VISHWANATH SAGAR S

18CBCOM105

1. Bad Bank - a good initiative ? challenges and advantages.

 Ans: A Bad Bank is an Asset Reconstruction Company (ARC). 

 Once it is formed, banks divide their assets into two categories (a) one with
non-performing assets and other risky liabilities and (b) others with healthy
assets, which help banks grow financially.
 ARC or Bad Bank buys bad loans from the commercial banks at a discount
and tries to recover the money from the defaulter by providing a
systematic solution over a period of time. 
 The bad bank will manage these Non-Performing Assets in suitable ways,
some may be liquidated, others may be restructured, etc.
 RBI, too, came up with a suggestion to form two entities to clean up the
bad loan problems ailing PSBs -PAMC (Private Asset Management
Company) and NAMC (National Assets Management Company). 
 PAMC would be formed by roping in banks and global funding companies. 
 This would invest in areas where there’s a short-term economic viability. 
 NAMC would be formed with government support, which would invest in
bad assets with short-term stress but good chances of turnaround and
economic benefit.

Benefits of setting up a bad bank

 The major benefit of forming a bad bank is asset monetization. It’s the
process of turning a non-revenue-generating item into cash.
 Bad assets would stay in the risky category, while the good one stays in the
other category, saving them from mixing together. 
 Since 40% of the NPA is concentrated only in 60 firms, so better we create a
centralized agency PARA, which will work as a Bad Bank and absorb the
losses from the PSBs.
 Since a bad bank specializes in loan recovery, it is expected to perform
better than commercial banks, whose expertise lies in lending.
 The recent IBC amendments make it complex for foreign players to take
part in resolution. 
 Experts believe a vehicle like AMC or ARC that could address the stressed
loan issue, till the bankruptcy code stabilizes, could be beneficial. 
 A single government entity will be more competent to take decisions rather
than 28 individual PSBs.
 Foreign investors with both risk capital and risk appetite would be more in
a government-led initiative, knowing that regulatory risks would stand
considerably mitigated in various stages of resolution, including take-outs.

Challenges with Bad Bank:

 A banking institution has to keep in mind its choices of assets to be
transferred into the risky category, business case, portfolio strategy, and
the operating model.
 Each of these choices must be made while considering the impact on
funding, capital relief, cost, feasibility, profits, and timing. 
 The government support is also necessary to help banks understand
regulatory and tax-related issues.
 Once the NPA problem is settled, the Bankers may become complacent and
again resume reckless lending.
 A one-size-fits-all approach to designing a bad bank can be very expensive
and less effective. 
 At least Rs. 25,000 to Rs. 30,000 crore of capital will be required to set up a
bad bank in the initial stages.

2. NPA - Do banks really bother?

Ans: A non-performing asset (NPA) is a banking industry term for a ‘bad
loan’ – i.e. one that has not been repaid within the stipulated time, or
where the scheduled payments are in arrears. A bank’s assets are the loans
and advances it extends to customers. If these clients, including companies,
 do not repay either interest or part of principal or both, the loan turns into
a bad loan.

Monetary watchdog Reserve Bank of India (RBI), while laying down in detail
the various circumstances when a loan will be deemed an NPA, broadly
defines non-performance thus: “An asset, including a leased asset,
becomes non-performing when it ceases to generate income for the bank.”

Today, Indian banks are so saddled with bad debts that they figure among
the worst in the world in this respect, and definitely the worst in the
BRICS bloc. As per CARE Ratings, India’s second-largest credit rating
agency, India falls in a group of countries beset with a ‘high level of NPAs’
– a collection of the world’s worst performers led by Greece. The only
other BRICS nation in India’s group is Russia, which has a lower (better)
NPA ratio than India’s.

Impact of NPAs:

 Profitability: The researchers found that the practice of provisioning on

account of incremental NPAs (25%-30%) often led to the bank’s profitability
getting reduced
 Credit contraction: Burgeoning NPAs reduces recycling of funds, and by
extension, also that of the bank’s ability to lend more. This, in turn, results
in interest income decline. On a macro level, it contracts money circulation
that can lead to an economic slowdown
 Liability management: High NPAs frequently goad banks to lower interest
rates on deposits and raise that on advances to sustain NIM. This may
prove a hurdle to growth
 Capital adequacy: Expanding NPAs add to the risk-weighted assets; this
means the bank has to buttress its capital base further as per Basel norms
on risk-weighted assets. This can mean borrowing at a high-interest rate
 Shareholders’ returns: When high incidence of NPAs affects profitability,
also hurt are bank’s shareholders; they are not only deprived of expected
returns, but also find the value of their investments eroded. (RBI guidelines
stipulate that banks with net NPA level of 5% and above take prior
permission from it to declare dividend or cap the dividend payout)
 Credibility: The credibility of the banking system also gets hit, which can
affect the economy as a whole.

3. Privatising banking sector - pro and cons.

Ans: Since times immemorial, banks have played a significant role in

strengthening the economy of our nation. No wonder banks are known as
the backbone of the economy. The first bank of India was the Bank of
Hindustan, which was established in the year 1770, and since then the
banking sector has undergone a massive revolution.
 A public sector bank is one where a majority of its stakes are held by
the Government like the State Bank of India (SBI) whereas a Private
Sector bank is one where a majority of the shares of the bank are
under the control of its shareholders like the HDFC Bank and the Axis
Bank.

 Although the basic facilities provided by the bank remain the same
irrespective of the category of the bank, the customers notice a
significant change in operational methodology between a public
sector bank and a private sector bank. The private sector banks
undoubtedly function way more effectively compared to the public
sector banks, but because of a longer duration of existence, public
sector banks have gained the trust of the common masses and are
mostly preferred over private sector banks. However, with changing
trends, a lot of businesses also prefer private sector banks because of
their efficiency.
  Since a public sector bank has the backing of the Government, there
is a strong sense of security among the customers that the bank will
survive no matter what. However, private banks make up for these
concerns through their technological advancements and superior
customer service. RBI also has stringent laws in place for both public
and private sector banks, which helps the RBI to manage these
banks’ lending and cash reserve ratios.

PROS:
 For operational efficiency, private sector banks are far more efficient as
compared to public sector banks. The private sector banks continuously
upgrade their services to keep up with the changing market trends and
reinvent their way of working to attract a larger customer base. This
ensures that the customers receive the most superior quality of service and
enjoy a hassle-free experience.
 Privatization of banks will also help to reduce the burden on the
Government of India. This is because private banks have stringent norms
for providing loans and dealing with frauds. This ensures that a bank would
not suffer too many losses because of insufficient background checks or
security.
 Public banks are constantly bullied for political motives, which makes it
difficult for them to function independently. Privatization will allow the
banks to focus on their long-term goals with reduced government
interference.
 When compared with PSU’s, most private sector banks are profitable and
this gives an idea that privatization might help in converting loss-making
ventures into profitable businesses.

CONS:

 While public sector banks cater to all sections of society, private sector
banks target mostly the upper strata and business conglomerates in the
 society. This may adversely affect the poorer sections of society and wipe
out the trust that the common masses have in the government.
 Public sector banks strive to make modern facilities available even in non-
profitable areas, while private banks choose to operate only in urban
settings where the possibility of generating profits is high.
 Privatization may also introduce variable income. This might result in panic
and protests across the country.