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What is 'Bad Bank' And Why Centre May Use it as Policy Option in Budget 2021 to Revive Banking Sector

(For representation) Finance Minister Nirmala Sitharaman will present the Union Budget 2021 on February 1. (REUTERS/Altaf Hussain)

(For representation) Finance Minister Nirmala Sitharaman will present the Union Budget 2021 on February 1. (REUTERS/Altaf Hussain)

A ‘bad bank’ can act as an aggregator of all stressed assets in the system, including mounting NPAs, and work towards the resolution of these assets, whereas banks can only focus on business.

The Indian banking sector weathered a tempestuous year ravaged by a deadly pandemic and the subsequent worldwide economic slowdown in 2020. While the government announced a series of measures to push funds to aid small and medium-sized companies, and micro-entrepreneurs as part of its Rs 20 lakh crore economic package, the RBI, too, did its part with a slew of liquidity measures amounting to Rs 12.7 lakh crore since February last year.

However, with Indian banks burdened under mounting NPAs, the Centre is mulling creating a ‘bad bank’.

What is a bad bank?

This is a long-pending idea worth experimenting at this juncture. Indian banking system has around 8.5 per cent gross NPAs. The RBI estimates this chunk to rise to 12.5 per cent by March. If things go further south, they may even spike to 14.7 per cent in a worst-case scenario.

A bad bank can act as an aggregator of all stressed assets in the system and work towards the resolution of these assets whereas banks can focus on business.

Since the government dominates the banking system, it is imperative that the government itself spearhead the bad bank idea.

At a time when the banking system is staring at a fresh round of non-performing assets (NPAs), time is perhaps ripe for Union Finance Minister Nirmala Sitharaman to chart out the roadmap to build one.

While the idea of a bad bank has been much maligned, some sections of the government suggest that without the RBI's nod this will be a non-starter. They are of the view that excessive dependence on capital infusion to shore up funds and make up for NPAs may not be the best way forward for PSBs.

There is increasing cost to government in servicing the over Rs 3 lakh crore recap bonds. For this fiscal alone, the interest cost is Rs 25,000 crore plus repayments on the date of maturity.

What is interesting is that on December 18, DEA Secretary Tarun Bajaj, in a CII webinar, while replying to a query on the possible setting up of a bad bank had said, "Banks are an important area which we need to correct. We are looking at various options including the option that you have mentioned, it is still in the works so let us wait a bit, let us wait for a slightly longer period for us to unveil."

According to the government, public sector banks are slated to raise Rs 60,000 crore from the market this year, while Rs 40,000 crore has already been raised by PSBs via equity and bonds.

Moreover, only Rs 20,000 crore worth of PSB recapitalisation has been okayed so far for the current fiscal. According to sources, additional recapitalisation has now been sought for the remaining fiscal, although the amount is not expected to be 'large'.

The banking system is the backbone of the economy and is often called its proxy. Although it is unwise to expect the budget to offer solutions to all the problems of the ailing sector in one go, it can certainly offer a blueprint for the industry.​

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