What Is A Bad Bank?
Bad bank is not a new concept. One of the early examples of a bad bank was demonstrated in Spain in response to its banking crisis that began from 1978. Corporacion Bancaria was set up with an equal partnership between private banks and the Bank of Spain. It was expanded to become the Deposit Guarantee Fund (DGF). The fund acquired the bad loans of banks to sell them off. The DGF was able to clean up its exercise in slightly above a year, but the cost was mostly borne by the taxpayers. The experience was repeated by Mellon Bank in the US that bought up about $ 1.4 billion of bad loans, mostly extracted from the real estate and energy sector. Down the road another entity named Grant Street national bank was carved out of Mellon Bank. This too was wound up by 1995 after its objective was broadly met.
In the process two broad formats of bad banks have emerged. The first is one where a specific bank assumes the assets of a single bank. This was the case for like the one created by Swiss National Bank(SNB) for UBS post 2008, in the form of a fund called SNB Stabilisation Fund. India had a limited experience with this form in the UTI 64 saga. The bad assets of UTI were housed in a separate company. The second option is a national or a sub-national entity to address a broader systemic problem of bad loans. Both can be further differentiated based on whether there is significant government funding or has been generated mostly through private participation. Experience gleaned from the Spanish crisis and later ones show that a system wide problem requires governmental support which in turn means it has to be paid for by the taxpayers. A corollary of that cost is that this can gain public support only if the unsuccessful owners and managers of the distressed assets are removed from their position. The latest Economic Survey discusses several aspects of bad banks but gives this issue a miss.
Why India Might Need A Bad Bank?
As the latest Economic Survey of the Government of India points out that the economy is suffering from a “twin balance sheet (TBS) problem”, where both the banking and corporate sectors were under stress. “Not just a small amount of stress, but one of the highest degrees of stress in the world. At its current level, India’s non-performing asset (NPA) ratio is higher than any other major emerging market (with the exception of Russia), higher even than the peak levels seen in Korea during the East Asian crisis”. This is crazy to even decipher.
Whenever economies have suffered this problem, in the next stage, banks have effectively shut shop on further lending. The economy has gone into a tailspin and growth plummeted. India has instead seen the problem emerge despite carrying on with a high growth path. The high NPA levels have not triggered banking crises. “There has not even been a hint of pressure on the banking system. There have been no bank runs, no stress in the interbank market, and no need for any liquidity support, at any point since the TBS problem first emerged in 2010. And all for a very good reason: because the bulk of the problem has been concentrated in the public sector banks, which not only hold their own capital but are ultimately backed by the government, whose resources are more than sufficient to deal with the NPA problem. As a result, creditors have retained complete confidence in the banking system”.
In other words, all the fundamentals of the financial sector has got squashed but has still worked since the government has been a banker. But even as this has been safe for the depositors can it last forever? The reasons why the mid-sized banks have not keeled over is the funds government is pouring into them from taxpayers’ money. In the absence of any correction, it can balloon to eat up all the tax money.
To quote the Economic Survey, “Banks around the world typically strive for a return of assets (ROA) of 1.5 per cent or above… But Indian public sector banks are much below this international norm. In fact, their ROA has turned negative over the past two years.”
And at the same time the companies that are in debt have no chance to improve either. This is because they can conceivably use their political clout to keep on getting more money on interest from the banks to pay for their losses but this finally leads them to bankruptcy. The only reason again why they have not gone bankrupt is because there was no provision till recently for a bankruptcy law in India. Worse, the stress among the corporate sector is spreading out of the club of large companies. “For much of the period since the global financial crisis, the problems of bad loans were concentrated in the large companies, which had taken on excessive leverage during the mid-2000s boom, while the more cautious smaller and mid-size companies had by and large continued to service their debts. Starting in the second half of 2016, however, a significant proportion of the increases in NPAs – four-fifths of the slippages during the second quarter – came from mid-size and micro, small and medium enterprises (MSMEs), as smaller companies that had been suffering from poor sales and profitability for a number of years struggled to remain current on their debts. This trend is likely to continue into 2017.”
Thus there is a need for a bad bank to take out the bad loans from the books of the commercial banks for being treated separately. Finance Minister Arun Jaitley has also given the green light to the idea. He told a post budget meeting, “It is also a possible solution. The Economic Survey 2016-17 has advised the establishment of a bad bank to deal with the NPA issue.”
How Would The Bad Bank Be Funded?
This is where the old chestnut about demonetisation comes in handy. Setting up a bank, good or bad, needs capital. The only entity at this point which has surplus capital is the Reserve Bank of India (RBI). Again, as the Economic Survey points out among all the central banks in the world the RBI is highly capitalised. The demonetisation windfall will create an additional capital base for them. This is the source to finance the bad bank.
What Should Be The Structure Of The Bad Bank?
It would purchase loans from the banks paying them money that frees up their capital. Since it will buy the loans from banks at the book value there will be no write-off of assets of the banks; which means the equity of the bank will not be hurt and thus would not need to add more capital to make the sale. It would then either convert the debt into equity and sell the stakes in auctions or cut down the debt in stages, cleaning up the financial system. But the key theme should be that it will not be just an accounting tool to park bad loans from banks, but it should be able to maximise recovery from the bad debt, so the various investors get reasonable returns. Basically, it should focus on economics and not just an accounting transfer. Most probably the bank will need a nod from Parliament to be created. The Survey suggests that it could be set up with a structure like the one done for the GST Network, which is broadly within the aegis of the public sector but with government owning 49 per cent. In any case, the bank has to be thoroughly professional, with “plans that maximise – and are seen to maximise – recovery value.”
What Are The Alternatives?
An alternative could be to set up instead a Sovereign Distressed Asset Fund (SDAF). The fund will pay the banks in terms of long-term bond, the maturity of which should coincide with maturity of the fund. The bonds will have built-in put options so that they may be retired by the SDAF if there is an early overall recovery. The payment of the principal and accrued interest at very low rates of interest of 3 per cent- 4 per cent is a necessary corollary. A variation of the same can be a zero coupon bonds but with principal guaranteed by government of India (GOI) and payable at the end of 10 years to finance such a fund. This will ensure that the GOI has no immediate cash outflow to support the banks. The bonds issued will be treated as assets on the books of banks. The core principle remains to maximise economic profit for the SDAF.
Finally it is quite possible that some banks will be reluctant to sell the bad assets to the bad bank. They could claim their recovery prospects of their specific bad assets will be better than the overall pool of bad debts. The counter could be if these banks are so confident they need not have categorised the loan as stressed in the first instance. The other solution may be to make it mandatory for the banks to sell the bad loans to the new entity.
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The United Nations has shaped so much of global co-operation and regulation that we wouldn’t recognise our world today without the UN’s pervasive role in it. So many small details of our lives – such as postage and copyright laws – are subject to international co-operation nurtured by the UN.
In its 75th year, however, the UN is in a difficult moment as the world faces climate crisis, a global pandemic, great power competition, trade wars, economic depression and a wider breakdown in international co-operation.
Still, the UN has faced tough times before – over many decades during the Cold War, the Security Council was crippled by deep tensions between the US and the Soviet Union. The UN is not as sidelined or divided today as it was then. However, as the relationship between China and the US sours, the achievements of global co-operation are being eroded.
The way in which people speak about the UN often implies a level of coherence and bureaucratic independence that the UN rarely possesses. A failure of the UN is normally better understood as a failure of international co-operation.
We see this recently in the UN’s inability to deal with crises from the ethnic cleansing of the Rohingya Muslims in Myanmar, to civil conflict in Syria, and the failure of the Security Council to adopt a COVID-19 resolution calling for ceasefires in conflict zones and a co-operative international response to the pandemic.
The UN administration is not primarily to blame for these failures; rather, the problem is the great powers – in the case of COVID-19, China and the US – refusing to co-operate.
Where states fail to agree, the UN is powerless to act.
Marking the 75th anniversary of the official formation of the UN, when 50 founding nations signed the UN Charter on June 26, 1945, we look at some of its key triumphs and resounding failures.
Five successes
1. Peacekeeping
The United Nations was created with the goal of being a collective security organisation. The UN Charter establishes that the use of force is only lawful either in self-defence or if authorised by the UN Security Council. The Security Council’s five permanent members, being China, US, UK, Russia and France, can veto any such resolution.
The UN’s consistent role in seeking to manage conflict is one of its greatest successes.
A key component of this role is peacekeeping. The UN under its second secretary-general, the Swedish statesman Dag Hammarskjöld – who was posthumously awarded the Nobel Peace prize after he died in a suspicious plane crash – created the concept of peacekeeping. Hammarskjöld was responding to the 1956 Suez Crisis, in which the US opposed the invasion of Egypt by its allies Israel, France and the UK.
UN peacekeeping missions involve the use of impartial and armed UN forces, drawn from member states, to stabilise fragile situations. “The essence of peacekeeping is the use of soldiers as a catalyst for peace rather than as the instruments of war,” said then UN Secretary-General Javier Pérez de Cuéllar, when the forces won the 1988 Nobel Peace Prize following missions in conflict zones in the Middle East, Africa, Asia, Central America and Europe.
However, peacekeeping also counts among the UN’s major failures.
2. Law of the Sea
Negotiated between 1973 and 1982, the UN Convention on the Law of the Sea (UNCLOS) set up the current international law of the seas. It defines states’ rights and creates concepts such as exclusive economic zones, as well as procedures for the settling of disputes, new arrangements for governing deep sea bed mining, and importantly, new provisions for the protection of marine resources and ocean conservation.
Mostly, countries have abided by the convention. There are various disputes that China has over the East and South China Seas which present a conflict between power and law, in that although UNCLOS creates mechanisms for resolving disputes, a powerful state isn’t necessarily going to submit to those mechanisms.
Secondly, on the conservation front, although UNCLOS is a huge step forward, it has failed to adequately protect oceans that are outside any state’s control. Ocean ecosystems have been dramatically transformed through overfishing. This is an ecological catastrophe that UNCLOS has slowed, but failed to address comprehensively.
3. Decolonisation
The idea of racial equality and of a people’s right to self-determination was discussed in the wake of World War I and rejected. After World War II, however, those principles were endorsed within the UN system, and the Trusteeship Council, which monitored the process of decolonisation, was one of the initial bodies of the UN.
Although many national independence movements only won liberation through bloody conflicts, the UN has overseen a process of decolonisation that has transformed international politics. In 1945, around one third of the world’s population lived under colonial rule. Today, there are less than 2 million people living in colonies.
When it comes to the world’s First Nations, however, the UN generally has done little to address their concerns, aside from the non-binding UN Declaration on the Rights of Indigenous Peoples of 2007.
4. Human rights
The Human Rights Declaration of 1948 for the first time set out fundamental human rights to be universally protected, recognising that the “inherent dignity and of the equal and inalienable rights of all members of the human family is the foundation of freedom, justice and peace in the world”.
Since 1948, 10 human rights treaties have been adopted – including conventions on the rights of children and migrant workers, and against torture and discrimination based on gender and race – each monitored by its own committee of independent experts.
The language of human rights has created a new framework for thinking about the relationship between the individual, the state and the international system. Although some people would prefer that political movements focus on ‘liberation’ rather than ‘rights’, the idea of human rights has made the individual person a focus of national and international attention.
5. Free trade
Depending on your politics, you might view the World Trade Organisation as a huge success, or a huge failure.
The WTO creates a near-binding system of international trade law with a clear and efficient dispute resolution process.
The majority Australian consensus is that the WTO is a success because it has been good for Australian famers especially, through its winding back of subsidies and tariffs.
However, the WTO enabled an era of globalisation which is now politically controversial.
Recently, the US has sought to disrupt the system. In addition to the trade war with China, the Trump Administration has also refused to appoint tribunal members to the WTO’s Appellate Body, so it has crippled the dispute resolution process. Of course, the Trump Administration is not the first to take issue with China’s trade strategies, which include subsidises for ‘State Owned Enterprises’ and demands that foreign firms transfer intellectual property in exchange for market access.
The existence of the UN has created a forum where nations can discuss new problems, and climate change is one of them. The Intergovernmental Panel on Climate Change (IPCC) was set up in 1988 to assess climate science and provide policymakers with assessments and options. In 1992, the UN Framework Convention on Climate Change created a permanent forum for negotiations.
However, despite an international scientific body in the IPCC, and 165 signatory nations to the climate treaty, global greenhouse gas emissions have continued to increase.
Under the Paris Agreement, even if every country meets its greenhouse gas emission targets we are still on track for ‘dangerous warming’. Yet, no major country is even on track to meet its targets; while emissions will probably decline this year as a result of COVID-19, atmospheric concentrations of greenhouse gases will still increase.
This illustrates a core conundrum of the UN in that it opens the possibility of global cooperation, but is unable to constrain states from pursuing their narrowly conceived self-interests. Deep co-operation remains challenging.
Five failures of the UN
1. Peacekeeping
During the Bosnian War, Dutch peacekeeping forces stationed in the town of Srebrenica, declared a ‘safe area’ by the UN in 1993, failed in 1995 to stop the massacre of more than 8000 Muslim men and boys by Bosnian Serb forces. This is one of the most widely discussed examples of the failures of international peacekeeping operations.
On the massacre’s 10th anniversary, then UN Secretary General Kofi Annan wrote that the UN had “made serious errors of judgement, rooted in a philosophy of impartiality”, contributing to a mass murder that would “haunt our history forever”.
If you look at some of the other infamous failures of peacekeeping missions – in places such as Rwanda, Somalia and Angola – it is the limited powers given to peacekeeping operations that have resulted in those failures.
2. The invasion of Iraq
The invasion of Iraq by the US in 2003, which was unlawful and without Security Council authorisation, reflects the fact that the UN is has very limited capacity to constrain the actions of great powers.
The Security Council designers created the veto power so that any of the five permanent members could reject a Council resolution, so in that way it is programmed to fail when a great power really wants to do something that the international community generally condemns.
In the case of the Iraq invasion, the US didn’t veto a resolution, but rather sought authorisation that it did not get. The UN, if you go by the idea of collective security, should have responded by defending Iraq against this unlawful use of force.
The invasion proved a humanitarian disaster with the loss of more than 400,000 lives, and many believe that it led to the emergence of the terrorist Islamic State.
3. Refugee crises
The UN brokered the 1951 Refugee Convention to address the plight of people displaced in Europe due to World War II; years later, the 1967 Protocol removed time and geographical restrictions so that the Convention can now apply universally (although many countries in Asia have refused to sign it, owing in part to its Eurocentric origins).
Despite these treaties, and the work of the UN High Commission for Refugees, there is somewhere between 30 and 40 million refugees, many of them, such as many Palestinians, living for decades outside their homelands. This is in addition to more than 40 million people displaced within their own countries.
While for a long time refugee numbers were reducing, in recent years, particularly driven by the Syrian conflict, there have been increases in the number of people being displaced.
During the COVID-19 crisis, boatloads of Rohingya refugees were turned away by port after port. This tragedy has echoes of pre-World War II when ships of Jewish refugees fleeing Nazi Germany were refused entry by multiple countries.
And as a catastrophe of a different kind looms, there is no international framework in place for responding to people who will be displaced by rising seas and other effects of climate change.
4. Conflicts without end
Across the world, there is a shopping list of unresolved civil conflicts and disputed territories.
Palestine and Kashmir are two of the longest-running failures of the UN to resolve disputed lands. More recent, ongoing conflicts include the civil wars in Syria and Yemen.
The common denominator of unresolved conflicts is either division among the great powers, or a lack of international interest due to the geopolitical stakes not being sufficiently high. For instance, the inaction during the Rwandan civil war in the 1990s was not due to a division among great powers, but rather a lack of political will to engage.
In Syria, by contrast, Russia and the US have opposing interests and back opposing sides: Russia backs the government of the Syrian dictator Bashar al-Assad, whereas the US does not.
5. Acting like it’s 1945
The UN is increasingly out of step with the reality of geopolitics today.
The permanent members of the Security Council reflect the division of power internationally at the end of World War II. The continuing exclusion of Germany, Japan, and rising powers such as India and Indonesia, reflects the failure to reflect the changing balance of power.
Also, bodies such as the IMF and the World Bank, which are part of the UN system, continue to be dominated by the West. In response, China has created potential rival institutions such as the Asian Infrastructure Investment Bank.
Western domination of UN institutions undermines their credibility. However, a more fundamental problem is that institutions designed in 1945 are a poor fit with the systemic global challenges – of which climate change is foremost – that we face today.