[‘Daily News Updates’ will provide you with a simplified understanding of the important economic/financial events across the country]
India’s First Bad Bank Finally Takes Shape
A Bad Bank is a bank set up to buy bad assets of banks and financial institutions. The purpose of setting up a Bad Bank is to clean up the balance sheets of (good) banks so that they can focus on lending.
- The Bad Bank buys non-performing assets/ NPA (bad assets) from banks at low prices
- Then it tries to recover these NPAs/ loans over a period of time or sell them to investors.
[Read more- WHAT IS A BAD BANK IN THE INDIAN CONTEXT?- EXPLAINED].
[The NPAs are assets that have stopped generating income for a bank. Bank’s assets comprise primarily of loans, and when these loans are on the verge of default (that is, about to go bad), they are classified as NPA.
In India, a loan is classified as NPA if the interest or any installment on the loan remains unpaid for a period of more than 90 days.
It (NPAs) affects the balance sheet and profitability of banks and limits credit availability to the corporate sector].
As reported by various news portals, India formally set up its first Bad Bank on 7th July 2021. The company was registered as National Asset Reconstruction Company Ltd. with Padmakumar Madhavan Nair as the Managing Director.
What are the drawbacks of a Bad Bank?
- It leads to moral hazard. The banks will become reckless in lending if they are certain that their bad loans will be bought by the Bad Bank.
- The Bad Bank will be initially funded by the Government. Most banks in India are owned by the Government. So it will just mean that the bad loan will be transferred from one account to another
- There are other solutions to NPA. The Government had enacted the Insolvency and Bankruptcy code in 2016 to simplify the process of resolution of NPAs. Then, there are 29 licensed Asset reconstruction companies (ARCs) in India. ARCs have a similar concept to bad banks, but they are privately owned. Also, they don’t buy all the bad loans from banks. They look at the business viability of these assets. ARCs are registered with RBI under Section-3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
Stock Limit on Pulses- Possible Implications
In September 2020, the Government had introduced the three controversial farm laws, of which the Essential Commodities (Amendment) Act was one. We had covered the same in this article.
[Under the (EC) Act, the Government has the power to impose limits on stocks held for particular produce. For instance, in March, hand sanitisers and masks were brought under the purview of the Act. This was done to prevent dealers from hoarding them and selling them at a higher price. An MRP was also fixed, with the sellers open to litigation if they sold above it.
Since the Act disincentivises investment in storage facilities, most of what is produced has to be sold, even if there is a bumper harvest. This leads to a lower price for the farmers. Also, selling excess produce leaves very little to be used when the harvest fails. Thus, a country like India experiences substantial price fluctuations in commodities such as onions].
Through the Amendment, the Government sought to “de-regulate cereals, edible oil, oilseeds, pulses, onions, and potatoes by amending the ECA 1955. Hence, stocking limits will not be imposed on these items unless there is an exceptional circumstance.” However, on 2nd July 2021, the Government imposed a stock limit on pulses till October 31st with immediate effect to reduce the price of pulses. As per the Order, wholesalers can stock only 200 MT of pulses (with not more than 100 MT of one variety), and retailers can stock only 5 MT. The Government could impose the limit as the Supreme Court had put a stay order on the three farm laws in December.
Since the Order, prices of pulses have plunged over 30%. “For instance, the wholesale rates of Tur dal dropped from Rs 114/kg on 25 June to Rs 65/kg on 8 July. Retail prices of the dal dropped from Rs 130/kg to Rs 87/kg in the same period.” Due to a crash in prices, farmers will be dissuaded from producing more pulses and move to remunerative crops. Traders will also be dissuaded from buying pulses from the farmers after the harvest season is over, due to a trust deficit (that a stock limit can still be imposed at any time). Further, India’s imports will also be affected as individual retailers and wholesalers will not import in large quantities. With the ever-rising demand for pulses in the country, these developments are undesirable and could have been avoided.
Economyria is now on Telegram. For a simplified analysis of topics related to economy/ business/ finance, subscribe to Economyria on Telegram