What Are Bad Banks?

What Are Bad Banks?

Rising Non-Performing Assets (NPAs) are no less than a financial pandemic hovering upon the Indian Economy for quite a long now. Finally, in what looked like a concrete measure to address the NPA issue, the government announced the establishment of a ‘Bad Bank‘. We know the term ‘Bad Banks’ is just being tossed around like any other word, but in this story, we will simplify the term for you and see if it can solve the NPA crisis.

Crux of the Matter

Simplifying The Term
In Budget 2021, the FM had proposed setting up a government backed Asset Reconstruction Company (ARC) for buying the stressed assets from the banks.

Such ARCs that ‘isolate high risk and illiquid assets’ like bad loans are called ‘Bad Banks.’

In simple terms, the proposed Bad Bank is a financial enterprise set up to purchase Bad Loans (Non Performing Assets) from other Banks.

Why The Setup?
As of September 2020,
9.7% of PSB loans, and
4.6% of private sector banks’ loans were NPAs.

The total NPAs amounted to ₹7 lakh crores!

The aim of the Bad Bank is to ease accounting burden of NPAs on banks by clearing their stressed balance sheets

How Will It Work?
1. ARC will buy NPAs from Banks.
2. This newly set up ARC will then be a holding company to an Asset Management Company (AMC).
3. The AMC in turn will recover money from the acquired NPAs by selling them.

Bankers estimate a corpus of ₹15,000 crores will be required for buying loans of ₹3 lakh crores. The funding is expected to be provided jointly by the Government and Banks.

Funding Mechanism
The ARC will be paying 15% cash upfront to the Banks. For the remaining 85%, a Security receipt will be issued by the ARC, payment of which would depend upon the amount recovered from selling the NPAs.

The Pros
– Consolidates all the bad loans under one single entity further easing the recovery hurdles.
– The goal is not to make a profit but to lessen the burden of the bank by arresting their losing market share.

– It is a mere shifting of assets from one entity to another – just accounting wizardry.
– Indirectly, it may incentivize commercial banks to operate recklessly given the safety net of Bad Banks that will keep absorbing NPAs.
– This is not the first time an ARC has been set up (although it’s a first govt ARC), so the historical data suggests that banks were able to recover only 30% of the amount of NPAs sold to ARCs.

Did you know that cabs were expected to be the reason for the increase in NPAs during the lockdown? Strange, right? Then quench your curiosity here.

  • A special-purpose entity is a legal entity created to fulfill narrow, specific or temporary objectives. SPEs are typically used by companies to isolate the firm from financial risk.
  • The first bank to use the bad bank strategy was Mellon Bank, which created a bad bank entity in 1988 to hold $1.4 billion of bad loans. Initially, the Federal Reserve was reluctant to issue a charter to the new bank, but Mellon’s CEO, Frank Cahouet, persisted and the regulators eventually agreed. 
  • Many companies see a business opportunity in buying NPAs. Buying NPAs from financial institutions with a discount, can be a lucrative business. Companies pay from 1% to 80% of the total loan and become the legal owner (creditor). The discount depends on the age of the loan, secured/ unsecured, age debtor, personal/ commercial debt, area of residence, etc.

Cabs May Drive Up NPAs

Banks are likely to witness a rise in defaults in automobile loans towards cabs attached to online cab aggregators like Ola or Uber. Slump in demand, lockdown due to Covid, and slow recovery rate will play a vital role in determining the extent of the NPAs.

Crux of the Matter

Automobile Loan Sector
Generally, automobile loans are taken with a repayment period of 5-7 years. As of April, banks’ total outstanding amount for the vehicle loan segment was ₹2.16 lakh crore. This includes both personal and commercial vehicles.

Uber and Ola’s platforms combined have 1.5 lakhs car in Delhi NCR and around 3 lakh across the country. Cars taken on loan by cab aggregators on average are priced between 5- 8 lakhs. Monthly average EMI comes around ₹15,000 for it due to the short tenure of the loan.

Even if, 1 lakh cars amongst the 3 lakh are on loan and average ₹15,000 EMI per month is paid then banks accumulate a loss of 1 lakh cars x ₹15000 = ₹150 crores. RBI has announced a moratorium on term loans for 6 months. Therefore, estimated losses borne by banks could go up to as high as ₹900-1,000 crore.

Rise In Risk Of NPA
Banks are likely to face a rise in NPAs in loans given to drivers of Cabs of aggregator platform. The moratorium would also result in burdening the borrower as the interest component continues to accrue on the outstanding loan during the moratorium period. The repayment schedule will reflect higher EMIs, which may lead to NPAs as revenues of cab drivers have stopped due to lockdown and Covid-19 Crisis.

Banks may also face the challenge of recovering the amount by selling a vehicle in second hand. But banks would be ready to extend fresh loans since the car would remain hypothecated to the bank and the loan is secured.

Other Factors Likely To Exacerbate NPAs

  • Uncertainty over restriction on public transport – phased recovery
  • Cab riders’ preference of using personal vehicles over Cab in wake of Coronavirus
  • Experts estimate at least 3 to 6 months to get back to 50% of original ride volumes
  • If companies push towards remote working, a large chunk of employees using cabs will not use it anymore
  • Revenue loss during the lockdown may result in less commission to drives by Cab service platforms
  • On May 10, 2019, Uber became a public company via an initial public offering. Following the IPO, Uber’s shares dropped 11%, resulting in the biggest first-day dollar loss in IPO history for the US. A month after going public, both COO Barney Harford and CMO Rebecca Messina stepped down.
  • Evergreening is a practice whereby banks extend even more loans to debt-laden companies to help them repay previous loans and hopefully earn enough revenue along the way to get out of trouble. Usually, it results in increased NPAs. The term is not to be confused with Evergreen Loans.
  • As per the Narasimham Committee, NPAs had been the single largest cause of irritation of the banking sector of India. The committee had highlighted that ‘priority sector lending’ was leading to the buildup of non-performing assets of the banks and thus it recommended it to be phased out. Subsequently, the Narasimham Committee-II also highlighted the need for ‘zero’ non-performing assets for all Indian banks with an international presence.

RBI To Pump Liquidity In The Market Even As NPAs Expected To Rise

RBI taking measures to cope with the slowdown

A mammoth task on the government’s shoulder is to protect India’s ₹2.7 trillion economy that is facing the threat of shut down due to coronavirus. Markets are facing a massive demand slump. RBI has, therefore, decided to infuse liquidity into the market to cope with the slowing demand.
Complete Coverage: Coronavirus

Crux of the Matter

RBI’s Measures
Due to coronavirus, markets and industries across the world are facing a massive slump in demand. In India, RBI has decided to pump ₹10,000 crores into the market via Open Market Operations (OMO) – buying back government securities – to increase liquidity and monetary transmission. In addition to this, RBI has also announced up to ₹1 trillion in long-term repo operations in multiple tranches, besides a $2 billion dollar swap, in which it will buy dollars from the market now and sell it six months from now, increasing the flow of rupee in the Indian economy.

The main focus of the Government is to keep the economy running without falling into a financial crisis. The small and medium-sized businesses (MSMEs) employ more than 100 million people and account for 45% of factory output and contribute 40% of the nation’s export. Thus, the Finance Ministry has reconsidered the repay terms of borrowed loans and interest rates for MSMEs. Loan tenors for MSMEs are also extended.

NPAs Hindering RBI’s Measures
On the other hand, the Indian financial sector especially banks are struggling because of high Non-Performing Assets (NPAs). Amid coronavirus threat, Indian banks are worried about a fresh spike in bad loans and thus have appealed to the government to ease the bad-debt classification criteria for the time being. The Indian banking sector is still healing from the bruises of Yes Bank debacle.


Non-performing Assets – A non-performing asset (NPA) refers to a classification for loans or advances that are in default or in arrears. A loan is in arrears when principal or interest payments are late or missed. A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations. More Info

Market Liquidity – In business, economics or investment, market liquidity is a market’s feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset’s price. Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much. In a relatively illiquid market, selling it quickly will require cutting its price by some amount. Money, or cash, is the most liquid asset, because it can be “sold” for goods and services instantly with no loss of value. There is no wait for a suitable buyer of the cash. There is no trade-off between speed and value. It can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs. More Info

Did RBI Not Listen to the Swan Song of Yes Bank?

India’s fourth-largest private sector bank, Yes Bank is witnessing a fallout because of the mounting Non-Performing Assets (NPAs) and mismanaged Balance Sheet. Rana Kapoor’s lending spree has now put the bank into the hands of RBI that has put a moratorium on withdrawal.

Crux of the Matter

Yes Bank was founded in 2004 by Rana Kapoor and Ashok Kapur when the Reserve Bank of India (RBI) was giving out banking licenses in the country. The commercial sector lender aimed at lending out to companies and sectors that were unable to acquire loans from elsewhere, adding high risk to its business model. As per many, the ‘Yes’ model helped the bank to grow exponentially.

With the focus on corporate lending and retail franchising, the bank declared its Initial Public Offering (IPO) in its debut year only. No sooner had the bank gained momentum, the co-founder of the bank, Ashok Kapur was killed in the 26/11 Mumbai Terror Attacks. The helm was now only in the hands of Rana Kapoor, who according to many was an aggressive lender. Yes Bank’s lending motto of ‘lending to the companies that no other bank lent’, proved to be fatal when non-performing assets (NPAs) and credit-deposit ratio started to show weakness.

The Beginning of the End
2014 could be marked as the year that was the beginning of the end for the corporate lender. Yes Bank Advances bubbled from Rs. 55,000 crores in FY14 to Rs. 2,41,000 crores in FY19. The Advances in FY19 were nearly 330% of that in FY14 – highest among comparables like HDFC, Axis, Kotak, ICICI, and SBI.

This, in turn, led to a rise in the number of defaulters. Yes Bank that once proudly said that it was below 1% NPAs, in September 2019 stood at 7.39%, worst among comparables. It had advanced loans to many companies like DHFL, IL&FS, Jet Airways, Cafe Coffee Day, Anil Ambani’s Reliance Group, Cox & Kings, etc. that suffered through the tough market and internal situations in recent.

A bank usually needs to provide for the defaults. A sufficient amount needs to be set aside as Provision in case of a bad loan. Yes Bank failed to have ample provisions for the ballooning bad loans. Its Provision Coverage Ratio was only 43.1%. Whereas, RBI recommends a 70%+ PCR.

One of the reasons that can be attributed to the low amount of provisioning could be the declining growth of deposits in the bank. The Credit-Deposit Ratio (CDR) – the ratio of loans advanced to deposits received – is one of the yardsticks of a bank’s performance. In 2014, Yes Bank’s CDR was among the industry’s lowest at around 70%, whereas in 2019 it was 106%. It means that the bank received only Rs. 100 deposit for every Rs. 106 it lent.

Its profitability began to dip because of the above-mentioned. In 2016, the bank wanted to raise capital through Qualified Institutional Buyers but it canceled the plan. Among other banks, RBI put Yes Bank under the scanner to see whether it was reporting NPAs properly. According to the Outlook Business Report, in FY16 it under-reported its NPAs at Rs. 749 crores. The bad loans amounted to a gigantic Rs. 4,900 crores in that period.

Reserve Bank of India also insisted Rana Kapoor to step down as the CEO & MD. In March 2019, Rana stepped down and Ranveet Gill took office. Many are also raising the question of why the RBI did not intervene when the Advances shot up year after year and when it knew Rana’s lending spree behavior.

Revival Plan
RBI, in order to safeguard the interests of all the stakeholders, put a moratorium on the withdrawal of amount of Rs. 50,000 till April 3, 2020. Depositors cannot withdraw on an aggregate of more than Rs. 50,000 till the moratorium ends. RBI in a draft revival plan also announced that public-lender State of India (SBI) might purchase a 49% stake in Yes Bank. SBI will infuse around Rs. 11,760 crores. Furthermore, SBI will not be allowed to reduce its stake to less than 26% for 3 years. RBI said that all the existing employees of the bank would retain their positions except a few ‘Key Managerial Personnel’ may be removed.

As per RBI’s Yes Bank Limited Reconstruction Scheme 2020, all the securities that are a part of the Additional Tier 1 Capital (AT-1) will be written down permanently. Its bondholders are mulling over filing a case against RBI’s revival plan. The AT-1 issued under Basel III norms has the following terms, “The write-down of common equity tier-I capital shall not be required before a write-down of any additional tier-I capital.” This lays down an exception that these bonds would absorb losses before Tier-1 equity of the bank. Investors are worried whether RBI’s move is an economically viable one as this move would wipe out bond investment value while maintaining the equity value. But this concern contradicts the law.

Rana Arrested
Former MD and CEO Rana Kapoor was arrested by Enforcement Directorate under the Prevention of Money Laundering Act (PMLA). He is accused of receiving many benefits for disbursing loans to companies in a critical situation. One of the cases accuses him that one of his family ventures received Rs. 600 crores in exchange for a non-repayment of loans from bankrupt-DHFL.

ED also probed Rana for the MF Hussain painting he bought from Priyanka Gandhi worth Rs. 2 crores. He possesses many such exquisite paintings with him. However, he usually took valuation certificates from experts but he did not take one for this painting.


Basel IIIis a global, voluntary regulatory framework on bank capital adequacy, stress testing, and market liquidity risk. This third installment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. It is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.

As part of the norms, economic output would be mainly affected by an increase in bank lending spreads, as banks pass a rise in bank funding costs, due to higher capital requirements, to their customers. To meet the capital requirements originally effective in 2015 banks were estimated to increase their lending spreads on average by about 15 basis points. Capital requirements effective as of 2019 (7% for the common equity ratio, 8.5% for the Tier 1 capital ratio) could increase bank lending spreads by about 50 basis points. The estimated effects on GDP growth assume no active response from monetary policy. To the extent that monetary policy would no longer be constrained by the zero lower bound, the Basel III impact on economic output could be offset by a reduction (or delayed increase) in monetary policy rates by about 30 to 80 basis points. More Info

UCO Bank Recovers Rs.800-900 Crore to Revamp Fraud-Hit Balance Sheet

State-owned lender UCO Bank has recovered Rs. 800-900 crores from its four stressed accounts during December quarter of Fiscal Year 2019-20, said UCO BANK MD and CEO, Mr. A K Goel. The Bank is switching to recovery mode after its former MD Arun Kaul was booked for siphoning loans worth Rs. 6.21 billion.

Crux of the Matter
  • The fraud-hit bank recovered stressed loans from RattanIndia Power Ltd., Essar steel, Ruchi Soya Industries Ltd. and Prayagraj Power.
  • With the help of the Corporate Insolvency Resolution Process (CIRP) UCO Bank manages will recover money from Essar Steel and Ruchi Soya.
  • The resolution process of the remaining two companies, RattanIndia Power and Prayagraj Power Generation has been executed under RBI’s Prudential Framework for Resolution of Stressed Assets. A lump-sum payment of Rs 6,574 crore from RattanIndia will help the bank to reduce its bad loans further.
  • Bank MD and CEO, Mr. A K Goel stated that to rebalance the current loan portfolio, UCO Bank has announced ‘Loan Carnival‘ from January 6.
  • As a part of that, it will disburse Rs. 2700 crore retail loans, and Rs. 1300 crore MSME loans.

National Company Law Tribunal(NCLT) is established by the Supreme Court to order to handle the laws regarding the companies. National company law tribunal is a quasi-judicial body in India. More Info

Insolvency and Bankruptcy Code (IBC) has been a big sigh of relief for MSMEs. It is the bankruptcy law of India which seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. It would ensure faster debt recovery or liquidation process. The IBC Law was brought about with the objective to ensure that ease of doing business greatly improves in India. More Info