Bad bank

Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

A bad bank is a separate entity that takes over stressed assets (bad loans, mainly NPAs) from banks. This lets the banks focus on fresh lending, while specialists handle recovery of the bad loans separately.

• Why it matters: bad loans lock up bank capital and slow down credit to the economy. A bad bank moves these loans off the banks' books, so the banks can lend again.
• In India, the bad bank is the NARCL-IDRCL pair. It is backed by a government guarantee of up to Rs 30,600 crore on its security receipts [1].

Explanation

Why a bad bank is needed

• NPA (Non-Performing Asset): a loan on which the borrower has stopped paying interest or principal for a set period. The bank earns nothing from it.
• The problem with keeping bad loans on the books:
• The bank must keep capital aside against them.
• Managers spend their time chasing old loans instead of making new ones.

• Credit to the economy slows down.

• The bad-bank answer:

• The loans are moved to a separate entity.
• The bank's balance sheet becomes "clean".

• Recovery experts at the bad bank work only on the stressed loans.

• Single-point decisions: a big company's debt is usually spread across many lenders. A bad bank brings that debt together in one place, so decisions come faster, including through IBC processes where they apply [2].

How it works (the Indian design)

• Two entities with different jobs. Both were set up by banks [2]:
• NARCL (National Asset Reconstruction Company Ltd): set up in 2021 and majority-owned by public sector banks (PSBs). It buys and holds the bad loans.

• IDRCL (India Debt Resolution Company Ltd): majority private. It manages and resolves the loans, like a debt manager.

• How NARCL pays the bank (the 15:85 structure) [1]:

• 15% in cash.

• 85% in security receipts (SRs). An SR is a paper that gives its holder a share of whatever is later recovered from the loan.

• Government guarantee [1]:

• It backs the SRs up to Rs 30,600 crore and is valid for 5 years.
• It covers the shortfall between the SR's face value and the amount actually recovered from the asset.
• Rs 30,600 crore is an overall ceiling.

Worked example

• A loan has a book value of Rs 1,000 crore. NARCL buys it at an agreed value of Rs 400 crore.
• The bank gets:
• Cash (15%) = Rs 60 crore

• SRs (85%) = Rs 340 crore

• Later, the asset is sold for only Rs 250 crore.

• Shortfall on the SRs = 340 − 250 = Rs 90 crore.
• The government pays this Rs 90 crore, within the Rs 30,600 crore ceiling and the 5-year window [1].

Global models

Country	Entity	Year	Context
USA	Resolution Trust Corporation (RTC)	1989	Savings-and-loan crisis
Sweden	Securum	1992	The classic success story
Malaysia	Danaharta	1998	East Asian crisis
Ireland	NAMA	2009	Property-bubble collapse

• What makes a bad bank succeed or fail:
• Sweden's Securum worked because it was fast and independent.
• Slow buying of loans and weak incentives lead to poor recovery.

In India

• How the idea grew:
• The Economic Survey 2016-17 proposed PARA (Public Sector Asset Rehabilitation Agency).
• The idea came back in the Budget 2021-22 announcement.

• The Cabinet approved the government guarantee in September 2021 [1].

• Legal base: NARCL works as an asset reconstruction company. ARCs are registered with the RBI under the SARFAESI Act, 2002.

• Target: NARCL planned to acquire stressed assets of about Rs 2 lakh crore, in phases, within RBI rules [1].
• Progress:
• An earlier PIB update reported that NARCL had acquired 22 accounts with an exposure of Rs 95,711 crore [4].
• After NARCL made offers, banks themselves resolved 28 accounts with an exposure of Rs 1.28 lakh crore [4]. This was an indirect effect: the offer pushed other solutions forward.

• NARCL recovered Rs 4,364 crore in FY 2025-26, about 70% of its total recoveries so far [3].

• Verdict: acquisitions have been much slower than the Rs 2 lakh crore plan [1].

Don't confuse with

• Asset Reconstruction Company (ARC): an ordinary ARC is a private company that buys bad loans at a discount, mostly for SRs, and carries no government guarantee. India's bad bank (NARCL) is set up by banks, majority PSB-owned, and its SRs carry a sovereign (government) guarantee [1].
• NARCL vs IDRCL: NARCL buys and holds the loans and is majority PSB-owned. IDRCL manages and resolves them and is majority private. Exams often swap the two roles.
• Securitisation: here a bank pools loans, often healthy (standard) loans, and sells them to investors as tradable securities. A bad bank takes over stressed loans only.
• SARFAESI enforcement: under SARFAESI, the lender itself takes possession of the pledged asset and sells it without a court. With a bad bank, the loan is transferred to another entity, which then handles recovery.

Prelims Hooks

• The PARA idea first appeared in the Economic Survey 2016-17. The Cabinet approved the NARCL SR guarantee in September 2021 [1].
• NARCL pays 15% in cash and 85% in SRs [1].
• The SR guarantee is up to Rs 30,600 crore for 5 years. It covers the shortfall between face value and the amount recovered [1].
• NARCL is majority PSB-owned and buys the loans. IDRCL is majority private and resolves them. Both were set up by banks [2].
• NARCL's planned pipeline was about Rs 2 lakh crore, to be acquired in phases [1].
• Match the bad bank to its country: RTC – USA (1989), Securum – Sweden (1992), Danaharta – Malaysia (1998), NAMA – Ireland (2009).

Mains Points

• Arguments for a bad bank:
• Banks get clean balance sheets and can go back to lending.
• Debt spread across many lenders is brought to a single decision point [2].

• The sovereign guarantee gives banks comfort on the value they will get [1].

• Arguments against:

• Moral hazard: banks may lend carelessly if they expect to be bailed out.
• Contingent liability: the guarantee is a cost to the government that appears only if recoveries fall short.

• Slow acquisition: Rs 95,711 crore acquired [4] against a Rs 2 lakh crore target [1]. Securum's lesson is that speed and independence decide success.

• Incentive design is the key: IDRCL's private majority follows the same idea as the skin-in-the-game rules for ARCs and securitisation. Whoever makes decisions on a loan should also share its loss. The bad bank works alongside Lok Adalats, DRTs, SARFAESI, ARCs and the IBC 2016. Together these channels recovered about Rs 10.17 lakh crore over the nine years to 2022-23 [5].

Related concepts

• Enforcement of security interest
• Securitisation
• Asset Reconstruction Company
• Security receipts

Read more

• Recovery channels: DRTs, SARFAESI, securitisation, ARCs and the bad bank