In her latest Budget-2021 our Finance Minister has floated the idea of BAD BANK. The concept behind the Bad Bank is to clean the Balance Sheet of all the PSU Banks which are getting clogged due to rising NPAs. The Government intend to open a separate bank which will take over all the NPAs. Government will deal with all those bad loans separately, so that banks are able to focus on fresh business.
Is it a good idea to open a separate bank to take over the Bad Loans of Nationalised banks? Presently there is a system of ARCs which are registered with RBI under Section-3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. There are many ARCs registered in India (majorly with foreign equity participation under Automatic route) which take over bad loans at negotiated rate, which extend up to 90% haircut in some cases, and thereafter, ARCs deal with such loans as per their choice. ARCs buy bad loan only if they find viable for their businesses and appear lucrative to them, otherwise they may not take over such bad asset of the bank. To overcome this deficiency, I think the idea of Bad Bank is floated.
Since ARCs are registered with RBI and they have to follow certain defined guidelines, in my opinion their scope of work could have been expanded rather than floating a new idea of Bad Bank and investing resources into it. Govt can infuse some equity into these ARCs and take managerial control of these entities, so that transfer of Bad Loan should not be left to the absolute discretion of these ARCs. This will save time, effort and resources of the Govt rather than floating a new Bank (or rather a Bad Bank).
If we analyse the reasons for rising NPAs, we can easily conclude that banks have failed to do due diligence/appraisal properly and loans were disbursed on face value of the promoters or relationship with the top management. If this trend continues, Govt may require several Bad Banks rather than opening only one bank.
Another reason for deterioration of bank’s health is distribution of small loans under various Social Schemes. From time to time Govt. come out with schemes of distributing small loans like Mudra Loan or loan schemes for small vendors who sit on the road side which are bound to go NPA and even before distribution Govt knows that this money is not likely to come back. However, due to various political and regional challenges, Govt sets target for the Nationalised Banks to release these small loans and bank officials are left with no option but to disburse these loans and it adversely affects the overall health of the bank.
Unless Govt exercises financial discipline in the country, does not stop giving/waiving loans for furthering political gains, stop giving loans to unviable big corporates, Bad Bank cannot save the health of these PSU banks.
There are still many unanswered questions in the proposed scheme of Bad Bank:
- What will be the criteria for selection of an Asset to be shifted to Bad Bank?
- Whether all loans will be shifted or only few select loans will be taken over?
- What will be the hair-cut for the transferring bank?
- What will be the mechanism of compensation to the transferring bank? Will that be one time or staggered?
- How the Govt will deal with such loans after takeover?
- What will happen to Govt sponsored loan schemes?
There was a clarification by our FM in Media regarding the concept of Bad Bank. As I could understand from her statement, there’s still no clarity as to how the proposed Bad Bank will operate. There’s no earmarked source from where money will be used to fund the new bank. As per her statement “investors have to bring their own money to run this bank and since PSU banks will be beneficiaries of this scheme, they should also invest in this bank”. In my view this is a very confusing statement and this announcement is without proper homework at the end of the Government.
Even if banks disburse advances after all kinds of checks and balances, there will always be some NPAs. Some businesses will always fail and some banks will always make bad loans. But these do not become insurmountable problems except in the event of external shocks. And these are manageable, if the business environment in the country is good and the banks are well run and regulated.
In my concerted opinion, we should not allow private players where stake of public in general is involved. A bank can be private, but the funds belong to Public at large. Such matters be “handled with extra-care”
Thank You
CA Kanta Sharma
(Senior Partner)
GRANDMARK & Associates
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