Bad Bank or Asset Management Company for Public Sector Banks

Setting up of a Bad Bank or Asset Management Company for Public Sector Banks (PSBs) has been in the consideration of the central government since 2017. The idea has gained momentum again in the wake of mounting non-performing assets in the Indian public sector banks. 

What is a bad bank or asset management company for PSBs? 

The bad bank or asset management company is basically is a company for the purpose of asset reconstruction. The idea of establishing a Public Sector Asset Rehabilitation Agency is mooted for taking over the bad assets of public sector banks so that PSBs can focus on the core business of lending to aid economic activities. The idea is that the bad bank would take over all the bad loans of public sector banks and focus on realization of the amount or settlement of liability. In case of failure to settle the liability or revive the unit,  bad bank would try to extract the residual value from underlying asset. 

There are more than 20 private sector Asset Reconstruction Companies (ARCs) in India. They were constituted as envisaged under the SARFEASI Act. They are empowered to purchase bad assets of banks including public sector banks and financial institutions.  Unlike the private counterpart, a government-owned bad bank would be concentrating on the loans with no salvage value continuing in the balance sheets of public sector banks. This action, in an indirect way, aims to bail out public sector banks. 

Is the NPA position in public sector banks grave? 

Let us examine the present position of NPAs in banking system. As on March 31, 2018 the quantum of Gross Non-Performing Assets (GNPAs), or bad loans of banks in India is Rs 10.25 lakh crore. This represents 11.8 % of total loans given by banking industry.  The growth in GNPA in FY 2017-18 alone is to the tune of Rs 3.13 L crore.   The alarming position of growth in bad loans is evident from the fact that the GNPA was only Rs. 2.50 L crores on March 31, 2014.    
Indian banks can be broadly segregated into two categories; private sector banks and public sector banks. With shareholding of more than 50%, government is the owner of 21 public sector banks. These PSBs account for about 90% of GNPA(Rs. 8.97 L crore).  The 18 private sector banks are in a better position with just Rs. 1.28 L Cr bad loans. 

In terms of quantum,  SBI  leads the chart with 2.23 L Cr. In banks like IDBI bank, the GNPA amounts for more than 25% of assets. Huge provision to be set apart for bad loans forced many banks to register losses. One of the major conditions for keeping banks under Prompt Corrective Action (PCA) with restrictions on functions by RBI is percentage of NPA.  Many PSU banks are already under PCA and many more are on the verge of categorization. 

Who will fund the bad bank for purchase of bad loans? 

Significant capital will be required to be pumped into the bad bank to purchase at least a major portion of gross NPAs of Rs. 8.97 L Cr GNPA of PSBs.  Majority holding of bad bank is expected to rest  with the government. This will lead to minimal operational freedom and private participation is likely to be minimal. Further, performance of  private sector asset reconstruction companies have not been robust.  Realizing the precarious situation, the Chief Economic Advisor of the government has indicated that a significant portion of investment in bad bank should come from Reserve Bank of India, the regulator of Indian Banking System. This being unlikely, the government alone will have to pump in huge quantum of amount into the bad bank to bring it into action.  

Will bad bank help PSBs to stand on its own? 

The reasons for increase in bad loans are many. Poor performance of infrastructure segment in general and power sector in particular is a major cause of accumulation of NPAs. Other reasons are poor corporate governance of PSBs and political interventions for lending and preventing recoveries.  
Last year, the government offered Rs. 2.11 L Cr  for the capitalization of the public sector banks. Rs. 90,000 Cr was released too. But due to the huge jump in provision for bad loans and consequent losses, nothing was left to serve as growth capital. Mounting NPAs and risk aversion have prevented banks from lending even to most eligible customers. Hiving off the NPAs from PSBs will definitely provide them confidence to concentrate more on the core business of lending. But, till the corporate governance issues are sorted out and political interferences are eliminated, PSBs may fail to register steady growth.