With Raghuram Rajan no longer the RBI governor, there is buzz that the central bank and government may consider a policy proposal to set up a “bad bank” to deal with Indian banking sectors NPA mess. Former RBI governor Raghuram Rajan was ‘fundamentally’ opposed to the idea of a bad bank, but with Urjit Patel now heading the central bank, the situation may change. There is widespread belief that the measures taken till now to deal with the banking sector’s huge NPA (Non-Performing Assets) problem, are insufficient to counter the problem at hand. According to an Indian Express report, the “bad bank” proposal may be reconsidered.
A “bad bank” would essentially help absorb the ‘toxic assets’ from loss-laden state-owned banks and lenders, the newspaper said. The “bad bank” is meant to buy NPAs from lenders to free up their books. This would help banks do fresh lending and then “suitably dispose of the toxic assets”. An official told the Indian Express that a decision on how to better tackle the stressed banking sector is likely in the next two to three months, and in that context the bad bank proposal may come up. “It is also necessary for the finance ministry to be on board with the idea,” the official is reported to have said.
So, why was Rajan opposed to the idea? Rajan was of the view that banks should themselves recover their dues. He also believed that in specific cases where the loans are not appropriately prices, the transfer of NPA to the “bad bank” would create further issues. Additionally, he thought that for India the idea of a good and bad bank may not make sense. He felt that most of the assets backing the banks loans are viable or can be made viable.
However, the official quoted above (who did not wish to be named) said that there is increasing realisation in the government that merely recapitalising banks will not solve the NPA mess, since the problem creating assets are still not getting cleaned up. The official also cited similar international examples where bad banks have been set up successfully.
The concept of a bad bank came from Mellon Bank in 1988 in response to problems in the bank’s commercial real-estate portfolio. According to McKinsey & Co, the concept of a “bad bank” has been applied in previous banking crises in Germany, France and Sweden. The plan to reconsider the bad bank proposal in India comes at a time when the gross bad loans as a percentage of the total bad loans has almost doubled to 8.7% as of June.