs. As the true extent of the NPA crisis is revealed, these lenders will find it increasingly difficult to raise capital in the market given the deteriorating asset quality on their balance sheets.

Although bad banks are helping these lenders rid their books of failed loans, such proposals remain of concern. Some analysts have raised the issue of moral hazard to the extent that by creating a bad bank the government is effectively setting a precedent that encourages reckless lending. Others doubt a state-run bank’s ability to increase collection rates, saying all a bad bank actually does is shift the burden from one entity to another.