All You Want to Know About Bad Bank UPSC

Ultimately, there are various topics that are most important for the economic section of the UPSC examination. So, in this article, we are going to share detailed information regarding one of the really very important topics in the economic section named “Bad Bank”.

What is Bad Bank?

A bad bank is a financial institution created to buy bad debt. Non-performing assets (NPAs), often known as poor bank loans, are a type of non-performing asset.

The goal of establishing a bad bank is to alleviate the pressure on banks by removing bad loans from their balance sheets and allowing them to lend freely to clients again.

Following the purchase of a bad loan from a bank, the bad bank may attempt to restructure and sell the nonperforming asset (NPA) to investors.

A bad bank earns a profit in its operations if it can sell a loan for more than it paid for it when it bought it from a commercial bank. However, producing profits isn’t always the main goal.

The objective is to ease the burden on banks, of holding a large pile of stressed assets, and to get them to lend more actively.

What are the advantages and disadvantages of establishing a bad bank?

Setting up a bad bank, it is stated, has the advantage of helping to combine all bad loans of banks under one roof. It has previously been tried out in nations such as the United States, Germany, Japan, and others.

The troubled asset rescue program, better known as TARP, was designed around the concept of a bad bank and executed by the US Treasury in the aftermath of the 2008 financial crisis.

During the financial crisis, the US Treasury purchased distressed assets such as mortgage-backed securities from US banks and later resold them when market circumstances recovered. It is anticipated that the Treasury generates $1 to $30 billion in revenue through its operations.

However, many critics have pointed out various flaws in the concept of a bad bank to deal with poor loans.

Former RBI governor Raghuram Rajan has been a vocal opponent of the notion, claiming that a government-backed bad bank would simply transfer problematic assets from public sector banks to a bad bank, which would then be owned by the government.

When the set of incentives confronting these institutions is essentially the same, there is little reason to assume that a simple transfer of assets from one pocket of the government to another will result in a satisfactory resolution of these bad debts.

Other analysts believe that unlike a bad bank set up by the private sector, a bad bank backed by the government is likely to pay too much for stressed assets. 

Will it assist in reviving the economy’s credit flow?

Some analysts believe that by taking bad loans off failing banks’ books, a bad bank can assist liberate capital worth over Rs. 5 lakh crore that banks have set aside as provisions against bad loans.

They claim that this will allow banks to use the freed-up cash to provide more loans to their consumers.

This provides the appearance that banks have unspent funds on their balance sheets that they could put to good use if only their bad loans could be eliminated.

However, banks’ reserve requirements should not be confused with their capital situation. This is because it’s possible that what’s preventing banks from lending more aggressively may not be the lack of sufficient reserves which banks need to maintain against their loans. 

Final Conclusion on All You Want to Know About Bad Bank UPSC

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