When all other ideas fail, there is always a “Bad Bank” to go back to. The then interim Finance Minister Piyush Goyal last revived the idea in 2018, when he set up a committee under PNB Chairman Sunil Mehta to study the possibility of the Asset Reconstruction Company, or in other words, a bad bank.
The 2017 Economic Survey explored the concept, proposing the establishment of a Public Sector Asset Rehabilitation Agency (PARA). Earlier, a 2015 asset review by the Reserve Bank under Governor Raghuram Rajan – which forced banks to recognize problem accounts as ineffective assets – also sparked controversy over bad banking as a possible solution.
In short, this idea is not a novel and has been suggested by different people at different times. There is no white paper floating in the public domain about what the Indian Banks Association, which has revived the idea, plans to make a bad bank, or what its proposed structure will be. But CNBC-TV18 has spoken to short-term banks to get a sense of what it might look like.
But first, what is a bad bank anyway? No, it is not a bad or corrupt bank or any of these things. A bad bank is called that because it stays with bad loans, or in the form of financial – non-performing assets (NPAs).
The idea is simple. Suppose Bank X offers loans to a few people and companies who can afford to pay the bank, and who fail to repay it gradually. Over time, these loans accumulate, interest rates continue to accumulate, and Bank X continues to provide large sums of money for negative exposure, as it realizes it may not be able to repay the loan.
One could argue that these loans are bad, or NPAs can just keep sitting on Bank X books and that could be the case. In practice, however, these NPAs could damage the bank. Investors, or any other partner, see large NPAs as a sign of poor health or financial weakness. The rise of NPAs seriously damages Bank X’s ability to borrow, lend, or run the business as a whole.
To remedy this problem, the negative banking model was first introduced in the 1980s. US Mellon Bank set up a bad bank back in 1988 to seize its toxic assets by removing its capital, and its five board members from Grant Street National Bank. Grant Street Bank did not take out the public money as ordinary banks do, but simply served the purpose of resolving or eliminating bad debt to repay as much money as possible, and ended up eliminating it a few years later in line with its intended purpose.
