To know the concept of bad bank, we first need to know the following things :
What Is The Loan ?
In finance, a loan is the lending of money by one or more individual, organization or other entities to other individuals, organization etc. The recipient ( i.e., the borrower ) incurs a debt and is usually liable to pay interest on that debt until it is repaid as well as to repay the principal amount borrowed .
What Is The Pay-Day Loan ?
A payday loan ( also called payday advanced, salary loan, payroll loan, small dollar loan, short term or advanced loan ) is a short term unsecured loan, often characterized by high interest rates .
According to a 2007 study by economist Michael A. Stegman, payday loans firms were extremely rare prior to the 1990s, but have grown substantially since then.
What Is Advanced Funding ?
Advanced Funding is any payment on future obligations . Advanced funding is usually deducted against some future obligation that the payer otherwise owes the payee . Most common examples of advanced funding are : payday loan, viatical settlement, lawsuit settlement advanced .
What Is A Default ?
Default is the failure to repay a debt, including interest or principal, on a loan security . A default can occure when a borrower is unable to make timely payments, or avoids or stop making payments .
Individuals, businesses, and even Contries can default if they cannot keep up their debt obligations .
What Are Arrears ?
Arrears is a financial or legal term for a part of debt that is overdue often missing one or more required payments . The amount of the arrears is the amount accrued from the date on which the first missed payment was due . The term is usually used in relation with periodically recurring payments such as rent, bills, royalties ( or other contractual payments ) and child support .
What Is A Non-Performing Assets ( NPA ) ?
A Non-Performing Asset ( NPA ) refers to those loans or advances that are in default or in arrears i.e., principal and interest payment are less or missed .
Lenders usually provide an additional time before classifying an asset as non-performing . Subsequently, the lenders or bank will classify the NPA into the following subcategories
Standard Assets :
They are NPAs that have been past due for anywhere from 90 days to 12 months, with a normal risk level .
Substandard Assets :
They are NPAs that have been past due for more than 12 months, with a higher risk level .
Doubtful Debts :
Non-performing assets in the doubtful Debts category bave been past due for at least 18 months .
Loss Assets :
These are non-performing assets with an extended period of non payment . With this class banks are forced to accept that the loan will never to repaid and must record a loss on their balance sheet .
What Is Bankruptcy ?
Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debt . Bankruptcy is imposed by a court order, often initiated by the debtor .
What Is Financial Distress ?
Financial Distress is a condition when promises to creditors of a company are broken or honoured with difficulty . If financial distress cannot be relieved, it can lead to bankruptcy .
What Is Restructured Loan ?
Loan Restructuring Fandamentally means the modification of the loan term and conditions . When a borrower faces financial distress, he can option to revisit, negotiate and reduce the chances of any payment doubtful .
The loan Restructuring process can be initiate by extending loan tenure with or without changes in the rate of interest .
What Is Written-Off Asset ?
Written-off assets are loan assets that have turned bad on account of repayment defaults for at least three consecutive quarters; and present difficult challenges in recovery .
What Is Stressed Asset ?
Before the period of 90 days, the NPAs are called Stressed Assets .
Stressed asset = NPAs + restructured loan + written-off assets .
Now we are ready to learn about 'Bad Bank' :
Bad bank is a financial entity that has been set up to buy and resolve the NPAs from various bank . Bank that used to sell stressed assets to bad bank are now free from bad loans or NPAs . As a result, they can now focus on how to grow their business by advancing fresh loans to borrowers required credit .
Bad Bank In India
In budget 2021-2022, the finance minister Nirmala Sitharaman had announced that a bad bank is being set up which will resolve bad loans worth about ₹ 2 lakh crore . The government has set up two new entities to acquire stressed assets from banks and then sell then in the market .
One of them is National Asset Reconstruction Company Ltd. ( NARCL ) . It will acquire stressed assets worth about ₹. 2 lack crore from various commercial bank in different phases .
Another entity is India Debt Resolution Company Ltd. ( IDRCL ) . It will then try to sell the stressed assets in the market .
The NARCL-IDRCL is the new bad bank in India . To make it work, the government approved of ₹. 30,600 crore to be used as a guarantee .