Can a ‘Bad Bank’ Solve the Growing NPA Crisis?
The rise of non-performing assets (NPAs) in the banking sector has become a significant concern in recent years, particularly in light of the economic downturns and market crashes. Despite the efforts of various regulatory bodies and policymakers to address this issue, the problem persists. One potential solution that has been proposed is the establishment of a ‘bad bank’.
The Concept of NPAs
An NPA is a classification assigned to a loan when it remains unpaid for more than 90 days. This problem can arise due to various reasons, including economic downturns, unscrupulous lending practices, and government exemptions for certain types of loans.
Historical Context and Challenges
Before the 2008 economic crisis, economists projected a boom, leading to a surge in heavy loans that borrowers failed to repay once the market crashed. Moreover, banks often granted loans without stringent verification of borrowers' credit scores and were too compliant with government regulations, such as the exemption of agricultural loans from PSBs (Public Sector Banks), which increased the NPAs of these institutions.
The Role of a Bad Bank
A bad bank is an asset management company tasked with managing and recovering NPAs on behalf of commercial banks. The concept was introduced during the tenure of Raghuram Rajan as the Reserve Bank of India (RBI) governor to address the issue of hidden NPAs. The utility of a bad bank lies in its potential to streamline the recovery process and reduce the workload on commercial banks, thereby enhancing their operational efficiency.
Government Involvement and Transparency
The government stake in a bad bank serves to ensure a faster and more effective recovery process. It also helps in identifying and punishing any involved entities or individuals involved in the non-recovery of loans. However, the success of a bad bank depends on various factors, including government efforts to identify and punish the culprits swiftly and to clearly outline the operational framework.
Challenges and Previous Experiences
While the idea of a bad bank sounds promising, its implementation faces several challenges. Critics argue that it might merely transfer stressed assets to the government without resolving the root causes of the problem. For instance, the evaluation of loan proposals often lacks a sound footing, and post-sanction follow-up is inadequate, leading to overdue accounts and eventually NPAs.
Global Examples of Failure
Previous attempts at establishing bad banks in countries like Mexico, Brazil, Argentina, Italy, Greece, Turkey, South Korea, Malaysia, and Indonesia have not been successful. In India, a similar approach was also attempted but faced similar issues. The core problem remains the lack of professional management and the inability to address the underlying issues of loan evaluation and post-sanction follow-up.
Way Forward
To enhance the effectiveness of a bad bank, commercial banks should adhere to the Basel guidelines while lending. Strict evaluation of borrowers' credit scores and post-sanction follow-up are crucial to prevent overdues and NPAs. The success of a bad bank is not guaranteed, but it can serve as a step in the right direction towards better loan management and recovery.
Conclusion
While a bad bank may not solve all the problems, it can be a valuable tool in managing and recovering NPAs. The key to its success lies in robust governance, transparency, and a clear operational framework. The involvement of the government and the strict adherence to loan evaluation and follow-up processes are essential for the effective functioning of a bad bank.