The idea of a bad bank — that could take over the non-performing assets (NPAs) weighing down public sector banks — is making a comeback. Finance Minister Piyush Goyal said last week that a committee of senior bankers would examine the possibility of constituting an asset reconstruction company (ARC) or an asset management company (AMC) that would be given responsibility for these loans. Essentially such a new institution would serve the same purpose as a bad bank — it would take the troubled assets off the PSBs’ balance sheets, and allow them to resume normal operations.
The idea of a bad bank has been around for some time, but it is far from clear why the arguments for it have gotten stronger. In fact, when it is considered that the new Insolvency and Bankruptcy Code (IBC) is now being given a chance to address the non-performing asset problem, the motivation for a bad bank would seem to have become weaker. The government should think long and hard before setting up yet another state-controlled financial institution. A state-run ARC or bad bank would essentially be faced with the same questions that had held up the resolution of NPAs earlier, and which the IBC seeks to solve: Who takes a haircut, and how much should that haircut be? In addition, once this process is isolated from existing lenders, then the new institution will have less bargaining power, and not more, with promoters and creditors.
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The Economic Survey 2016-17 had argued that a Public Asset Rehabilitation Agency at the central level would make sense, as it would be better placed to deal with the politicking and interest groups that are at play in the revival of NPAs. Equally, however, it could be argued that such an organisation would simply replay the errors of the past — there is no reason to suppose that a new public institution will be less prone to making the sort of politically-influenced decisions that led to the NPA crisis in the first place. Two other arguments for such an agency were that it would solve the co-ordination problem between creditors and that it could be mandated to recover assets within a defined time period. But these are both explicit goals of the IBC process as well.
The key to solving the NPA problem now and permanently is not the creation of yet another state-controlled financial institution, which would import all the flaws of those that currently exist. While a bad bank would take care of existing NPAs, it’s unclear what happens to the possible future flow of such loans in the absence of a proper risk assessment expertise at many state-owned banks. The key is governance reform and the operational, functional and statutory independence of those that currently exist. The government should not allow bankers to pass the buck and evade accountability. They will have to own up to the losses that past bad decisions have caused to their balance sheets, and not shift the responsibility on to some other entity. It is the IBC process that should be given all needed support, and endowed with greater transparency and capacity.