The government today discussed the possibility of creating a Bad Bank or National Asset Management Co.(NAMCO) as per press reports available on the web http://economictimes.indiatimes.com/news/economy/policy/pm-narendra-modi-discusses-plan-to-set-up-a-national-asset-management-company/articleshow/48872058.cms
This is a welcome step. A few pointers that should be pertinent to discuss right away since the proposal is now getting seriously looked at as a very urgent measure to shore up the economy and derisk the NPA laden banking space.
1. Bad Banks have provided relief in the past to economies suffering from a credit meltdown post bursting of asset bubbles such as Germany (1980s), China (1990s), Sweden(1992),Ireland(2009),Netherlands(2011), Spain(2012), Portugal(2014), Latvia(2010).
2. Bad banks, in theory, operate on a short time frame project workflow basis for recovery of bad assets; while the good bank can continue to operate on a process driven manner and continue with the job of financial intermediation and credit allocation. The absence of bad assets on the books of good banks allows the good bank to concentrate fully on the evaluating credit proposals without the dead weight of past bad assets.
3. In practice, the threat of moral hazard is very real and the implementation must be such that it does not allow bad lending practices attain official sanction by the "Bad Bank" bailout. Also, small borrowers and small ticket lending that have gone bad must be kept out of the Bad Bank so that enough time is given to small borrowers to recover and repay.
4. So, Bad Bank is to be created out of the non-performing assets of the banking industry at book value or market value whichever is a fair price for the buyer(Bad Bank) and the seller(Original Bank). Needless to say, the original banks have to immediately recognize the value lost post default or due to non-repayment of the loan. But that is a given, or else shy would any investor put money in a Bad Bank and take the risk of losing capital because there is no certainty that defaulter/ borrower will repay the loan in the future.
5. The investor in the Bad Bank can be a private investor, original bank, or the Government or a combination of the three. Any model can work provided a workable and practical model of regulation and laws is put in place quickly and effectively. Even a model where the original bank forms a subsidiary bad bank at an arms length can work as evidenced by CitiBank recently in the US which has successfully implemented this model in the backdrop of the 2008 credit crisis. But the challenge in such cases is strong and effective regulatory oversight and regulatory framework.
6. The Bad Bank is not a going concern with a long life time like normal banks. It is at most a 4 - 5 year project where the investor is interested in recovering the money from the defaulters in a project management sense of business and exiting the business or handing it over to traditional banks who may be interested in buying the now-healthy not-so-Bad Bank.
That said, the creation of Bad banks will require new legislation- but examples in many nations abound as stated earlier above. These nations including Spain and Ireland had to undergo a thorough legislative law making and regulatory rule making before Bad Banks could become a reality and the challenge in the face of urgency is that these tasks be completed with great urgency.
Why should we display so much urgency? The global macroeconomic environment is nothing to be comfortable about, and ditto is the current state of our domestic banking system. If we are comfortable with dribbling the buck , then we can just stick around with the status quo and pray to God to make things better. But if we want to address the fact that every year 1 million young people are joining the workforce, then we can't just dribble- we must advance the game plan proactively to the next level without waiting for some crisis to goad us into action.
This is a welcome step. A few pointers that should be pertinent to discuss right away since the proposal is now getting seriously looked at as a very urgent measure to shore up the economy and derisk the NPA laden banking space.
1. Bad Banks have provided relief in the past to economies suffering from a credit meltdown post bursting of asset bubbles such as Germany (1980s), China (1990s), Sweden(1992),Ireland(2009),Netherlands(2011), Spain(2012), Portugal(2014), Latvia(2010).
2. Bad banks, in theory, operate on a short time frame project workflow basis for recovery of bad assets; while the good bank can continue to operate on a process driven manner and continue with the job of financial intermediation and credit allocation. The absence of bad assets on the books of good banks allows the good bank to concentrate fully on the evaluating credit proposals without the dead weight of past bad assets.
3. In practice, the threat of moral hazard is very real and the implementation must be such that it does not allow bad lending practices attain official sanction by the "Bad Bank" bailout. Also, small borrowers and small ticket lending that have gone bad must be kept out of the Bad Bank so that enough time is given to small borrowers to recover and repay.
4. So, Bad Bank is to be created out of the non-performing assets of the banking industry at book value or market value whichever is a fair price for the buyer(Bad Bank) and the seller(Original Bank). Needless to say, the original banks have to immediately recognize the value lost post default or due to non-repayment of the loan. But that is a given, or else shy would any investor put money in a Bad Bank and take the risk of losing capital because there is no certainty that defaulter/ borrower will repay the loan in the future.
5. The investor in the Bad Bank can be a private investor, original bank, or the Government or a combination of the three. Any model can work provided a workable and practical model of regulation and laws is put in place quickly and effectively. Even a model where the original bank forms a subsidiary bad bank at an arms length can work as evidenced by CitiBank recently in the US which has successfully implemented this model in the backdrop of the 2008 credit crisis. But the challenge in such cases is strong and effective regulatory oversight and regulatory framework.
6. The Bad Bank is not a going concern with a long life time like normal banks. It is at most a 4 - 5 year project where the investor is interested in recovering the money from the defaulters in a project management sense of business and exiting the business or handing it over to traditional banks who may be interested in buying the now-healthy not-so-Bad Bank.
That said, the creation of Bad banks will require new legislation- but examples in many nations abound as stated earlier above. These nations including Spain and Ireland had to undergo a thorough legislative law making and regulatory rule making before Bad Banks could become a reality and the challenge in the face of urgency is that these tasks be completed with great urgency.
Why should we display so much urgency? The global macroeconomic environment is nothing to be comfortable about, and ditto is the current state of our domestic banking system. If we are comfortable with dribbling the buck , then we can just stick around with the status quo and pray to God to make things better. But if we want to address the fact that every year 1 million young people are joining the workforce, then we can't just dribble- we must advance the game plan proactively to the next level without waiting for some crisis to goad us into action.
