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Indian Finance Minister Nirmala Sitharaman recently announced her intention to create a "bad" bank. Thus, the government is trying to solve the problem of non-performing loans: their amount could exceed 10 trillion rupees ($ 100 billion) by March next year. Ukraine is also planning to create a bad bank as one of the steps for the successful privatization of PrivatBank. “For Privat to be of interest to a serious investor, it must be divided into“ bad ”and“ good ”banks. This is the first step, "- in an interview said the head of the National Bank of Ukraine Kirill Shevchenko.
Let's see what a “bad” bank is and how it can help in a situation with non-performing loans. So, a “bad” bank is a legal entity designed to help banks clean up their balance sheets by getting rid of bad loans - NPA (Non-performing Asset). These are loans for which there is no repayment of either the principal or interest for more than three months.
As you know, banks earn income from the interest they receive on loans issued. At the expense of it, the financial institution pays interest on deposits. Deposits from individuals and legal entities are used by banks to provide loans. So when the borrower does not repay the loan, it is difficult for the bank to repay the deposits to its clients. To compensate for this, the financial institution may charge higher interest rates for future loans or offer lower interest rates to its depositors. However, this will only work if the share of non-performing loans is small.
Otherwise, the "bad" bank will come in handy. It is a bank created specifically to buy bad loans and other illiquid assets from a financial institution. The bank, as a rule, sells assets to the “bad” bank at the market price, therefore, it gets the opportunity to resume lending. The managers of a “bad” bank mainly focus on the liquidation or sale of acquired high-risk assets. At the same time, the proceeds from their sale help banks to recover some of the bad loans.
Bad banks are usually created during a crisis when long-standing financial institutions are trying to rebuild their reputations and wallets. The first such bank was created by the American Mellon Bank in 1988 to consolidate its "toxic assets". The new institution was named Grant Street National Bank (GSNB). GSNB bought bad loans from Mellon Bank at a 53% discount. The "bad" bank focused on recovering bad loans and was disbanded in 1995 after achieving the goal. Further similar models were used by Finland, Sweden, Indonesia, Belgium.
"Bad credit sows in good times"
Return on bad loans in India has traditionally been low - up to a third of total loans. Non-performing loans began to accumulate rapidly in 2006-2008, when economic growth was rapid. The global financial crisis of 2007-2008 almost did not affect India, so banks provided loans to everyone, right and left. “Bad credit sows in good times,” said Rangarajan, the former head of the central bank, rightly.
Injection of more than $ 35 billion of taxpayers into troubled banks from 2005 to 2009. didn't help much. The situation improved slightly (40-45%) after the 2016 bankruptcy law. However, banks are still afraid to lend, as a result - private investment has dropped sharply. Last July, Fitch Ratings announced that Indian banks would need 15 to $ 58 billion in new funding by 2022.
Therefore, the government plans to launch a "bad" bank that will "suck" $ 27 billion in bad loans from commercial banks. That would still only be a quarter of the $ 100 billion NPA. However, this is not the first time that India is facing a bad credit crisis and founding a "bad bank". In fact, there have been 28 such firms over the past two decades.
This time the government has formed two companies - one state-owned, which will buy bad loans, and the other partially private, which will concentrate on selling assets. The government will pay the difference between the expected value of the commercial bank's assets and what the “bad” bank can get from the sale.
Some experts argue that a "bad bank" will not be the magic wand that has cured the systemic problem of Indian banks. State banks will have to become truly independent and lend in a market-risk-sensitive manner.
The local authorities must take care, in particular, to create the right team and incentives to ensure innovation for the effective sale of the underlying assets. After all, each asset is unique, so strategies will depend on their specifics. It is also necessary to organize a coordinated bidding process to ensure that assets are acquired at fair value. At the same time, the government should remain an active participant in the process to ensure timely course adjustments.
Indian Finance Minister Nirmala Sitharaman recently announced her intention to create a "bad" bank. Thus, the government is trying to solve the problem of non-performing loans: their amount could exceed 10 trillion rupees ($ 100 billion) by March next year. Ukraine is also planning to create a bad bank as one of the steps for the successful privatization of PrivatBank. “For Privat to be of interest to a serious investor, it must be divided into“ bad ”and“ good ”banks. This is the first step, "- in an interview said the head of the National Bank of Ukraine Kirill Shevchenko.
Let's see what a “bad” bank is and how it can help in a situation with non-performing loans. So, a “bad” bank is a legal entity designed to help banks clean up their balance sheets by getting rid of bad loans - NPA (Non-performing Asset). These are loans for which there is no repayment of either the principal or interest for more than three months.
As you know, banks earn income from the interest they receive on loans issued. At the expense of it, the financial institution pays interest on deposits. Deposits from individuals and legal entities are used by banks to provide loans. So when the borrower does not repay the loan, it is difficult for the bank to repay the deposits to its clients. To compensate for this, the financial institution may charge higher interest rates for future loans or offer lower interest rates to its depositors. However, this will only work if the share of non-performing loans is small.
Otherwise, the "bad" bank will come in handy. It is a bank created specifically to buy bad loans and other illiquid assets from a financial institution. The bank, as a rule, sells assets to the “bad” bank at the market price, therefore, it gets the opportunity to resume lending. The managers of a “bad” bank mainly focus on the liquidation or sale of acquired high-risk assets. At the same time, the proceeds from their sale help banks to recover some of the bad loans.
Bad banks are usually created during a crisis when long-standing financial institutions are trying to rebuild their reputations and wallets. The first such bank was created by the American Mellon Bank in 1988 to consolidate its "toxic assets". The new institution was named Grant Street National Bank (GSNB). GSNB bought bad loans from Mellon Bank at a 53% discount. The "bad" bank focused on recovering bad loans and was disbanded in 1995 after achieving the goal. Further similar models were used by Finland, Sweden, Indonesia, Belgium.
"Bad credit sows in good times"
Return on bad loans in India has traditionally been low - up to a third of total loans. Non-performing loans began to accumulate rapidly in 2006-2008, when economic growth was rapid. The global financial crisis of 2007-2008 almost did not affect India, so banks provided loans to everyone, right and left. “Bad credit sows in good times,” said Rangarajan, the former head of the central bank, rightly.
Injection of more than $ 35 billion of taxpayers into troubled banks from 2005 to 2009. didn't help much. The situation improved slightly (40-45%) after the 2016 bankruptcy law. However, banks are still afraid to lend, as a result - private investment has dropped sharply. Last July, Fitch Ratings announced that Indian banks would need 15 to $ 58 billion in new funding by 2022.
Therefore, the government plans to launch a "bad" bank that will "suck" $ 27 billion in bad loans from commercial banks. That would still only be a quarter of the $ 100 billion NPA. However, this is not the first time that India is facing a bad credit crisis and founding a "bad bank". In fact, there have been 28 such firms over the past two decades.
This time the government has formed two companies - one state-owned, which will buy bad loans, and the other partially private, which will concentrate on selling assets. The government will pay the difference between the expected value of the commercial bank's assets and what the “bad” bank can get from the sale.
Some experts argue that a "bad bank" will not be the magic wand that has cured the systemic problem of Indian banks. State banks will have to become truly independent and lend in a market-risk-sensitive manner.
The local authorities must take care, in particular, to create the right team and incentives to ensure innovation for the effective sale of the underlying assets. After all, each asset is unique, so strategies will depend on their specifics. It is also necessary to organize a coordinated bidding process to ensure that assets are acquired at fair value. At the same time, the government should remain an active participant in the process to ensure timely course adjustments.
