[Jan] Bad bank Flashcards
What is it?
A bad bank conveys the impression that it will function as a bank but has bad assets (NPAs) to start with. Technically, a bad bank is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time. The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans. The takeover of bad loans is normally below the book value of the loan (A Rs. 100 crore loan of a bank can be purchased by a bad bank in just Rs. 40 crore because the present value/valuation of loan has decreased as it has turned bad) and the bad bank tries to recover as much as possible subsequently.
The bad bank concept is in some ways similar to an Asset Reconstruction Companies (ARC) [which purchase NPAs from banks and they do recovery] but is funded by the government initially, with banks and other investors co-investing in due course. The presence of the government is seen as a means to speed up the clean-up process.
Benefits of bad banks?
This helps banks or FIs clear-off their balance sheets by transferring the bad loans and focus on its core business lending activities.
Large debtors have many creditors. Hence bad bank could solve the coordination problem, since debts would be centralised in one agency.
It can effect speedier settlements with borrowers by cutting out individual banks.
It can drive a better bargain with borrowers and take more stringent enforcement action against them.
It can raise money from institutional investors rather than looking only to the Government.
Issue with bad banks?
it has to take a haircut because when Rs 100 goes bad, the actual amount that can be expected is lower than Rs 100 and that leads to haircut. When it takes haircut that will impact the P&L (Profit & Loss).
K V Kamath committee?
said companies in sectors such as retail trade, wholesale trade, roads and textiles are facing stress.
