Is a bad bank a good idea for India?

Abstract

The banking sector in India has been facing the twin balance sheet crisis for a number of years. The balance sheets of banks are filled with stressed advances given to business that have failed to take off. The balance sheets of the corporates are also affected by the slowdown in economic activity. This creates a cycle of sluggishness since the balance sheets of the banks and the corporates are linked. Reviving business activity from the current slowdown requires availability of credit from the banks. Banks are not able to provide this credit since their capital adequacy levels are affected heavily by the loans given to these corporates which have turned into NPAs. This vicious loop is called the twin-balance sheet problem. The way out of this loop can be to boost the banks through recapitalisation and equity funding, and to boost the corporates through restructuring of business and revival of economic activity such that they are able to repay the loans taken. To solve this twin balance sheet problem, the government recently proposed the formation of a National Asset Reconstruction Company that would relieve the banks of these stressed assets, and actively aim to restructure and resolve these assets.