Indian Finance Minister Nirmala Seetharaman announce in the Budget (2021) that sooner India will have their First Bad Bank. Now Question arises, what is Bad Bank?
We will look into the matter and will know that is it a newer concept or some other country had also used this concept before. This is a Financial Organization which will Purchase Non-Performing Asset (NPA) from the Bank and will sell into the Market. It is also called Asset Management Company.
The Government of India Introduces the NARCL (which will purchase the Non-Performing Asset from the Bank) and IDRCL (which helps in Selling the NPA and collect Money).
To work this complete Structure Government funded Rs 30,600 crores of money to NARCL so that It will purchase NPA from the Bank. After Purchasing NPA from the Bank, NARCL will give 15% of the Money to Bank and Remaining 85% of the Money will be Returned in 5 years.
So, It is nothing but a combination of NARCL and IDRCL. If Everything goes fine, Government is estimated to recover Rs 2 Lac crore from the Bad Debt.
Bad Bank = NARCL + IDRCL
Terms & Definition
- NPA: NPA is Non-Performing Asset. When Bank gives Loan to Individual or Company and the Individual or Company neither pay Installment within 90 days nor give Loan Interest amount, then Bank considered that Loan as a Non- Performing Asset. It means the Asset which do not generate revenue.
- NARCL: National Asset Reconstruction Company Limited. It will help in Purchasing Non-Performing Asset from the Bank and return money at 15:85 structure in which 15% of the money will be immediate given in cash and issue security receipt for the remaining (85%).
- IDRCL: India Debt Resolution Company Limited. It will help in Selling the Non-Performing Asset throughout the country
Why Bad Bank is Required?
A very common question is raised that Bank have the recovery agents then why this structure is required?
Yes. The Bank have Recovery agent but they are placed or employed to recover low amount of money. The Core work of a Bank is to get deposit and provide Loan to the customers. It also creates a Bad name if Bank sells the Stressed Asset or involve in recovering Loan. Also, The Recovery Agent do not involve in Recovering High Amount of Money.
This Structure will help in resolving Stressed Asset worth more than Rs. 500 crores. Every year the amount of Bad Debt/Loan is Increasing and it is estimated to touch Rs. 8.50 lac crore till date.
So, To Tackle the Situation the Government of India Introduced the Bad Bank Structure so that immediate action can be taken place on Stressed Asset. This Structure helps in recovery of Loan and will clean the Balance sheets of Bank. So, It is required to minimize loss and the Bank should focus on their core job of giving Loan
Bad Banks Model
There are 4 basic Model . Below is the details
- On Balance Sheet Guarantee
- Special Purpose Entity
- Internal Restructuring
- Bad Bank Spin Off
On Balance Sheet Guarantee: In this Model, Bank gets Government
Guarantee on NPA. So, The Bank do not need to provide any capital.
For example: There is a Bank called PQR whose NPA has increased unbelievably. Now, In Such Situation Government Guarantees for Such NPA. It means that Bank do not have to spend capital on NPA ( it do not have to spend capital on process of getting NPA).
Now, The Bank can give Fresh Loan to customers.
- Special Purpose Entity: Here Bank transfers all its Bad Assets to the Government backed another Organization (AMC) .
For Example: All the NPA of Bank (say PQR) is transferred to the Government Backed AMC (Here the Government or Central Bank creates an Asset Management Company).
Now, This AMC will manages the NPA. So, in this Way the Bank can concentrate on their Core Job of giving Fresh Loans to the Customers.
- Internal Structuring: Here the Bank creates the Separate Unit or Subsidiary to hold the Bad Asset. The Risk is still covered by the Main Bank.
For Example: PQR Bank creates a Separate Unit called PQR Asset Management Co. and transferred all its NPA to this AMC. Since It is a Subsidiary, Risk arising through NPA is always be a part of Main Bank because In the Financial Statement, you still have to maintain Capital to Risk Related Assets Ratio.
- Bad Bank Spin Off: Here Bank make a new Independent Bank to hold its Bad Asset. Here Bank (say PQR) creates an Independent Bad Bank to take care of their NPA.
Some Bad Banks in World
The concept is not a new one. Here we will look a couple of Bad Banks who help in resolving the financial loss.
Mellon Bank , USA (1988)
Mellon Bank is the first Bank to use the concept of Bad Bank. This Bank surrendered to massive Non-Performing Asset or Bad Loan which was more than $1 billion.
So Mellon bank was unable to raise fresh capital at decent interest rates and it was compelled to reject new applications because the Bank do not have any capitals to accept new loan applications.
Then Non-Performing Loans of Mellon Bank is transferred into a separate Bank, it helped clean up their balance sheet. It allows them to continue their Loan operation and boost up their finances and in due course it stabilizes earnings.
A new names Grand Street National Bank was made and with the help of Investment Bank Drexel Burnham Lambert (They Purchase all the Bad Loans $1 billion from Mellon Bank with a discount of $575 million in cash and securities) , All the Bad Loan and NPA which were transferred to them were resolve, reshuffled or reconstructed and they were Securitized and then they were Sell off.
Over period of time All the money was successfully recovered. Here they follow the Model called Bad Bank Spin Off Model
Sweden Financial Crisis (1994)
In Sweden, Housing Loan Bubble burst between 1990-1994, It is just similar to Subprime mortgage crisis (2007-2008) , severe credit crisis happened and many banks became bankrupt.
Swedish Government, with the help of Mckinsey and Company (Consultant), they fill capital in a new asset management company called Securum. Now, Securum took over 3000 loans from Nordbanken which were comprising of around 1274 companies and it tried to do restructuring, resolution, settled and everything.
So Nordbanken was relieved from the bad loans and the model became successful. The Model comes under Special Purpose Entity.
Bad Bank is a Separate and Focused Entity which only looks on the NPA so that Financial Loss should be resolved or minimized. It helps the Bank to do their Core Job of Lending Loan so that the Bank can earn.