Saturday Brain Storming Thought (151) 05/02/2022


A Bad Bank is a corporate entity that alienates illiquid and risky assets held by banks and financial institutions or a group of bank

It is created to help banks clear their balance sheets by transferring their bad loans so that the banks can focus on their core business of taking deposits and lending money

A Bad Bank structure may also assume the risky assets of a group of financial institutions, instead of a single bank

Bad Loan

A Loan that will not be repaid


When a bank stops receiving payment of principal and interest towards a particular loan for more than three months, that loan account is treated as NPA

Bad Debts

When the borrowers of a bank start defaulting on their payments reverently, the loan accounts are categorised as Bad debts

And when these bad debts spike beyond manageable limits, a separate bank might have to be created to look after them collectively

This new bank is called a bad bank

History about Bad Bank

The first bad bank was created in 1988 by US-based Mellon Bank to hold it’s stressed assets

Following this success, it became a phenomenon of sorts and the model was followed in several countries as the US, Finland, Sweden, Indonesia and Belgium

Now India’s Finance Minister Nirmala Sitaraman has formally expressed it’s intent to start a bad bank but the bigger challenge would be to sell those stressed assets to prospective buyers to resolve the crisis

Weak Bank

A weak bank is one whose liquidity or solvency is or will be impaired unless there is a major improvement in its financial resources, risk profile, strategic business direction, risk management capabilities and/or quality of management

Proposed Model for a Bad Bank

1) the proposed structure envisages the setting up of a National Asset Reconstruction Company (NARC) to acquire stressed assets in an aggregated manner from lenders, which will be resolved by the National Asset Management Company (NAMC)

2) A skilled and professional set-up dedicated to Stressed Asset Resolution will be ably supported by attracting institutional funding in stressed assets through strategic investors, AIFs, special situation funds, stressed asset funds, etc for participation in the resolution process

3) further, transferring these stressed assets to bad banks will entail recovery of 15% cash and 85% in sovereign guaranteed security deposits

This government guarantees but will carry a zero-risk weight, for a specified period of time

4) the net effect of this approach would be to build an open architecture and a vibrant market for stressed assets

Arguments for Bad Banks

1) Providing lending leverage to banks

a) capital being freed up from less than fully provisioned bad assets

b) capital freed up from security receipts because of sovereign guarantee

c) cash receipts that come back to the banks and can be leveraged for lending, also freeing up provisions from the balance sheet

2) International Precedent

a) the US implemented the Troubled Asset Relief Program (TARP) after the 2008 crisis, which help the US economy after the Subprime crisis

b) it was modeled around the idea of a bad bank

3) Revival of Credit Flow Post-Covid

Some experts believe that a bad bank can help free capital of over Rs 5 lakh crore that is locked in by banks as provisions against bad loans

Arguments against a Bad Bank

1) Not a Panacea

a) it is argued that creating a bad bank is just shifting the problem from one place to another

b) without fundamental reforms to solve the NPA problem, the bad bank is likely to become a warehouse for bad loans without any recovery taking place

2) Tight Fiscal Position

a) an important concern is regarding mobilizing capital for the bad bank

b) in an economy hit by the pandemic, it is hard to find buyers for distressed assets and the government is also in a tight fiscal position

3) No clear procedure

a) there is no clear procedure to determine at what price and which loans should be transferred to the bad banks

b) this may create political Challenges for the government

4) Moral Hazzard

Former Governor of RBI, Raghuram Rajan believes that setting up a bad bank may also create moral hazard problems among the banks that would enable them to continue with their reckless lending practices, further exacerbating the NPA problem

Introduction of Bad Bank in India

On 16 September 2021, Finance Minister Nirmala Sitaraman announced the setting up of a bad bank, which the center had earlier proposed in its 2021-22 Union Budget
Bad Bank Initiative

The bad bank, designed to take over Rs 2 lakh crore worth of NPAs (non-performing assets) from domestic banks was incorporated in July and is called National Asset Reconstruction Company Ltd (NARC)

Funding for Bad Bank

Public Sector Banks (PSBs) and Public Fls will hold a maximum of 49% stake and the rest will be with private sector lenders

1) Rs 30600 crore government guarantee for security receipts issued by the NARCL as part of the resolution of bad loans will be valid for a period of five years

2) an India Debt Resolution Company Ltd will also be set up


National Asset Reconstruction Company Ltd

NARCL has been incorporated under the companies act and has applied to RBI for a license as an Asset Reconstruction Company (ARC)

NARCL has been set up by banks to aggregate and consolidates stressed assets for their subsequent resolution

PSBs will maintain 51% ownership in NARCL

India Debt Resolution Company Ltd (IDRCL)

It is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts

Detection time for bad loans

Average lag time of 57 months in the detection of large bad loans

Challenges for Bad Bank

1) it is not easy to reduce the bad loans in the country

2) recovery of bad loans is a tough task in a democratic country like India because banks are under several political interferences

3) Banks can’t take severe steps against the wilful defaulters due to political pressure

4) Many loans are distributed under political interference

5) these defaulters have political asylum, that is why debt is not paid on the due date

Working of NARCL – IDRCL and Guarantee offered

1) The NARCL will first purchase bad loans from a bank

2) it will pay 15% of the agreed price in cash and the remaining 85% will be in the form of security receipts

3) when the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest

4) if the bad bank is unable to sell the bad loan, or has to sell it at a loss, then the government guarantee will be invoked

5) the difference between what the commercial bank was supposed to get and the bad bank was unable to raise, will be paid from the Rs 30600 crore that has been provided by the government

6) this guarantee is extended for a period of five years

Security Receipts

Section 2(1) (zg) of the SARFAESI Act

It means a receipt or other security, issued by an ARC to any qualified buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder, thereof, of an undivided right, Title or interest in the financial asset involved in securitization

Key Takeaways of Bad Bank

1) Bad banks are set up to buy bad loans and other illiquid holdings of another financial institution

2) critics of bad banks say that the option encourages banks to take undue risks leading to moral hazard, knowing that poor decisions could lead to a bad bank bailout

3) Examples of bad banks include Grant Street National Bank

Types of Bad Bank Structures

1) Bad-bank spinoff

The most common structure, in which a bad bank is created as a legally separate entity to hold bad assets

2) On-Balance sheet guarantee

Banks protect a portion of their portfolio against losses with a guarantee backed by the government

3) Internal restructuring

Establishes a separate, internal unit to isolate bad assets, often used when toxic account for more than 20%™αof a banks balance sheet

4) Special-purpose entity

Undesirable assets are transferred from a banks balance sheet to a bad bank, which is usually sponsored by the government

Benefits of setting up a Bad Bank

1) asset Monetisation, it’s the process of turning a non-revenue-generating item into cash

2) bad assets would stay in the risky category, while the good one stays in the other category, saving them from mixing together

3) since 40% of the NPA is concentrated only in 60 firm’s, so better we create a centralized agency PARA, which will work as a bad bank and absorb the losses from PSBs

4) since a bad bank specializes in loan recovery, it is expected to perform better than commercial banks, whose expertise lies in lending

5) the recent IBC amendments make it complex for foreign players to take part in the resolution

6) experts believe a vehicle like AMC or ARC that could address the stressed loan issue, till the bankruptcy code stabilizes, could be beneficial

7) a single government entity will be more competent to take decisions rather than 28 individual PSBs

8) capacity building for a complex workout can be better handled by the government which has regulatory control and has management skill sets in public sector enterprises

9) foreign investors with both risk capital and risk appetite would be more in a government-led initiative, knowing that regulatory risks would stand considerably mitigated in various stages of resolution, including take-outs

Compiled by:-

Avinash Kulkarni

Chartered Engineer, Govt Regd Valuer, IBBI Regd Valuer

error: Content is protected !!
Scroll to Top