Bad Bank: A perfect solution for bad debts

 

What is Bad Bank?

Bad Bank is a house of bad loans or NPA’s. It would serve only to aid in the recovery of these risky assets. It is also known as Public Sector Rehabilitation Agency (PARA).
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It is an entity that buys bad loans/ NPA’s from commercial banks & financial institutions at a discounted price.

Example

A commercial bank lends 100 crores to the borrowers. Out of that 80 crores paid by the borrowers but the rest 20 crore is not recoverable. So, the commercial bank considered that 20 crores as a bad loan or NPA’s. Now, a bad bank will handle this situation. So, it buys that bad loan from a commercial bank at a discounted price. Then, It will recover the loan amount from borrowers. Like this, these banks work and earn their profit.

Advantages

• Bad banks help commercial banks by absorbing all their bad assets, usually at a price below the value of these loans & manage them & finally recover the money over the period.

• Commercial banks get free from bad assets. Banks can take a more positive look at the new loans.

• These banks do not involve themselves in the lending or depositing process but it helps commercial banks to clear their balance sheets and resolve their bad assets.

• Balance sheet of the commercial bank will improve.

• It builds more confidence & trust in banks.

• It allows the banks to focus on their core activity like lending & depositing rather than on the recovery of loans.

Disadvantage

• This bank will create moral Hazard. This means it enables banks to continue with their reckless lending practices.

Problems resolved by bad bank

• It effects speedier settlement with borrowers by eliminating the individual banks.

• As a single Large lender, it can drive a better bargain with borrowers & take more stringent action against them.

Need of Bad Bank

• Stockpile of NPA’s or bad loans has had several ill effects on the economy at large.

• Stressed assets or bad loans of banks are making it difficult for new lending.

• It constrains new investments in projects that can power the economy.

• As bad debt keeps rising, it raises the costs to raise the PSB’s.

• High NPA’s force banks to keep their lending rates high to boost their profits but now the lending rates will be less due to bad banks.