156

156. Bad Bank

Topic: 156/200
Hit List - Prelims 2021

GUNA MATHIVANAN
BAD BANK
• Finance Minister Nirmala Sitharaman in her
Budget speech revived the idea of a ‘bad bank’
by stating that the Centre proposes to set up an
asset reconstruction company to acquire bad
loans from banks.

• However, generating profits is usually
not the primary purpose of a bad
bank — the objective is to ease the
burden on banks, holding a large pile
of stressed assets, and to get them to
lend more actively.
What is a ‘bad bank’?
• A bad bank is a financial entity set up to buy non-
performing assets (NPAs), or bad loans, from
banks.
• The aim of setting up a bad bank is to help ease
the burden on banks by taking bad loans off their
balance sheets and get them to lend again to
customers without constraints.
• After the purchase of a bad loan from a bank, the
bad bank may later try to restructure and sell
the NPA to investors who might be interested in
purchasing it.
• A bad bank makes a profit in its operations if it
manages to sell the loan at a price higher than
what it paid to acquire the loan from a
commercial bank.
Pros of setting up a bad bank
• A supposed advantage in setting up a bad bank is
that it can help consolidate all bad loans of
banks under a single exclusive entity.
• The idea of a bad bank has been tried out in
countries such as the United States, Germany,
Japan and others in the past.
• The troubled asset relief program, also known as
TARP, implemented by the U.S.
• Treasury in the aftermath of the 2008 financial
crisis, was modelled around the idea of a bad
bank.
• It is estimated that the Treasury through its
operations earned nominal profits.
 Cons
• Former RBI governor Raghuram Rajan has been
one of the critics, arguing that a bad bank backed
by the government will merely shift bad assets
from the hands of public sector banks, which are
owned by the government, to the hands of a bad
bank, which is again owned by the government.
• There is little reason to believe that a mere
transfer of assets from one pocket of the
government to another will lead to a successful
resolution of these bad debts, when the set of
incentives facing these entities is essentially the
“While this may be good news for public
same.
sector banks, which have been reluctant
• Other analysts believe that unlike a bad bank set
to incur losses by selling off their bad
up by the private sector, a bad bank backed by
loans at cheap prices, it is bad news for
the government is likely to pay too much for
taxpayers, who will once again have to
stressed assets.
foot the bill for bailing out troubled
banks”
The Union Budget 2021-22 proposes to set up a
‘bad bank’. Consider the following statements
about ‘bad bank’.
1. A bad bank is a financial entity set up to buy non-
performing assets from banks.
2. The primary aim of setting up a bad bank is to
help ease the burden on banks and get them to
lend again to customers without constraints.

Which of the statements given above is/are

correct?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
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