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For the first time, SBI has sold bad loans to Asset Reconstruction Companies (ARC)
Based onThe recent news report says that faced with unprecedented levels of stressed assets (also known as NPAs or non performing assets), banks led by the country’s largest lender SBI sold over Rs.10,000 crore of bad loans to asset reconstruction companies (ARC) in March alone. SBI which had reported 5.73 per cent NPAs in the December quarter, led the chart by reportedly selling close to Rs.4,000 crore to ARCs. This was the first time the bank has do so. published reports
According to a spokesperson of SBI, the Bank was selling Rs.3,500-4,000 crore of its Rs.6,77,800 crore NPAs to ARCs in Financial Year 2014.  In march, banks reportedly invited bids to sell Rs.42,800 crore of bad assets.

The definition of a bad bank (ARCs in the above case) goes like this – this bank I set up to buy the bad loans of a bank with significant nonperforming assets at market price.  By transferring the bad assets of an institution to the bad bank, the banks clear their balance sheet of toxic assets (non-performing assets or those assets which had lost greatly in value) but would be forced to take write downs.  Shareholders and bond holders stand to lose money from this solution (but not depositors).  Banks that become insolvent as a result of the process can be recapitalized, nationalized or liquidated.

From the above it is clear that if these bad loans cannot be sold, then they have to be written off from the balance sheet of respective banks.  Therefore, selling these loans at throwaway price makes sense because getting something is better than getting nothing.

How does the ARCs (or bad banks benefit) by buying these bad loans.  First of all, one thing is clear that these ARCs (bad banks) are sitting on huge piles of cash.  Some key staff working in a bad bank initially has to work very hard chasing delinquent payments, restricting complex securities and bargaining with potential buyers.

From international bank’s view point, a well known example of a bad bank was Grant Street National Bank, which was created in 1988 to house the bad assets of one  Mellon Bank.  The financial crisis of 2008 (felt worldwide) revived interest in the bad bank solution, as managers at some of the world’s largest institutions contemplated segregating their nonperforming assets into bad banks.

Some critics point out that creation of bad banks encourages the normal banks to take undue risks, which they otherwise would not, i.e. a moral hazard is risk-taking.  Another criticism is that the option of handing the loan over to the bad bank becomes essentially a subsidy on corporate bankruptcy. Instead of developing a company that is temporarily unable to pay, the bondholder is given an incentive to sue for bankruptcy immediately, which makes it eligible for sale to a bad bank.  Thus, it can become a subsidy for banks on the expense of small businesses.

Going by the above, it seems ARCs ( or bad banks) have come to stay in India mainly to help different financial institutions window dress their balance sheet nicely and favourably acceptable to different concerned agencies (by doing away with their non performing assets).
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