Story of a bad bank

Normally when you come across people talking about a ‘bad bank’, you will lose no time to comprehend that the story is all about bad customer service rendered by a bank. But let me tell you that your comprehension about the mention of a bad bank in a conversation may be wrong.

Basically, the Covid-19 pandemic has rolled out wholesale changes globally in socio-economic sphere, in fact in every aspect of life. Among other things, terminologies in place are getting dual meaning when used in the context of ongoing pandemic and its impact on the lives of people. As the pandemic-induced economic lockdown dismantled even strong economies and left millions and millions of people jobless and with reduced incomes, the banking system all over world started caving in to the unprecedented coronavirus –induced situation. With respect to Indian banking industry, the situation is very fragile as far as asset classification is concerned and apprehensions loom large that bad loans are going to mount to unprecedented levels.

A surge in bad loans means that survival of a good number of banks would be at stake as the industry in pre-Covid crisis was already overloaded with huge pile of bad loans. Now, corona-induced bad loans will cripple them and could be a final nail in the coffin of those banks loaded with huge non-performing assets (NPAs).

While there is no end of Covid-19 pandemic visible in near future, the banks have started feeling the heat, especially when EMI moratorium has ended and borrowers have been strongly pushing for relief in interest portion charged during the moratorium. When all stakeholders including the regulator (Reserve Bank of India), government and even the Supreme Court of India currently stand locked on the issue, it’s the banking community which visualizes that all is not going to be well with their loan portfolios. In this situation they have a genuine reason to fear surge in bad loans to unprecedented levels.

Here it is worth to mention a report by India Ratings and Research (Ind-Ra) about the impact of the pandemic on banks. According to the report, Covid-19 and the associated policy response is likely to result in an additional Rs 1,67,000 crore of debt from the top 500 debt-heavy private sector borrowers turning delinquent between FY21 and FY22. This is over and above the Rs 2,54,000 crore anticipated prior to the onset of the pandemic, taking the cumulative quantum to Rs 421,000 crore, the report said.

Given that 11.57 per cent of the outstanding debt is already stressed, the proportion of stressed debt is likely to increase to 18.21 per cent of the outstanding quantum.

The rating agency said in a scenario wherein funding markets continue to exhibit heightened risk aversion, corporate stress could increase further by Rs 1.68 lakh crore, resulting in Rs 5.89 lakh crore of the corporate debt becoming stressed in FY21-FY22. Consequently, 20.84 per cent of the outstanding debt could be under stress in the agency’s stress case scenario.

With the situation getting murkier for the banks in coming times, it makes a sense for them to find out ways and means to clean their balance sheets of rotten loan portfolio to absorb the inevitable shock of another spell of bad loans which is on cards. In the context of carving out a process of cleaning their books, the concept of bad bank has been making frequent rounds in media headlines. In fact, there has been a buzz around the creation of a bad bank, hyped as a cure for growing bad loans.

Let me quote former Reserve Bank of India governor Duvvuri Subbarao who while commenting on creation of a bad bank stated that such a bank is not only necessary but also “unavoidable”. That our banks need support is in little doubt. The sector is struggling to find its feet, bogged down by a mountain of bad loans made worse by the covid pandemic.

Even the Economic Survey 2017 had proposed this idea, suggesting the creation of a bad bank called Public Sector Asset Rehabilitation Agency (PARA) to help tide over the problem of stressed assets.

The former RBI Governor noted that with the economy contracting by at least five per cent this fiscal year, non-performing assets (NPAs) will balloon.

Also, according to RBI’s Financial Stability Report, gross NPAs of banks may rise to 12.5 per cent by March 2021 under baseline scenario, from 8.5 per cent in March 2020.

Even as there are other channels to deal with the bad loans like Asset Reconstruction Companies and the bankruptcy, the idea of bad bank got support from the former RBI governor. “The bankruptcy framework is already overloaded and it simply will be unable to deal with this huge additional burden. It is important, therefore, indeed more than ever before, that much of the resolution takes place outside the Insolvency and Bankruptcy Code (IBC) framework,” he said.

So what is exactly is idea of a bad bank?  In the backdrop of above discussed situation, the idea of setting up a bad bank emerged when stress in the banking sector has been projected to rise in the near term.

To negotiate this upcoming challenge, the banking industry has proposed the setting up of a government-backed bad bank.

A bad bank actually buys the bad loans and other illiquid assets of other banks and financial institutions, which clears their balance sheet. The banking sector, led by the Indian Banks Association (IBA), had in May submitted a proposal for setting up a bad bank to the finance ministry and the RBI, proposing equity contribution from the government and the banks.

This was based on an idea proposed by a panel on faster resolution of stressed assets in public sector banks headed by former PNB Chairman Sunil Mehta. This panel had proposed an asset management company (AMC), ‘Sashakt India Asset Management’, for resolving large bad loans two years ago.

There were talks about creating a bad bank in 2018 too, but it never took shape.

Globally speaking, as reported by Hindu BusinessLine, it was in 1999, when China set up four state-controlled AMCs — Cinda, Huarong, Great Wall and Orient — to mop up bad loans from the country’s ailing banks. In 2012, after teetering on the brink of a payments crisis, Spain set up a bad bank — Sareb — to take over about €50 billion worth of property and loan assets from the country’s ailing banks, with the intention of turning the loans around. But while the bad banks of China and Spain have helped take doubtful assets off the banks’ hands, they themselves haven’t succeeded in fully restructuring these assets or making money off them. China’s AMCs have found restructuring not so lucrative, and have ventured into lending and investing in foreign bonds for profits. Spain’s Sareb has remained a loss-making entity from the word go.

So, while looking at the success of bad banks in the global arena, the idea of establishing such a bad bank here in the country raises question marks. We have asset reconstructions companies in place and they too are in the business of buying bad loan from the banks. Isn’t it better to strengthen the system governing functioning of ARCs rather than toying with the idea of establishing a bad bank?

In the words of an expert, even as the concept of a bad bank has worked in some countries, the kind of structure proposed to create this bank here is nothing but subjecting, infected assets into a quarantine centre. He says it is neither the vaccine nor the ventilator for bad loans.

Notably, reports quoting experts suggest that the creation of a bad bank in its present format can only provide a temporary reprieve, by enabling transfer of a large chunk of NPAs, to make the banks’ balance sheet look better. But it does not address the structural problems of resolution and is a sort of ‘window dressing’.

(The views are of the author & not the institution he works for)