InvestorQ : What are the challenges you see for the idea of Bad Bank to be implemented in India?
diksha shah made post

What are the challenges you see for the idea of Bad Bank to be implemented in India?

Arti Chavan answered.
1 year ago

The first big challenge for a bad bank is the availability of adequate capital. If the bad bank has to hold so much of loans, they ought to be well capitalized. While the government and the PSU banks will provide the initial seed capital required, most of the capital will have to be raised from other institutional investors. Hence their IRR has to be taken care of too.

This is risky business so the capital providers will need clarity on the IRR they will earn and also the kind of lock-in of capital before they get an exit. But that is the easier part as it pertains to macro issues. There are other challenges too. The more practical challenges pertain to the process involved in the bad bank.

A couple of challenges immediately come to mind. Firstly, India does not have a robust secondary market for stressed debt, unlike a lot of other matured economies in the US and Europe. Hence assessments are likely to be subjective. Secondly, bad bank will lighten the balance sheet and improve ROI on paper but it does not provide 100% liquidity.

It is believed that due to these practical constraints, many banks may still prefer the NCLT driven liquidation model. A very important point is that the bad bank itself may create systemic risk. The success of a bad bank predicates on its assumptions underlying the assessment of loan quality. Assumptions can sour and that can become a big source of risk.