I.T.

S SCHOOL OF
MANAGEMENT, GHAZIABAD

A
Project Report
On
Study about Bad Bank in India

Under the Supervision of: Submitted By:

Dr. Rajeev Johari Vipin Upadhyay
(Associate Professor) PGDM Batch (2021-23)
 Abstract

A Bank is a financial institution entrusted with the

responsibilities of accepting deposits, lending money and
performing other related activities. The deposits received
by the bank from variety of the customers are further
distributed in the form of loans to the masses. If
everything goes right, the repayment of the loan is regular
and the loan is classified as standard asset, but in adverse
situation the same asset can become a burden for the bank
too wherein the repayment is not regular owing to several
reasons. These assets are termed as substandard and
consequently NPAs (Non-performing assets). With an
objective to tackle the problem of the mounting NPA’s
effecting the profitability and soundness of the banking
sector, a new type of bank termed as Bad Bank has been
conceptualized. Bad bank refers to the special type of
banks which buys the distressed assets from the existing
bank for the purpose of recovery and realization. The
basic purpose of setting these specialized institutions is to
free the books of existing banks from NPAs. Bad banks
purchase these assets at discount with the purpose of
managing them for speedy recovery. The present paper
focuses on the concept of the bad banks, its origin and
applications across the globe. The various regulatory
mechanisms already functioning in the Indian Banking
sector to overcome the problem of mounting NPAs and
their achievements so far has also been discussed. The
IBA proposed model of Bad banks has also been studied
in this paper. The paper attempts to through light on the
need of banks, its advantages and hindrances in the path
of the formation of these banks.

Keywords: NPA, Bad Bank, Financial Stability, IBA,

PCR, CRAR, GDP.
 Introduction

The assets of the banks are classified as follows:

Assets of Banks

Performing/ Non-Performing
Standard Assets Assets

Sub Standard Doubtful Loss

The non-performing assets of the bank are classified in

the 3 categories on the basis of length of the time overdue
and probability of repayment. An asset of a bank is
classified as non- performing wherein the loan payments
have not been paid for a period of 90 days.
In case of CC/OD accounts: the account is treated as Non-
performing if it is left out of order more than 90 days. In
case of Agricultural advance wherein the interest or
principal installment remains overdue for 2 harvest
seasons in case of short duration crops and 1 harvest
season for long duration crops is considered as Non
performing. An asset classified as NPA for less than 12
months is considered as Substandard Asset. An asset that
is not performing for more than 12 months is termed as
Doubtful Asset. An asset in which there are no chances of
repayment and is required to be written off are termed as
Loss Assets. The non-performing assets of the bank is not
a new concept and has been always remained a matter of
concern for all the policy makers, government and the
bankers. Since Industrialization, the amount and the no. of
NPAs in the financial sector has witnessed an increasing
trend.
Various policy measures are adopted by RBI and the
government of India from time to time to solve the
problem of mounting NPAs such as SARFESI Act, IBC
etc. The latest concept introduced in this direction is of
Bad Banks.
Bad banks are not the banks entrusted with the
responsibility of performing normal banking operations of
accepting deposits and lending but these are the
specialized financial institutions that will buy the toxic
and non-performing assets of the bank and thus relieve
their burden. The concept of Bad banks was although
recommended by various experts earlier too but the
concept gained utmost importance in the year 2020 when
the Finance Minister gave approval to this new form of
banks during budget presentation for the year 2020-21.
 Objectives of the study

• To study the concept of bad bank.

• To highlight the international perspective of the
implementation of Bad bank and IBA proposed
model of Bad Bank.
• To study the relevance of this concept with Indian
Economy along with its advantages and hindrances in
the path of Centralised Bad Banks.
 Research Methodology

The present paper is a mix of conceptual and analytical

study. The study of the concept of the bad banks and the
international perspective of the same has been done on the
basis of the data collected from newspapers, websites and
the journals. The RBI’s Report on trend and progress of
banking 2019 and 2020 has been analyzed to study the
NPA position and the achievements of the existing
mechanisms in solving the problem of NPAs in the banks.
 Concept of Bad Bank

With an objective to tackle the problem of the mounting

NPA’s effecting the profitability and soundness of the
banking sector, a new type of bank termed as Bad Bank
has been conceptualized. Bad bank refers to the special
type of banks which buys the distressed assets from the
existing bank for the purpose of recovery and realization.
The basic purpose of setting these specialized institutions
is to free the books of existing banks from NPAs. Bad
banks purchase these assets at discount with the purpose
of managing them for speedy recovery. The establishment
of these new banks will not certainly wipe out the NPAs
from the banking sector but certainly the segregation of
good and bad assets will help in better management of
assets and increased focus on fresh landings.
The concept of the bad bank was proposed in the
Economic Survey 2017 which highlighted the
establishment of Public Sector Asset Rehabilitation
Agency (PARA) to tackle the problem of stressed assets.
The focus of this agency is to buy the toxic NPAs from
the banks for the purpose of speedy recovery and
enforcement of stringent actions against the defaulters.
Till now the government is toying with the idea of
formation of the bad banks.
The first bad bank was established in the United States in
1980s by Mellon Bank. During 2008 crisis various
countries across the globe used the concept of bad banks
to tackle the problem of NPAs for example Sweden,
Finland, France, Germany, Indonesia are among those
few countries. The success story of the Malaysia’s bad
bank termed as Danaharta can be used as a model in our
country to establish bad bank.
 IBA Proposed Model of Bad Bank

Due to the outbreak of COVID-19, it was expected that

the NPAs of the banks will increase owing to the reduced
demands in the markets and failure of few businesses.
Therefore, to protect the banks beforehand, IBA has made
a proposal before the RBI and the ministry of finance for
the establishment of Bad banks. The proposed structure is
based on the recommendations of a panel headed by
former PNB chairman Sunil Mehta, called ‘Sashakt’ two
years ago. The proposed initial capital of Bad bank is Rs
1000 crore which is required to be supplied by the
government.
The IBA has purposed 3 tier structures for Bad Bank
comprising of:
• Asset reconstruction company (ARC)
• Asset management company (AMC)
• Alternate Investment Fund (AIF)
a) The Asset Reconstruction Company will be
backed by the Government and is entrusted with
the responsibility of buying bad loans from the
banks and issue Security Receipts in return.
b) The ARC will hold Security receipts of 15%.
c) Banks will get 15% of the cash and will hold
85% of Security Receipts. Therefore, it is termed
as 15:85 structures.
d) AMC would be managed by both the public and
private bodies including banks as well.
e) AMC will have trained professionals to support
the efficient management and speedy recoveries.
f) Alternate Investment Fund (AIF) to support the
trading of these security receipts in the secondary
market.
 Need of Bad Bank in India

The study of the concept of the bad bank and its success
stories in the other countries raises the questions that
whether there is a need of bad bank in our country or not
and why the government is reluctant to this new form of
banks. In our country, as mentioned earlier various efforts
have been done from time to time to reduce the adverse
impact of NPAs on the profitability and the financial
stability. But still the problem of NPAs persists in the
economy.
Although various mechanisms are already in place to
solve the problem of NPAs but the situation is still very
serious and has been worsened by the outbreak of COVID
19. Following points highlights the performance of the
existing mechanisms in the recoveries of the NPA and
thus led to origination of Bad banks.
The following table shows the non performing loans to
total loans (percentage) of different countries from the
2008 to 2019 period.

Table 1: Bank Non-performing Loans to Total Loans

(percentage)

Note: Non performing loan is a term used globally

instead of non-performing asset and period for
classification of loan as non-performing is same in all of
the countries mentioned above.
 Table 2: Asset Quality of Indian Banking Sector
(Amount in ₹ crores)

Table 2 above shows the data of all the scheduled

commercial banks in India, the Gross NPAs amount has
decreased by ₹ 36,671 crores from the year ended 2019 to
the year ended 2020. There has been a fall in NPA ratio
also from 9.1% to 8.2%. these fall in the non performing
assets is because of improvement in the resolution
process.
When we see the current scenario, with the onset of the
COVID 19 pandemic, all the countries around the world
have opted for nation-wide lockdowns to curb the virus,
this has seriously hampered the economic wheel and due
to this pandemic, every sector of the economy is at risk,
we may see a significant jump in non-performing assets
(NPAs) around the world. As per Financial Stability
Report (Jan, 2021) there will be spike in NPAs and Gross
NPA ratio of all Scheduled commercial Banks may
increase from 7.5 per cent in September 2020 to 13.5
percent by September 2021.
Table 3: Ranking of countries on the basis of
'Resolution of insolvency’

Table 3 shows the top 5 countries in the resolution of

insolvency of companies, resolution of insolvency is one
of the parameters in the 'Ease of doing business' index
calculation. Under this factor, Finland, US, Japan,
Germany, and Norway are the top five countries in
efficient resolution. The whole procedure from filing the
insolvency to the completion of resolution is highly
effective in these countries. India is at 52nd position out of
190 countries, this rank is been achieved because of the
constant effort of the government in improving the
business environment especially by incorporating the
'Insolvency and Bankruptcy code 2016', this legislation
has influenced the ranking of the Indian economy in this
index.
 ARCs in India

The first asset reconstruction company setup in India was

ARCIL (Asset Reconstruction Company (India) Limited)
in 2002 it was sponsored by the State Bank of India, IDBI
Bank, ICICI Bank, and Punjab National Bank (PNB)
(SARFAESI Act 2002 defines "sponsor as any person or
an institution holding more than 10 percent of paid-up
equity capital of ARC”). So far, twenty-eight asset
reconstruction companies have been registered with RBI
under section 3 of SARFAESI Act 2002 to handle the
resolution process. the nature of ARCs in India is mostly
private sector owned but some of them have been
sponsored by public sector banks.
The following table shows the presence of commercial
banks in the shareholding of these Asset reconstruction
companies in India and it shows the sponsor commercial
banks.
Table 4: Banks as shareholders in Indian Asset
Reconstruction Companies
(ARCs)
Table 4 shows the Indian commercial banks as a
shareholder in these ARCs. Out of twenty-eight
companies registered with RBI under section III of the
Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act 2002 as of 31st Jan,
2020, only 9 ARCs have a presence of banks (Mostly
public sector banks are present in shareholding) in
shareholding and also the percentage of shareholding is
small in many of the ARCs. If we look at commercial
banks as a sponsor in the above many of the ARCs
sponsor are commercial banks out of these nine ARCs.
So, the conclusion from the above table would be that the
ARCs in India are mostly private sector owned.
The following table shows NPAs recovered by banks
through ARCs and IBC resolution option.

Table – 5: NPAs recovered by banks through ARCs

and IBC
(Amounts in Crores)

As per the information available in RBI's report on 'Trend

and Progress of Banking in India'. There are four options
for the asset recovery; Lok Adalats, Debt Recovery
Tribunals, SARFAESI Act 2002 (ARCs) and IBC
(Insolvency and Bankruptcy Code, 2016). As we can see
in the table 5 given above, out of these four options,
details of two resolution options are given. Insolvency
and Bankruptcy code 2016 has major percentage in
recovery, out of the total amount involved, 31.3% is
handled by IBC and recovery rate is 61.3%, which is
higher than Asset Reconstruction Companies recovery.
Before the promulgation of IBC 2016, the ARCs were the
major participator in recovery of the stressed assets but
after the IBC 2016, resolution process got a major start,
the total amount involved in entire recovery process got
three times the amount recovered before the IBC 2016.
The focus of the IBC 2016 is on resolution of corporate
insolvency. With the incorporation of National Asset
Reconstruction Company (Bad Bank) there will definitely
be increase in the total amount involved in resolution
process and the share of ARCs in recovery amount will
also increase.
 Advantages of a Centralised Bad Bank

Evidence world-wide suggests that a centralised bad bank

can help in substantial stress reduction and has various
systemic benefits, complementing and enabling the pre-
existing stressed asset resolution mechanisms.
• For selling banks, the clear segregation of weak
assets from the rest grants an occasion and rationale
to restructure its balance sheet and reshape the
business model, while providing transparent insights
to customers and investors into the bank’s core
performance. By freeing up provisions and thereby,
boosting capital for lending, CAMCs enable banks to
support the economy. Scarce human resources can
also concentrate on more important banking
operations such as new lending, rather than managing
distressed assets and corporate restructuring.
• The CAMC model can be relied upon when banks do
not have sufficient resources to resolve large amounts
of NPAs through individual departments within
banks or through subsidiaries. As opposed to internal
restructuring, a CAMC provides a swift vehicle to get
stressed assets off a bank’s balance sheet and reduces
 the need for fresh recapitalisation either from the
government or from markets.
• Leveraging this mechanism, banks can avoid fire
sales of assets which result in lower recovery values.
Gradual sales through CAMCs that have expertise in
the field can help in optimal recovery rates.
• CAMCs are usually driven by other concerns in
addition to value maximisation, such as preserving
the economic value of assets. For instance, RTC
timed the sale of its real estate assets so as to not
cause further deterioration in prices.
• Consolidation of stressed loans in bad banks and
centralised ownership of collateral can effectively
address the problems faced by individual banks in
attracting investors for these assets. For instance,
public AMCs in Asia provided a market for NPLs by
giving banks an option to either sell their NPLs or
through forcing them to offload the problematic
assets (Lee, 2020).
• Centralised AMCs and public or private ARCs can
complement each other, like in Thailand, and need
not be substitutes in stressed assets management. Bad
banks can hold assets which the private AMCs may
not, due to their long gestation periods, or the assets
 that might not be adequately profitable in the medium
term but are economically important and have
significant positive externalities (Acharya, 2017).
• CAMCs are usually set up through special acts of law
or through government orders. As such, they can be
bestowed with special legal powers to accelerate loan
recovery, as seen in some successful experiences
such as Danaharta.
• The use of cash and/or coupon-paying government-
guaranteed securities to purchase NPAs, apart from
being more attractive than the SRs issued by private
ARCs, improve banks’ balance sheets and add to the
income of the financial institutions. It facilitates more
efficient price discovery through creation of a vibrant
market for distressed assets and a uniform valuation
criterion as compared to private forces working in
isolation.
 . Challenges of a Centralised Bad Bank

Economists and policymakers have long acknowledged

that the establishment of a bad bank is fraught with many
trade-offs. These include – how to relieve banking stress
without encouraging moral hazard; how to minimise the
cost to the government exchequer and how to arrive at a
valuation that is fair to both the acquiring entity as well as
the seller. In view of the following serious challenges,
utmost care needs to be taken in their design and
structure.
• Bad banks, essentially formed to ease the burden off
banks’ balance sheets, may encourage further build-
up of risky assets. Knowing that they have the bad
bank option to fall back on, banks may become less
vigilant in giving out loans, leading to the problem of
moral hazard.
• The design of CAMCs needs to be carefully crafted
to suit country-specific and/or sector specific
requirements. Furthermore, there is also a tendency to
deviate from the primary objective as in the case of
China’s big four bad banks, wherein investments in
financial institutions—such as banks and insurance
companies—rather than in bad loans, now constitute
 a major part of their business (Ingves, Seelig, & He,
2004). There is also a need to provide proper
incentives to their governing bodies and employees,
as staff recruitment and retention are problems that
often arise.
• Financing remains a dominant issue in the context of
a central bad bank. Unless carefully designed and
efficiently executed, the cost of setting up a CAMC
falls inevitably on the resource-constrained
government, and ultimately, on the taxpayers. Even
in countries where the CAMC has succeeded in
reducing the NPLs, it has come at a cost to the
government exchequer (Fung, George, Hohl, & Ma,
2004).
• Another challenge that emerges is keeping the bad
bank funded enough to tackle a major share of NPLs.
International experience suggests that in certain
cases, the bad bank’s resources accounted for a
miniscule share of the bad assets, thus rendering the
whole exercise redundant.
• Market creation for distressed assets and their fair
valuation at both the buying and selling stages is
another operational challenge that arises, as it
determines the viability and sustainability of the
 solution. Asset disposal by state-owned AMCs may
be disincentivised by challenges such as political
pressures against selling of certain assets and the fear
of audit scrutiny relating to sell-offs (Fung, George,
Hohl, & Ma, 2004).
• The CAMCs, by virtue of being financed by the
government, are required to take a macroeconomic
perspective rather than focusing on asset value
maximisation. Thus, their decisions relating to either
sell-offs or retaining the assets may be constrained by
the need to help stabilise asset markets.
• Lack of transparency in operations and lack of
reliable data can hinder the objective valuation of
assets and creation of optimal portfolios for resale
(Deloitte, 2020). In countries such as Ireland and
Spain, insufficient or missing documentation created
hurdles in smooth functioning of their CAMCs (Cas
& Peresa, 2016).
 Conclusion

Creation of a bad bank at the current juncture may prove

helpful in reducing banking stress and kick-start the
credit cycle. The cross-country evidence suggests that if
the logistical and financial challenges are carefully
navigated, experiments of centralised bad bank can have
more hits than misses. While it may be unfair to hail
them as a universal antidote to deal with financial stress,
they have proven to be a worthwhile exercise when
armed with conductive institutional frameworks.
Experience of international best practices suggests that
the NARCL in India is likely to serve as a time-efficient
mechanism, while reviving investor interest in primary as
well as secondary markets for stressed assets and SRs,
respectively. Going forward, continued commitment,
professional staff and transparency in operation will help
in making the exercise cost and time effective. At the
same time, care needs to be taken to ensure that fresh
slippages are arrested, and bank balance sheets are
strengthened to avoid future build-up of stress.
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https://www.inspirajournals.com/uploads/Issues/1091
871774.pdf

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https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/03AR_
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