Bad Banks: Good or Bad?

Our finance minister, Nirmala Sitharaman, has announced that Center would be setting up Bad Banks to take the stress off of financial institutions. It wouldn’t be said an unanticipated doing as the plan isn’t new and has been talked about many times in the past few years, but it certainly was a little shock nonetheless. Indian markets aren’t used to have Bad Banks around.

What is a Bad Bank?

Speaking in layman’s tongue a Bad Bank is just a dumping ground for banks to put all its bad assets. Now assume a bank carrying a very heavy bag with lots of assets, and when the weather gets deteriorated (economy goes down), that heavy bag will most probably lead the bank to its demise. In such case, the bank could make a sperate subsidiary and transfer all of its toxic (potentially and existing) and non-performing assets to it, at their actual realizable value, which, of course, is lesser than book value. Bank does get hit by a sudden loss in this way, but this helps it survive through the worsening economic times and rise again once it starts to get better.

So, Bad Banks is just a dump-yard?

In oppose to what I said earlier in layman’s tongue, Bad Banks are more than just a dump yard for NPAs, toxic and potentially toxic assets. Now think of them as a recycle bin. There are high chances that these assets might recover after a few years when the economy improves and get back on tracks. Though saying that all of them will be recovered would be a lie, but many of them will be enchased.

What does that mean in the Indian context?

Central Government has announced to set up Bad Banks which will not be subsidiary of banks, but a separate entity in itself. Bank would be welcomed to transfer their toxic assets there in order to get the stress off of their back.

As per recent studies around 8% of loans have gone toxic, aka overdue by more than 90 days. Bad Banks could be proven very essential to the economy as the number of non-performing assets are assumed to be going up after Covid times too, over 13.5% by September 2021 as per the Reserve Bank of India reports. In fact, stressed asset in Indian financing system worth over Rs. 2.25 trillion

Moreover, the government will not be owning any share or equity in these Bad Banks and they will be established as a private sector entity as private sector works more efficiently with claiming the debts.

In the end, Bad Bank is named as ‘Bad’ and ‘Bank’, but in reality, a Bad Bank is not a bank in any way, and certainly not bad.