The Central government is likely to soon approve the setting up of the country's first bad bank, which was first proposed by Union Finance Minister Nirmala Sitharaman in her Budget speech of 2020-21, reports said

The proposed bad bank — National Asset Reconstruction Company Limited (NARCL) — will manage the bad debt of public sector banks and other financial institutions. It is expected to have a government guarantee of about Rs 31,000 crore.

The transfer of non-performing assets (NPAs) from banks and other financial institutions to NARCL is expected to take place by the end of this fiscal year. The banks have already identified around 22 bad loans worth Rs 89,000 crore to be transferred to the NARCL in the initial phase.

Earlier on June 25, the Indian Banks’ Association (IBA) filed an application with the Union Ministry of Corporate Affairs for the incorporation of the NARCL.

Also Read: Bad bank to be incorporated very soon; IBA files application to register National ARC, AMC

While countries like the United States and Sweden adopted the idea of bad banks in the 1980s, it is a relatively new concept in India.

What's a bad bank?

As the name indicates, a bad bank buys the bad loans and other illiquid holdings of other lenders and financial institutions. Subsequently, the bad bank resolves non-performing assets (NPAs) over a period of time.

Basically, a bad bank holds problem loans for banks and sells them to investors at a reduced price. It acts as an asset reconstruction company or an asset management company.

The objective is to help clear the balance sheets of the banks and other financial institutions and maintain the health of the banking sector.

Reserve Bank of India (RBI) Governor Shaktikanta Das earlier said, "Bad banks have been under discussion for a long time, we are open to looking up any proposal on bad banks. It is for the government to come up with such a proposal, and if any, we will examine the proposal."

Why is a bad bank needed?

NPAs, already mounting in the country for the past decade, have shot up dramatically in the wake of the pandemic. In fact, the total gross NPAs of the banking system were recorded at 7.5 percent of the overall industry loan book in September 2020.

According to a projection made by the RBI early this year, the NPAs are expected to shoot up to 13.5 percent by March-September this year. Thus, there is a need for a bad bank.

Experts divided on bad bank

Those sceptical of the proposed bad bank say that there are already many asset reconstruction companies in operation and banks often fail to sell them bad loans. Besides, banks sell bad loans at a discount price, so, there is already some loss involved.

On the other hand, some economists are of the view that several countries have successfully made use of bad banks to tide over NPAs and India can also replicate the success.

(Edited by : Kanishka Sarkar)