EXPLAINED | What Is Bad Bank? Rs 30,600 Cr Sovereign Guarantee For Banks Extended By Modi Govt

Sitharaman said that the government has cleared the proposal to provide Rs 30,600 crore government guarantee for security receipts issued by NARCL.

(Representative Image/Getty)

New Delhi: In order to address the problems faced by non-performing assets (NPAs) related to bad loans in public sector banks, Finance Minister Nirmala Sitharaman on Thursday announced that the Union Cabinet has cleared ‘bad bank’, country first-ever initiative. 

Sitharaman said that the government has cleared the proposal to provide Rs 30,600 crore government guarantee for security receipts issued by the National Asset Reconstruction Company (NARCL) as part of resolution of bad loans. 

The government guarantee will allow banks to transfer their non-performing assets (NPAs) to NARCL. 

What Is Bad Bank?

A bad bank is a bank set up to buy the bad loans and other illiquid holdings of another financial institution.

It can help banks clear off their balance sheets by transferring bad loans and focus on it's banking and lending activities. The first bad bank was created by US-based Mellon Bank in 1988 to hold its "toxic assets".

Bad banks have been institutionalised and considered a success in several countries including the US, Sweden, Finland, Belgium, and Indonesia. 

The proposed bad bank or NARCL will pay up to 15 per cent of the agreed value for the loans in cash and the remaining 85 per cent would be government-guaranteed security receipts.

The government guarantee would be invoked if there is loss against the threshold value.

The government guarantee will be available on the gap between the face value and actual realised value of the assets to ensure that banks do not lose out on stressed asset sale, while also helping to clean up their balance sheet.

Sharing details of the latest reform initiative taken by the government to clean up the banking sector, the Finance Minister said that banks have already recovered Rs 5,01,479 crore in last six years. Of this, Rs 3.1 lakh crore has been recovered since March 2018.

Along with National Asset Reconstruction Company Ltd, Sitharaman said that the government is also setting up an India Debt Resolution Company Limited. PSBs will have 51 per cent ownership in NARCL, while PSBs and public financial institutions will have a maximum of 49 per cent stake.

Sitharaman added that the government guarantee will give more confidence to the lenders to sell their assets to NARCL.

Sitharaman, in her 2021-22 Union Budget speech, had announced the setting up of a 'bad bank', including an asset reconstruction company and asset management company to take over the existing stressed debt of banks.

Experts Welcome Move

"I see the Finance Minister's roadmap on bad banks as a welcome move. The Rs 30,600 crore government guarantee for security receipts issued by NARCL will be instrumental in improving recoverability. Eventually, this will be a pivotal factor in ensuring banks’ balance sheets are in good shape," Jaya Vaidhyanathan, CEO, BCT Digital told ABP LIVE.

Meanwhile, Anish Mashruwala, Partner, J Sagar Associates said: "The sovereign guarantee will support the regulatory provisioning requirement of the RBI on the security receipts portion under the structure and allow the banks to free up that capital without the burden of additional provisioning - effectively allowing more participation from the banks to resolve their NPAs through the bad bank."