Former RBI 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 NPAs are likely to balloon and much of the resolution will have to take place outside the IBC framework.

Even Economic Survey 2017 had proposed this idea, suggesting the creation of a bad bank, called Public Sector Asset Rehabilitation Agency, to help the lenders tide themselves 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.

“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,” Subbarao said.

The former RBI governor noted that with the economy contracting by at least 5 per cent this financial year, non-performing assets (NPAs) will balloon. Also, according to the RBI’s Financial Stability Report, the gross NPAs of banks may rise to 12.5 per cent by March 2021 from 8.5 per cent in March 2020.

“The bankruptcy framework is already overloaded and it will be unable to deal with this huge additional burden. It is important, more than ever before, that much of the resolution takes place outside the Insolvency and Bankruptcy Code framework,” he said.

Before the Covid-19 crisis, the economy was already decelerating, real gross domestic product (GDP) growth had moderated from 7 per cent in 2017-18 to 6.1 per cent in 2018-19 and 4.2 per cent in 2019-20.
The growth projections for the current financial year by various global and domestic agencies indicate a sharp contraction in the Indian economy, ranging from (-)3.2 per cent to (-)9.5 per cent.

Earlier on, Subbarao said he had some reservations about a bad bank but, in view of the recent experience, he is veering towards the idea of it.

“First I believed the bankruptcy framework will put resolution on track and help clean up the system,” he said, adding that in hindsight that faith seems misplaced.

Subbarao admitted that he also had concerns about the capital structure of the bank. “If capital has to come from the public sector banks (PSBs), the problems that bogged down PSB chiefs from taking bold decisions — fear of retribution — will persist.”