By Ruma Dubey

There is currently talk of the Govt setting up the Bad Bank. It will be BIG and ugly. This bad bank goes under the acronym of PARA - Public Asset Rehabilitation Company.

The word “bad” has a negative connotation so cannot help but wonder how good will come from bad?

The concept of the Govt is really very simple, obviously borrowed from developed countries which have such Bad Banks. There will be this bank which will buy up all the Non Performing Assets (NPAs) of all the 28 Public Sector banks (PSBs). The PSBs, instead of writing them off, sells it to this bank, obviously at a discount and shows the profit or loss earned in the balance sheet. For the PSB, that NPA gets over the moment it sells it to the bank. The NPA buying bank will pay some money and balance might be given in the form of securities as and when it manages to sell the distressed asset.

This is broadly the concept of the Bad Bank. It is “bad” because it will be buying the bad loans. This concept began in 1988 in USA (where else!) and Melon Bank was the first to use this strategy. It held $1.4 billion of bad loans and it was dissolved in 1995. Such a Bad bank exists in UK – UK Asset Resolution, AMCON in Nigeria, National Asset Management Company in Ireland, SAREB in Spain, OHY Arsenal in Finland and Retrivia & Securum in Sweden.

The idea was first mooted in the Economic Survey and the Govt will be the majority stake owner.

Before we run down this BIG idea, let’s look at the possible advantages.

• PSBs will have cleaner balance sheets as all the bad will get transferred to PARA.
• PSB CMDs will be relieved of the onerous task of credit recovery and this new bank can do the job better as it has no relationship with the said CEO of the defaulting company.
• PSBs can concentrate on growth and shift focus from recovering credit.
• Banks get de-risked and they can become healthy enough to recapitalize themselves.

Well, now a look at the possible de-merits.

• A Bad Bank is basically transferring bad loans from 28 banks to one single bank – the NPA problem does not vanish; it just gets concentrated into one bank.
• The bank will take over only the big NPAs and of core sectors like infra and basic metals, which top the NPA list. But here itself, each company would have a debt averaging some Rs.15,000 to Rs.20,000 crore. Can you imagine how much NPA this bank will have to take over?
• Where will the huge capital required to set up such bank, which will need very deep pockets to buy NPAs, at least to the tune of Rs.70,000 crore, come from? Indradhanush itself for Rs.75,000 crore and spread over four fiscals.
• If Govt owns majority stake, where is the autonomy? The case will be exactly what PSBs are currently going through.
• Setting up a Bad bank is complex and expensive because it requires setting up a separate organization, equipped with a skilled management team, IT systems and a regulatory compliance set-up.
• The big problem – how do these banks value the assets and how do they arrive at a pricing mechanism for buying the NPAs?
• Will the bad bank sell the NPAs that it buys to investors – FIIs and others at a huge haircut? And to make them look attractive, will the Govt stand as a guarantor?
• Devising a transparent method, free from crony capitalism and conflict of interest, for identifying such projects will be a key challenge in the design of a bad bank.
• A one-size-fits-all approach, which is what this bank will do, simply will not work.

The Bad bank is nothing but an Asset Reconstruction Company (ARC) owned by the Govt.  This is just like shoving all the dirt under a new carpet. We have run out ideas and this is the best we could borrow from the West.

The bad bank will be a temporary problem as the PSBs will continue to pile up new bad debt as their way of functioning, lack of autonomy, political interference; all will remain same. The aim should be to address the root cause and that is something which this bad bank will not resolve.