What is Bad Bank? How does this work? & What is an NPA?

Recently, the central government has approved the establishment of a bad bank. Are you hearing about Bad Bank for the first time? If yes, then do not worry, today you will understand everything related to this topic in an easy way?

What is Bad Bank?

A Bad Bank is set up to separate the stressed assets held by a bank from its performing assets. Once liquidated, the stressed asset is removed from the bank's balance sheet. It helps in cleaning the bank balance sheet. In addition, the bad bank handles the servicing and liquidation of stressed assets transferred over time.

History of Bad Bank:

The first bad bank in the world was created in 1988 by US-based Mellon Bank to hold its stressed assets. After its success, it became a model that was followed in many countries such as the US, Finland, Sweden, Indonesia, and Belgium.

How will the bad bank work?

NARCL will take over and consolidate the identified NPA accounts from banks while IDRCL will handle the debt resolution process under a special arrangement. This special arrangement will be as per the scope defined in the 'Debt Management Agreement' to be executed between the two entities.

What is NPA?

A non-performing asset (NPA) is a loan given by a bank that has stopped adding interest and principal value to the bank for a period of more than 90 days. In other words, when a bank stops receiving the principal and interest payments for a particular loan for more than three months, that loan is considered as NPA.

Let us understand this with an example, suppose a person gets a loan of 5 lakhs from a bank at 10% per annum interest for some business. But after a few months, his business collapses (or due to any other reason) due to which he is unable to return the principal amount along with interest to the bank. If he is not able to do so for 90 days then that bank loan becomes NPA.

How do NPAs affect the banking sector?

Banks earn their income in the form of interest received on loans given to borrowers. From that income, the bank pays interest to the depositors. The balance between interest income and paid-in income is the profit earned by the bank. This is the reason why the interest charged by the bank is always higher than the interest paid to the depositors.

NPAs reduce the profitability of banks due to an increase in operating costs and a fall in their interest margins. Banks with high levels of NPAs usually levy 'carrying cost' on non-performing assets, reducing their profitability

The Indian banking industry is severely affected by non-performing assets. This means that about 10% of the loan is never repaid, resulting in a substantial loss of funds to the banks. When restructured and unrecognized assets are added the total stress will be 15-20% of the total loan. The NPA crisis has become a big problem in India.**********

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