Prof. Anand S

Non-performing assets are a severe problem for many banks in India. Non-performing assets are loans on which banks have not recovered principal and interest for more than 90 days. Banks have to recover their loans to run their operations and pay their depositors. Also, a growing pile of bad loans prevents it from issuing new loans necessary for economic activity.

What's a bad bank?

Bank saddled with these bad loans sell these assets to a bank designated to deal with it. National Asset Reconstruction Company Ltd (NARCL) is the official entity set up to handle this problem. When such bad assets are taken off the balance sheets of many banks, those banks are in a better position to start lending afresh. It will take over ₹ 2 lakh crores of NPAs. The NARCL will pursue recoveries on this massive pile of loans.

How does it operate?

NARCL will take over these loans at a discount between 80% and 90% of the original value. It does not have to pay this amount upfront to the banks looking to get rid of these loans. Instead, it forks out 15% of the value, paying the balance in Security Receipts, which will be redeemed when they recover some amount on these stressed loans. The government has agreed to fill the gap between the Security Receipts and actual recoveries up to ₹30,600 crores. This facility is called a backstop, which can improve the value of Security Receipts to the banks. Security Receipts are like bonds that yield an income stream based on recoveries from loans.

<aside> 🧹 The government does not use the term Bad Bank for NARCL. The first bad bank in the world was created in 1988 by US-based Mellon Bank to hold its stressed assets. Following this success, it became a phenomenon of sorts. Several countries such as the US, Finland, Sweden, Indonesia and Belgium followed the model.

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