What is a bad bank and why Centre may set one up

The Centre is mulling setting up a bad bank to deal with the rising NPAs in Indian lenders

The Covid-19 pandemic, ensuing lockdowns and the state of the Indian economy have significantly ravaged the banking sector of the country. While the Centre rolled out a Rs 20-lakh crore package for the small and medium companies, the Reserve Bank of India (RBI) also announced liquidity-boosting measures to the tune of Rs 12.7 lakh crore.

The banks, however, face a burgeoning number of bad loans or non-performing assets (NPAs). To address this issue, the Centre is contemplating setting up a bad bank.

What is a bad bank?

A bad bank is an institution which acts as the aggregator of all stressed assets in the system. Lenders can then focus on regular business activities and growth, while the resolution of these assets can be taken up solely through the bad bank.

With rising NPAs in the Indian banking system, this idea has been on the table for a while. Presently, lenders have 8.5 per cent gross NPAs, which, as per RBI expectations, is set to to rise to 12.5 per cent by March. With a new round of NPAs ahead due to the pandemic, this is being dubbed as the perfect time for Union Finance Minister Nirmala Sitharaman to build a bad bank.

Experts quoted in a News18 report suggest that without a nod from the central bank, it is unlikely that a bad bank will be set up. It is believed that the reliance on the RBI for funds and resolution of NPAs is not the way to go for banks.

Lenders have raised Rs 40,000 crore through equity and bonds, while the government has said that banks will shore up Rs 60,000 crore from the market this year. The Centre has also approved a recapitalisation exercise worth Rs 20,000 crore this fiscal.