The biggest problem that banks in India deal with is that of Non-performing assets (NPAs). Before we understand what NPAs are, let’s understand what an asset is, and how a bank earns a profit.
A bank gives out loans to people or businesses who need money. In return, it charges interest on the principal (principal is the money it has loaned). The interest on the principal is equal to the profit that the bank earns in this transaction. Hence, when it gives a loan, it earns profit on it, making the loan an asset for it.
But, what if the person/business who borrowed this money fails to return it? In this case, the asset has turned out bank for the bank, right? It hoped to earn a profit on the money that it had loaned, but now the recovery of even the principal amount is not possible.
So, the bank has lost money on the overall transaction, and the asset becomes a non-performing asset or NPA. A few NPAs in the bank’s portfolio are inevitable, but what if their size becomes too large? In that case, the profit of the bank reduces drastically as it has to set aside large provisions to cover up for NPAs.
Moreover, it avoids lending to small businesses because it fears that they will default. So, it becomes very cautious in lending loans and doesn’t approve them for any business that may seem even remotely risky. As a result, people with no accumulated wealth who need loans the most to start a new venture don’t get any support from banks.
A very counterproductive effect of NPAs in Public Sector Banks is that it requires taxpayers’ hard-earned money to save such banks from going out of business. Basically, when a government-owned bank has a lot of accummulated NPAs, then they use tax money to inject capital in the bank so that bank’s lending activities are not affected.
How Big Is The Problem Of NPAs In India?
Indian banks have been in trouble ever since the Global Financial Crisis of 2008. In early 2000s, business sentiments were positive. Banks were willingly giving out loans but it all collapsed during the GFC 2008. Businesses floundered and as a result, they couldn’t repay the money they had borrowed.
This led to the Twin Balance Sheet Problem, i.e. the balance sheet of both banks and companies were struggling.
Then of course, there are financial scams that lead to NPAs. Remember the infamous Vijay Mallya and Nirav Modi scams? Of course, they individually contribute very little to the whole problem, but collectively, it is still a lot.
In 2020, the COVID-19 pandemic hit and many small and medium businesses had to bear the brunt of it. Economic activity got severely affected. As a result, they couldn’t repay the loans they had borrowed, adding to the problem of NPAs.
Read More: Demystified: What Is A Bad Bank; The Debated Concept Introduced By Arun Jaitley & Now Piyush Goyal
The Need For Bad Bank And How It Functions
Due to the mounting problem of bad loans, the formation of a bad bank was suggested. The purpose of this bank would be to take over all the NPAs from the banks so that the latter can continue with their normal activities without stressing about this problem.
Finally, our Union Finance Minister Nirmala Sitharaman has announced the formation of a bad bank or National Asset Reconstruction Company Limited (NARCL) and allocated the budget of Rs 30,600 crore to it.
It will acquire stressed assets worth Rs 2 lac crore from banks. But, what will it do by accumulating such loans? It would sell the stressed assets in the market for which a separate entity called India Debt Resolution Company Ltd (IDRCL) has been set up.
NARCL would buy NPAs from the bank by paying 15% of the cost. The remaining 85% would be paid back to the bank after the NPA is successfully sold off in the market.
But what if they can’t sell the asset or sell it at a loss? This is why the government has allocated Rs 30,600 crore to it. This money would be used in exactly such conditions to pay back the bank.
Would A Bad Bank Be The Solution To India’s Growing NPA Crisis?
Not really. The thing is, the stressed asset is still there. Its ownership is just shifted from one bank to another.
Moreover, who will buy these NPAs in the market? These NPAs have been there for a very long time and the banks could not figure out a solution to resolve them till now. So, who will take enough risk to actually buy these assets?
But from the taxpayers’ perspective, it is not a solution, not really. It is just a temporary fix. But, the overall problem would be solved only when the lending pattern of banks is made better.
Surveys show that it is big businesses and influential people who are responsible for this problem majorly. Not small farmers and businessmen. Despite this, banks continue to give loans to the former while rejecting the latter. As a result, the underlying problem is never solved.
So Why Is It Good?
It would definitely provide relief to the commercial banks, which can take their minds off these NPAs and focus on their regular work of lending and depositing money. They would get the money from the bad bank for all their stressed assets.
Moreover, it will empower them to give out loans to MSMEs as well and not just big businesses because they know that the risk of default is covered by the NARCL. This gives our economy a major boost and also uplifts the socially and economically backward people.
Experts also believe that it would help free up the capital that’s been set aside as a provision against the bad loans. The value of that is close to around Rs 5 lac crore.
So, having a bad bank is a good idea, but that alone does not solve many root problems. But it is, nevertheless, a good start.
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This post is tagged under: bad bank, narcl, national asset reconstruction company limited, indian banks’ association, nirmala sitharaman, finance minister of india, arun jaitley, banks, non performing assets, npa, bad assets, loans, balance sheet, banks biggest problem, india, economy, finance