Not a good idea

A bad bank will do nothing to solve the problems

A “bad bank” is reportedly being planned to deal with the fallout of the non-performing assets crisis, which has constrained commercial bank credit growth for years. It is understandable why this idea is returning to the forefront of policy now — reviving credit growth is a necessary condition for emerging from the sudden sharp stop that the economy has been subjected to as a consequence of the pandemic and efforts to contain it. Yet the arguments for a bad bank are no more palatable or powerful now than they were the last few times it was the flavour of the day— mid-2018, for example, when an expert committee recommended it as a solution. The plan now, as reported in this newspaper, is that banks will transfer about Rs 60,000 crore worth of stressed assets to a new asset reconstruction company (ARC), which will seek to turn them around. The government would own 50 per cent or less of the capital, putting in Rs 9,000-10,000 crore of equity. The ARC, having taken the troublesome assets off the balance sheets of the bank, would then allow them to resume normal operations and lending. 

As planned — even if government participation is capped at 50 per cent — this is just another state-controlled financial institution, and the government should think long and hard about setting up yet another of the sort. After all, the problems that have bedevilled the state-led financial sector are not going to pass this new bank just because it has a different name. Any state-controlled ARC would be forced to deal with the same questions that the heads of nationalised banks are asking themselves — namely, how much of a haircut to take on an asset? Who will share in it, and how much? And who will be held responsible for the size of the haircut? The adherents of a bad bank are yet to answer why these issues will be solved differently by calling the new public-sector institution an ARC instead of a bank. Indeed, such an organisation would have less of an ability to deal with other creditors than the banks, since its bargaining power would be reduced. And, of course, there is the age-old problem of political influence in decision-making. Will the new ARC, if the state government has 50 per cent, be willing to shut down unprofitable assets which have political salience — say, a thermal power plant in a state that is going to the polls? Finally, as Raghuram Rajan kept on pointing out, the very creation of a bad bank would require the banks to make decisions they have so far been unwilling to make — namely, decide a value for the assets that they will have to pass on to the bad bank. 

The pandemic must not be used as an excuse to brush the crisis of state-controlled banking under the carpet. Many in public-sector banks see a bad bank simply as another way to evade responsibility for the crisis. This should not happen. Reform of the banking system, and independence from the government, is the only way to revive effective banking and move on. The bad bank achieves neither of those goals.