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BAD BANKS & DFI

BAD BANKS

The proposal for the establishment of a bad bank was unveiled in the Budget 2021 session. It has been done to tackle the mountain of default debts which pose a threat to the whole financial system. By shifting their non-performing loans to an organization structured as an asset manager or an asset reconstruction company, a bad bank will effectively help banks clean up their balance sheets, eventually helping boost the credit flow to the economy.


India’s economy entered into a pandemic weakened by 140 billion $ bad loans. The problem further worsened after Narendra Modi’s government announced the lockdown that led to the collapse of business operations. As of September 2020, the total gross NPAs of the banking system was 7.5 percent of the overall industry loan book. The stress test of the reserve bank indicates that the bad loan ratio will increase to 13.5 percent by September 2021(highest since 2000). According to an estimate, non-performing assets totalling Rs 899,803 crore will be transferred to the bad bank.


Professionally run bad banks, financed by private lenders and sponsored by the government (NPA), can be an efficient tool to deal with non-performing assets. The government's intervention can be seen as a way to speed up the process of clean-up.


However, according to some experts, the establishment of ARC/AMC may allow banks to continue risky lending practices because of the issue of moral hazard. Moreover, it will be hard to mobilize resources as it would be difficult to find buyers for bad loans in a pandemic hit economy.


DFI


At the 2021 budget session, the new DFI (Development Finance Institution) was introduced. A Development Finance Institution is a financial institution that, on a non-commercial basis, provides funding for economic development projects. The proposed DFI will be used to finance social and economic infrastructure projects identified under the National Infrastructure Pipeline (NIP). With a capital base of 20000 crores, the institution will be launched and a lending target of 5 lakh crore in three years has been set. It will act as a catalyst for infrastructure.


In the past, ICICI and IDBI were both set up as DFIs in initial stages but were later converted to universal banks. The retail deposit access was cornered by commercial banks and the availability of long-term financing without government guarantees was limited. The new DFI will be 100% government-owned and it will also lift its capital through the market. Later it will get more stakeholders as per financing needs.


-BY RISHI & SHREYA

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