Union Finance Minister Nirmala Sitharaman has announced the concept of bad bank in the country. In her budget speech, Sitharaman said that an Asset Reconstruction Company Limited and Asset Management Company will be set up that will manage the bad debt of public sector banks like State Bank of India, Punjab National Bank and others.
“The high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books. An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realization,” she said in her speech.
Bad Bank – Explained
The announcement is significant as it will seek to provide financial stability in the banking sector. Sitharaman said that the high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books.
An ARC and AMC will be set up to consolidate and take over the existing stressed debt. It will then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realization. In other words, it will hold problem loans for public sector banks which can then be sold on to investors at a reduced price. This will ultimately help clean up the balance sheets of banks.
The new framework will help clean up the balance sheets of public sector banks and make future requirements of capital less onerous.
The industry reacted in a positive mood to the decision to create a special vehicle to house banks’ sour debts.
Dinesh Kumar Khara, Chairman, SBI, said that the announcement to set up an ARC and privatizing a couple of public sector banks are all positive steps for the financial sector.
“Social sectors have received large attention in the budget with a thrust on developing a health and education infrastructure on a mission mode. This will augment human capital, an essential prerequisite for inclusive growth,” he said.
Why Bad Bank is necessary?
The existing stock of bad loans is a big worry for public sector banks. As of September 2020, the total gross NPAs of the banking system was 7.5 per cent of the overall industry loan book.
According to the Reserve Bank of India’s (RBI) projection, this is expected to shoot up to 13.5 per cent by March-September this year.
According to an estimate, non-performing assets totalling Rs 899,803 crore will be transferred to the bad bank.