- Can a ‘bad bank’ solve the growing NPA crisis?
- Government regulations and tech platforms
Editorial: Can a ‘bad bank’ solve the growing NPA crisis?
- Finance Minister Nirmala Sitharaman in her Budget speech on Monday revived the idea of a ‘bad bank’ by stating that the Centre proposes to set up an asset reconstruction company to acquire bad loans from banks.
- GS Paper 3: Indian Economy (issues re: planning, mobilisation of resources, growth, development, employment); Inclusive growth and issues therein.
- What is the Budget proposal on non-performing assets and can it help recapitalise public sector banks? 15 Marks
Dimensions of the Article:
- What is a ‘bad bank’?
- What is the extent of the crisis faced by banks?
- What are the pros and cons of setting up a bad bank?
- Will a ‘bad bank’ help ease the bad loan crisis?
- Will it help revive credit flow in the economy?
What is a ‘bad bank’?
- A bad bank is a financial entity set up to buy non-performing assets (NPAs), or bad loans, from banks. The aim of setting up a bad bank is to help ease the burden on banks by taking bad loans off their balance sheets and get them to lend again to customers without constraints. After the purchase of a bad loan from a bank, the bad bank may later try to restructure and sell the NPA to investors who might be interested in purchasing it.
- A bad bank makes a profit in its operations if it manages to sell the loan at a price higher than what it paid to acquire the loan from a commercial bank.
- However, generating profits is usually not the primary purpose of a bad bank — the objective is to ease the burden on banks, holding a large pile of stressed assets, and to get them to lend more actively.
What is the extent of the crisis faced by banks?
- According to the latest figures released by the RBI, the total size of bad loans in the balance sheets of Indian banks at a gross level was just around ₹9 lakh crore as of March 31, 2020, down significantly from over ₹10 lakh crore two years ago.
- While the size of total bad loans held by banks has decreased over the last few years, analysts point out that it is mostly the result of larger write-offs rather than due to improved recovery of bad loans or a slowdown in the accumulation of fresh bad loans.
- The size of bad loan write-offs by banks has steadily increased since the RBI launched its asset quality review procedure in 2015, from around ₹70,000 crore in 2015-16 to nearly ₹2.4 lakh crore in 2019-20, while the size of fresh bad loans accumulated by banks increased last year to over ₹2 lakh crore from about ₹1.3 lakh crore in the previous year.
- Further, due to the lockdown imposed last year, the proportion of banks’ gross non-performing assets is expected to rise sharply from 7.5% of gross advances in September 2020 to at least 13.5% of gross advances in September 2021.
What are the pros and cons of setting up a bad bank?
- A supposed advantage in setting up a bad bank, it is argued, is that it can help consolidate all bad loans of banks under a single exclusive entity. The idea of a bad bank has been tried out in countries such as the United States, Germany, Japan and others in the past.
- The troubled asset relief program, also known as TARP, implemented by the U.S. Treasury in the aftermath of the 2008 financial crisis, was modelled around the idea of a bad bank.
- Under the program, the U.S. Treasury bought troubled assets, such as mortgage-backed securities, from U.S. banks at the peak of the crisis, and later resold them when market conditions improved.
- According to reports, it is estimated that the Treasury through its operations earned nominal profits.
- Many critics, however, have pointed to several problems with the idea of a bad bank to deal with bad loans.
- Former RBI governor Raghuram Rajan has been one of the critics, arguing that a bad bank backed by the government will merely shift bad assets from the hands of public sector banks, which are owned by the government, to the hands of a bad bank, which is again owned by the government.
- There is little reason to believe that a mere transfer of assets from one pocket of the government to another will lead to a successful resolution of these bad debts, when the set of incentives facing these entities is essentially the same.
- Other analysts believe that unlike a bad bank set up by the private sector, a bad bank backed by the government is likely to pay too much for stressed assets. While this may be good news for public sector banks, which have been reluctant to incur losses by selling off their bad loans at cheap prices, it is bad news for taxpayers, who will once again have to foot the bill for bailing out troubled banks.
Will a ‘bad bank’ help ease the bad loan crisis?
- A key reason behind the bad loan crisis in public sector banks, some critics point out, is the nature of their ownership. Unlike private banks, which are owned by individuals who have strong financial incentives to manage them well, public sector banks are managed by bureaucrats who may often not have the same commitment to ensuring these lenders’ profitability. To that extent, bailing out banks through a bad bank does not really address the root problem of the bad loan crisis.
- Further, there is a huge risk of moral hazard: Commercial banks that are bailed out by a bad bank are likely to have little reason to mend their ways. After all, the safety net provided by a bad bank gives these banks more reason to lend recklessly, and thus, further exacerbate the bad loan crisis.
Will it help revive credit flow in the economy?
- Some experts believe that by taking bad loans off the books of troubled banks, a bad bank can help free capital of over ₹5 lakh crore that is locked in by banks as provisions against these bad loans.
- This, they say, will give banks the freedom to use the freed-up capital to extend more loans to their customers. This gives the impression that banks have unused funds lying in their balance sheets that they could use if only they could get rid of their bad loans.
- It is, however, important not to mistake banks’ reserve requirements for their capital position. This is because what may be stopping banks from lending more aggressively may not be the lack of sufficient reserves, which banks need to maintain against their loans.
- Instead, it may simply be the precarious capital position that many public sector banks find themselves in at the moment.
- In fact, many public sector banks may be considered to be technically insolvent as an accurate recognition of the true scale of their bad loans would show their liabilities as far exceeding their assets.
- So, a bad bank, in reality, could help improve bank lending not by shoring up bank reserves, but by improving banks’ capital buffers.
To the extent that a new bad bank set up by the government can improve banks’ capital buffers by freeing up capital, it could help banks feel more confident to start lending again.
Editorial: Government regulations and tech platforms
- The Centre has issued notice to Twitter after the micro-blogging site restored more than 250 accounts that had been suspended earlier on the government’s ‘legal demand’.
- The government wants the platform to comply with its earlier order of January 31 by which it was asked to block accounts and a controversial hashtag that spoke of an impending ‘genocide’ of farmers for allegedly promoting misinformation about the protests, adversely affecting public order.
- GS Paper 3: Role of media and social-networking sites in internal security challenges; Internal security challenges through communication networks.
- Why has the Centre issued a notice to Twitter and what are the laws governing the cyber world? 15 Marks
Dimensions of the Article:
- Are platforms required to comply with government requests?
- What does the law in India cover?
- What are the Centre’s powers vis-à-vis intermediaries?
- How does the government block websites and networks?
- What are the obligations of intermediaries under Indian law?
- Is the liability of the intermediary absolute?
Are platforms required to comply with government requests?
- Cooperation between technology services companies and law enforcement agencies is now deemed a vital part of fighting cybercrime, and various other crimes that are committed using computer resources.
- These cover hacking, digital impersonation and theft of data. The potential of the Internet and its offshoots such as mail and messaging services and social media networks to disseminate potentially harmful content such as hate speech, rumors, inflammatory and provocative messages and child pornography, has led to law enforcement officials constantly seeking to curb the ill-effects of using the medium.
- Therefore, most nations have framed laws mandating cooperation by Internet service providers or web hosting service providers and other intermediaries to cooperate with law and order authorities in certain circumstances.
What does the law in India cover?
- In India, the Information Technology Act, 2000, as amended from time to time, governs all activities related to the use of computer resources. It covers all ‘intermediaries’ who play a role in the use of computer resources and electronic records.
- The term ‘intermediaries’ includes providers of telecom service, network service, Internet service and web hosting, besides search engines, online payment and auction sites, online marketplaces and cyber cafes.
- It includes any person who, on behalf of another, “receives, stores or transmits” any electronic record. Social media platforms would fall under this definition.
What are the Centre’s powers vis-à-vis intermediaries?
- Section 69 of the Act confers on the Central and State governments the power to issue directions “to intercept, monitor or decrypt…any information generated, transmitted, received or stored in any computer resource”.
- The grounds on which these powers may be exercised are: in the interest of the sovereignty or integrity of India, defence of India, security of the state, friendly relations with foreign states, public order, or for preventing incitement to the commission of any cognisable offence relating to these, or for investigating any offence.
How does the government block websites and networks?
- Section 69A, for similar reasons and grounds on which it can intercept or monitor information, enables the Centre to ask any agency of the government, or any intermediary, to block access to the public of any information generated, transmitted, received or stored or hosted on any computer resource.
- Any such request for blocking access must be based on reasons given in writing. Procedures and safeguards have been incorporated in the rules framed for the purpose.
What are the obligations of intermediaries under Indian law?
- Intermediaries are required to preserve and retain specified information in a manner and format prescribed by the Centre for a specified duration. Contravention of this provision may attract a prison term that may go up to three years, besides a fine.
- When a direction is given for monitoring, interception or decryption, the intermediary, and any person in charge of a computer resource, should extend technical assistance in the form of giving access or securing access to the resource involved, and must comply with the request to intercept or monitor or decrypt the information concerned.
- Failure to extend such assistance may entail a prison term of up to seven years, besides a fine. Failure to comply with a direction to block access to the public on a government’s written request also attracts a prison term of up to seven years, besides a fine.
- The Act also empowers the government to collect and monitor data on traffic. When an authorised agency asks for technical assistance in this regard, the intermediary must comply with the request. Non-compliance may lead to a prison term of up to three years, besides a fine.
Is the liability of the intermediary absolute?
- No. Section 79 of the Act makes it clear that “an intermediary shall not be liable for any third-party information, data, or communication link made available or hosted by him”. This protects intermediaries such as Internet and data service providers and those hosting websites from being made liable for content that users may post or generate.
- However, the exemption from liability does not apply if there is evidence that the intermediary abetted or induced the commission of the unlawful act involved. Also, the provision casts a responsibility on intermediaries to remove the offensive content or block access to it upon getting “actual knowledge” of an unlawful act being committed using their resources, or as soon as it is brought to their notice.
- In Shreya Singhal vs U.O.I (2015), the Supreme Court read down the provision to mean that the intermediaries ought to act only “upon receiving actual knowledge that a court order has been passed, asking [them] to expeditiously remove or disable access to certain material”. This was because the court felt that intermediaries such as Google or Facebook may receive millions of requests, and it may not be possible for them to judge which of these were legitimate.
- The role of the intermediaries has been spelt out in separate rules framed for the purpose in 2011. In 2018, the Centre favoured coming up with fresh updates to the existing rules on intermediaries’ responsibilities, but the draft courted controversy. This was because one of the proposed changes was that intermediaries should help identify originators of offensive content.
- This led to misgivings that this could aid privacy violations and online surveillance. Also, tech companies that use end-to-end encryption argued that they could not open a backdoor for identifying originators, as it would be a breach of promise to their subscribers.
Other proposed changes, which have not been acted upon, include rules that intermediaries should deploy automated tools for proactively removing or disabling public access to unlawful information, and to have a 24×7 mechanism to deal with requisitions of law enforcement.