September 20, 2021
Buy my loans!
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Good morning. We have been always talking about pollution issues and shifting to electric vehicles. The Kolkata police have set a precedent now!
Replacing old vehicles, Kolkata Police are going to get over 200 Tata Nexon electric vehicles on lease. The idea is to keep the pollution levels under check. Great way to lead the change!
📰 FEATURE STORY
The good and bad of a ‘bad bank’
Last week, the Cabinet gave green signal to the much debated ‘bad bank’ idea. Now that the bad bank is back in discussion, we are here to discuss the pros and cons of this concept. But before that, what is a bad bank? It is an entity that would take over the bad loans of public sector banks (PSB) at discounted rates and sell them in the market.
This screams good news for banks with stressed assets. They will let go of loans that are toxic and also make money out of it. With the recovery money, banks can lend more to people and get back in good shape. So, the bad bank will be a bountiful gift to the banks. But such a wonderful proposition does not come without loopholes. Critics say that this concept will only shift bad loans from one entity (PSBs) to another (bad bank). So they don’t see much hope in introducing a bad bank.
Before anything else, let’s see what a bad loan is. Say a company has borrowed a huge amount of money from a bank. Over time, the firm needs to repay the loan. But what if the company faces huge losses? There is no way it can pay back its loans. This then becomes a bad loan. In technical terms, it is called a ‘non-performing asset’ (NPA) of the bank. Banks either write off the bad loan, or partially recover by selling the underlying assets like buildings, machinery, etc.
We know that a bank does not only offer loans. People also deposit their money in banks and withdraw from it whenever they want. This deposited money is a bank’s liability because it uses this money to offer loans to other people. So the bank pays a certain amount of interest to its customers for the amount they have deposited. When NPAs accumulate, the bank will not have enough money to pay interest to its customers. It then falls into a financial crisis.
This issue of bad loans has tormented the banking industry for quite some time now. In 2015, an asset quality review was conducted which showed that banks were heavily stressed by bad loans. To tackle this problem, Asset Reconstruction Companies (ARC), which are private companies who buy off bad loans, were opened. But that didn’t help much. Since 2017, many economists have suggested the creation of bad banks. Up until now, nothing materialized due to various reasons. Many alternatives like the Insolvency and Bankruptcy Code and capitalization of banks have been tried out. But the government has finally decided it’s time to form India’s first ever bad bank.
A bad bank is the need of the hour
One look at the present scenario tells us that the banks are beyond stressed. The pandemic situation has only worsened the bad loan situation as many businesses have faced losses. In an official report, the Reserve Bank of India predicted that the bad loans would rise from 7.48% in March 2021 to 9.80% in March 2022. However, if a bad bank is formed, it will help in unclogging the stressed banks and lead to a good economic growth.
When a bank has an excess of NPAs, all of its profits will be used up to cut the losses of the bad loans. Subsequently, the banks will become wary of lending loans to businesses and consumers in the future. If the bank is reluctant to lend, it will become difficult for the economy to grow. Once the bad bank comes to action, it will help alleviate some of the stress of the banks. This would encourage banks to give fresh loans to businesses. Thus there won’t be a freeze in the economy.
Like we discussed, we already have ARCs to buy bad loans from banks. The difference between an ARC and a bad bank is that the latter is supported by the government. Since it is the government that is behind this business, many PSBs would feel confident in transferring their NPAs to the bad bank. Moreover, dealing with the private ARCs is seen as a time-consuming process. At the end of the day, it is not very profitable. Now that the government is lending a helping hand to banks, it is likely that these problems will be sorted out.
To understand how the banks will get better profits from a bad bank, we need to understand how the bad bank will function. The bad bank will consist of two entities – the National Asset Reconstruction Company Limited (NARCL) and the India Debt Resolution Company Ltd (IDRCL). The NARCL will acquire stressed assets worth ₹2 lakh crore from several PSBs. Of course, the NARCL will strike a deal with the banks and purchase the bad loans at a lower price. It will pay 15% of the amount and give out a security receipt for the rest 85% of the amount. It’s the IDRCL’s responsibility to sell these assets in the market. Once the assets are successfully sold, the remaining amount will be returned to the banks. Even if the bad bank sells the loan at a loss, it will repay the bank from a government guarantee of ₹30,600 crore within five years. This means, once a bank hands over its NPAs to the bad banks, there is a guaranteed return of money. This surety is a huge plus point to the bad bank concept.
Now, you might wonder why the government should work hard to solve this problem when it is looking to privatise PSBs. A PSB with a lot of NPAs would not attract profitable valuations. Instead, if a bad bank is established, it might solve the bad loans problem and also increase the capital of banks.
A bad bank might not solve the problem
Every time the bad bank concept was proposed, there were a set of experts who vehemently opposed the idea. Many of them continue to object to it. They argue that there are several existing structures like ARCs that have been trying to solve the NPA problem for a long time. But the banks have not been able to sell their bad loans to them. Experts say there is not much reason to believe that the bad banks can perform better than these structures.
The government has promised that the bad bank will resolve the bad loans and return the money to the banks within five years. From what we have seen in the past, this is going to be a mammoth task to achieve. These stressed assets generally have very little value on the table. So there is a lack of interest among buyers to pitch in a lot of money for the assets. This is the main reason the ARCs have not worked out well in the past. So the government’s guarantee to do away with bad loans is not as simple as it sounds.
The question then is do we need a bad bank at all? Former RBI Governor Raghuram Rajan had earlier opposed the proposal of a bad bank. He says the bad loans will only be shifted from the PSBs to the bad bank, both of which are government run institutions. So the idea to simply push the toxic asset from one government pocket to another will not improve the matter. This is because it is the government that has to initially purchase the stressed assets. If the bad bank is unable to resolve the problem, it will take money out of the government guarantee and pay the bank. So this is a risky trade that the government is entering.
It is now that the water turns murky. It’s because be it in recapitalizing the banks or offering them government guarantees, the money goes right out of the taxpayers’ pocket. And when the bad bank fails to sell the stressed assets at a profitable price in the market, it is the taxpayer’s money that the government hands out to the banks. This idea does not sit well with many of the taxpayers.
With the entry of the bad bank, PSBs will happily transfer their NPAs without addressing the root cause of the problem – why are NPAs rising? In fact, PSBs might consider the bad banks as a safety net and continue to lend impulsively. They might extend more loans with the belief that even if it turns into a bad loan, it will be taken over by the bad bank. If this happens, the bad loan crisis will worsen.
🕵️ BEYOND ECHO CHAMBERS
For the Right:
Speak Out, Get Raided: A Handbook for Living in ‘New India’
For the Left:
The value that Prime Minister Modi adds
🏴 STATE OF THE STATES
Stress Driving (Maharashtra) – Cities like Mumbai, Bangalore and Delhi are infamous for traffic congestion and commuting issues. This makes our driving scenes pretty dull and stressful. A recent survey conducted by UK car-sharing company Hiyacar reveals that Mumbai is the most stressful city in the world for driving. It has got a score of 7.4 out of 10. The factors considered were the number of vehicles in the city, the severity of traffic congestion, quality of roads, public transport options, number of traffic accidents per year and others. Delhi ranked fourth and Bangalore ranked 11th with scores of 5.9 and 4.7, respectively.
Ropeway Travel (Delhi) – Traffic and transport difficulties are the day-to-day sagas of every developed city in India. Several new techniques are being introduced to make commuting easier. A ropeway link between Vaishali Metro Station on the Blue Line and Mohan Nagar Station on the Red Line are on cards. A detailed report on the project has been submitted to the Ghaziabad Development Authority (GDA). If a metro line had been constructed between these two stations that are on different corridors, it would have resulted in a whooping ₹1800 crores being spent. Now, this project is pegged at ₹487 crores. It will have 249 carriages with a capacity of 10 passengers. With four halts, it will take around 15 minutes to cover the distance. The ropeway project is expected to ease congestion on the roads and make travelling between the Red and Blue lines easier.
Sewage Cleaning (Telangana) – As we all know, cleaning sewer line blockages is not an easy task and people engaged in cleaning those suffer a lot. In a bid to reduce the need for human intervention while cleaning manholes, the Hyderabad Metropolitan Water Supply and Sewerage Board has decided to create special sewerage cleaning units (SSCU). These are assisted by a new technology that eases the work. The cleaning will be ensured by skilled workers and robust modern technology. It is indeed true that technology offers key solutions to many of our problems.
Development Utilities (Odisha) – Dams are beneficial structures that help in saving and distributing water. Adding to this, the Odisha government is working towards making lands near dams a place for recreation, tourism and education. The government has directed the officials to develop the area around dams as recreation spots and learning spaces with museums, audio-visual shows, guided tours, boating and camping amenities. This will also help students to know more about scientific technologies and understand the construction and usage of dams. Recreating large lands near dams as tourist and educational spots is indeed a welcome move.
Historic Milestone (Manipur) – Geographical Identification (GI) tags identifying certain products and their unique place of origin are certainly a pride for any state. Manipur’s Hathei chilli and Tamenglong orange have now been granted GI tag by the Government of India. Chief Minister N Biren Singh called this a milestone in the history of Manipur. More than a milestone, this will hugely benefit the farmers of the state. Hathei chilly and Tamenglong mandarin oranges are very famous and are extensively cultivated in the state. So, this will boost sales of these products.
🔢 KEY NUMBER
1,03,12,095 – Workers who registered in the e-Shram portal, as on Sunday. The portal is an attempt by the Union government to create a national database of workers in the unorganised sector. Unorganised workers include those who work in construction, apparel manufacturing, gig work, etc.