BAD BANK
Govt considers ‘bad bank’ proposal despite doubts.
FinMin officials say an announcement could be made in the Budget
Arup Roychoudhury & Dilasha Seth
BS February 19, 2016
The Centre is likely to set up a “bad bank” to take over the non-performing assets (NPAs) of the country’s financial institutions, and is examining a policy proposal paper on the matter.
As such, the setting up of an asset reconstruction company backed by the sovereign is a long-drawn process and these are still early days. Even then, senior government sources say Finance Minister Arun Jaitley might make an announcement in the upcoming Union Budget as part of his medium-term plans for the financial sector. There have been inter-ministerial discussions on the matter.
Earlier in February, Reserve Bank of India (RBI) Governor Rajan had said there was “no need” to set up a separate “bad bank” to deal with stressed assets of public sector (PSU) banks. “PSU banks themselves have the backing of the government, so there is no need to create a new entity that has the backing of the government. The issue is now to clean it up,” he had said at an event in New Delhi.
Rajan had also said the pricing of assets of a government-owned bad bank could get entangled with the Comptroller and Auditor General or the Central Vigilance Commissioner.
“The government is examining the proposal of setting up a ‘bad bank’, which will take over NPAs of public sector lenders and help them clean up their books. Deliberations with stakeholders are in the initial stages,” said an official.
The third quarter of financial year 2016 saw a sharp rise in banks’ NPAs because of stress in sectors like steel, power and infrastructure.
“The (RBI) governor has made valid points, which will be taken on board. However, there is no rule that says if the regulator is opposed to something it should not or cannot be done. A decision will be taken considering all views,” the official added.
The asset reconstruction company would not be RBI’s problem as it would just take over toxic assets of banks, said another official. However, experts say a bad bank alone will not be a solution, it will have to be ensured that banks do not fall back and come up with more toxic assets.
Sources said the idea was being drawn from various countries that had set up such banks, the latest being the Troubled Assets Relief Program (TARP) by the US Treasury after the collapse of Lehman Brothers in 2008.
However, the aim will be to ensure that the exchequer does not take the entire financial hit and that banks themselves be asked to pick up the burden once they have cleaned up their books. Under the Indradhanush scheme, while the government’s promise of recapitalising PSU banks over a three-year period seems to be on track, it seems inadequate considering the scale of stress. Of the Rs 25,000 crore meant for 2015-16, the government has pumped in about Rs 20,000 crore in 13 PSU banks so far. The government will infuse another Rs 5,000 crore in the current financial year to strengthen bank balance sheets. PSU banks will get Rs 25,000 crore in the next financial year, followed by Rs 10,000 crore each in 2017-18 and 2018-19.
For the December quarter, almost all state-owned lenders reported lower profits or slumped to losses on the back of higher provisioning for NPAs. State Bank of India Chairman Arundhati Bhattacharya has warned that the level of NPAs might rise in the March quarter, even as Jaitley promised further steps to deal with the situation.
THE PROPOSALS
Centre studying proposal paper on govt-backed asset reconstruction company / ‘Bad bank’ to take over NPAs of PSU banks and help them clean balance sheets / Banks expected to bear the burden of such a move / Sources say deliberations at an early stage.
COMPILED BY ME
MY LETTER TO BUSINESS STANDARD ON BAD BANK
BAD BANK
MY LETTER IN TODAY’S BUSINESS STANDARD …..
Following is the edited version of my letter published in today’s BS:
Letters: Managing a bad bank
Business Standard, February 21, 2016
With reference to the report, “Govt considers ‘bad bank’ proposal despite doubts” (February 20), the idea is worth a try. A “bad bank” will basically buy the bad loans of a bank with significant non-performing assets (NPA) at the market price. By transferring bad assets of an institution to a “bad bank”, banks will try to clear their balance sheets of toxic assets but will have to take write-downs. Shareholders and bond-holders, but not depositors, would likely lose money from such a move.
The history of banking worldwide contains several instances of bad banks. One oft-cited example is Grant Street National Bank, which was set up in 1988 to house the bad assets of The Bank of New York Mellon. The US sub-prime mortgage collapse of 2008 revived interest in bad banks as a solution, as managers at some of the largest banking institutions considered segregating their NPAs into bad banks.
In 2009, a report by McKinsey & Company identified four basic models for bad banks: 1) In an on-balance-sheet guarantee, the bank uses some mechanism (typically a government guarantee) to protect part of its portfolio against losses. While simple to implement, this situation is difficult for investors to assess; 2) In an internal restructuring, the bank creates a separate unit to hold the bad assets. This solution is more transparent, but doesn’t isolate the bank from risk; 3) In a Special Purpose Entity, the bank transfers its bad assets to another organisation, typically one backed by the government. Such a solution requires substantial government participation.
The Reserve Bank of India (RBI) and the finance ministry have to pick the model that best suits their needs.
Several experts are of the view that the first year of a bad bank determines its success. The challenge is how to deal with a large number of non-performing loans in a variety of sectors in different geographical locations and several types of industries. If the bad bank does not quickly get a grip on the loans, a lot of value would be lost and the capital requirements of the bad bank would change drastically.
A well-defined process on how different loans should be handled has to be established. This process has to be followed and managed well, else the bad bank will find itself in chaos. Let us hope the RBI takes a quick decision on this issue.
J S Broca New Delhi
LINK:
http://www.business-standard.com/article/opinion/letters-managing-a-bad-bank-116022100688_1.html
22.02.2016