Former Reserve Bank of India Governor D Subbarao made a strong case for setting up a bad bank saying it is “not just necessary but unavoidable” in the present circumstances when non-performing assets (NPAs) are likely to balloon and much of the resolution will have to take place outside the Insolvency and Bankruptcy Code framework.
Even the Economic Survey 2017 had proposed this idea, suggesting the creation of a bad bank called Public Sector Asset Rehabilitation Agency (PARA) to help tide over the problem of stressed assets. “The standard advantage of a bad bank is that the entity taking a decision on the sale price is different from the entity accepting that price. Conflict of interest and corruption are avoided, and importantly, are seen to be avoided,” he said in an interview to news agency Press Trust of India.
“There are some successful models of bad banks with carefully designed carrots and sticks. Danaharta of Malaysia, for example, is a good model to study in designing our own bad bank,” Mr Subbarao said.
The former RBI Governor noted that non-performing assets (NPAs) will balloon with the economy contracting by at least five per cent this fiscal year. Also, according to the RBI’s Financial Stability Report, gross NPAs of banks may rise to 12.5 per cent by March 2021 under a baseline scenario, from 8.5 per cent in March 2020.
“The bankruptcy framework is already overloaded and it simply will be unable to deal with this huge additional burden. It is important, therefore, indeed more than ever before, that much of the resolution takes place outside the Insolvency and Bankruptcy Code (IBC) framework,” he said.
The economy was already decelerating before the coronavirus crisis hit the country. Growth in its real gross domestic product (GDP) had moderated from 7.0 per cent in 2017-18 to 6.1 per cent in 2018-19, and 4.2 per cent in 2019-20.
The projections for the current year by various global and domestic agencies indicate a sharp contraction in the economy, ranging from 3.2 per cent to 9.5 per cent.
Earlier, Mr Subbarao said, he had some reservations about a bad bank, but he is veering towards the idea in view of recent experience. “First, I believed the bankruptcy framework will put resolution on track and help clean up the system,” he elaborated.
Mr Subbarao admitted that he also had concerns about the capital structure of the bank.
“Where will the funding come from? If capital has to come from the public sector banks (PSBs), the problems that bogged down their chiefs from taking bold decisions – fear of retribution – will persist,” he said.
“If it’s got to come from the private sector, there will be issues of crony capitalism. If it’s got to be from the government, the question is: wouldn’t the government be better off using that money to capitalise individual banks, which, at any rate in theory, looks more efficient?”