What is a bad bank and its function?
A bad bank is an institution that takes over blind loans and other illiquid assets from lenders and helps them start over with a clean slate. Such a mechanism helps a bank segregate its good assets from bad assets, making it easier for it to raise capital by issuing equity or debt, or both. The segregation of toxic assets helps instill confidence with potential investors who can then examine the lender’s financial health with greater clarity. Additionally, by transferring credit to a bad bank, lenders can prioritize business funding while allowing a specialized institution to focus on maximizing credit recovery.
Why is it suddenly being talked about now?
the Indian economy slipped into a technical recession and shrunk in the first two quarters of this financial year. This year it is expected to shrink by 7.5%. The pandemic lockdown put in place to contain Covid infections has already hit corporate and individual revenue, affected their ability to repay loans and potentially sparked a surge in banks’ distressed assets. Despite regulatory leniency in the form of a credit moratorium, many borrowers can find it difficult to service their loans, and lenders must reserve capital to cover these losses. A bad bank can set you free to start lending.
Were there parallels around the globe?
Bad banks resonated during the 2007-09 global financial crisis. Citigroup has transferred approximately $ 900 billion in loans to its bad bank unit, Citi Holdings. Bad Banks also helped Barclays and Bank of America get over their stresses. The Republic of Ireland set up a bad bank to get its financial chaos under control.
Why is it important to fight toxic credit?
Banks and other financial institutions are the main drivers of economic growth because they are the formal credit channels. As things stand, lenders, especially government ones, are facing massive non-performing loans. This has made them risk averse and undermined their ability to lend to fuel economic recovery from the shock of the Covid-19 pandemic that rocked the world. Banks will find it difficult and exorbitantly expensive to raise capital on the market if the development of asset quality remains uncertain and economic growth is delayed or even endangered.
Should the center set up a bad bank?
If a bad bank removes bad loans from the banks’ balance sheets, that is a good idea. However, the center is not yet enthusiastic about the idea. Finally, there are several private asset recovery firms that buy bad loans at a discount. Also the Bankruptcy codealthough not perfect, contributed to higher recoveries. The question also arises of the moral hazard a government-funded bad bank can create by allowing reckless lending to continue. There are also fears that in the end there will be another case where good money is thrown after bad.
Never miss a story again! Stay connected and informed with Mint. Download our app now !!