3 models to buy back public NPLs: Global experiences for debt crisis

The idea of buying back non-performing loans (NPLs) from the public was discussed by former Prime Minister Thaksin Shinawatra, who mentioned that he had consulted with Prime Minister Paetongtarn Shinawatra on how to solve household debt problems, particularly regarding NPLs. 

The proposal is to purchase these bad debts from financial institutions, thereby allowing citizens to have more financial flexibility in their lives and livelihoods.

This approach to solving debt issues through NPL buybacks has been implemented by several countries to resolve financial crises and assist the public. The models vary depending on the economic context and specific goals that need to be achieved.

Here, we will explore three different models of NPL buybacks and analyze the pros and cons of each:

1. Direct Government Purchase of NPLs

In this model, the government uses its budget to buy bad debt from the public or financial institutions directly. This can either be done using the entire budget or a portion of it, buying NPLs from financial institutions at market prices well below their actual value. The government would then manage these debts. The model can take the following form:

1) Direct Government Purchase of Bad Debt from Banks

An example of this is the Troubled Asset Relief Program (TARP) in the United States in 2008. The US government allocated $700 billion to purchase bad debts from banks and insurance companies to stabilize the financial system and prevent the collapse of major financial institutions.

Advantages:

This measure helps maintain stability in the banking system.

It prevents the crisis from spreading to the overall economy and can quickly stimulate economic recovery.

Disadvantages:

The large financial outlay burdens the government's budget, increasing national debt.

There is criticism that such a measure primarily benefits the banks rather than the citizens.

2) Establishing a Government-Owned Asset Management Company (AMC)

An example of this model is the approach taken by Thailand to address bad debt after the 1997 financial crisis, where the Thai Asset Management Corporation (TAMC) was established. TAMC was responsible for purchasing bad debts from banks and negotiating with debtors to restructure their loans, providing relief to the public.

The establishment of an AMC is a model that Pichai Chunhavajira , Deputy Prime Minister and Minister of Finance, mentioned as a potential way to manage debt by purchasing non-performing loans.

Advantages:

This model allows banks to quickly issue new loans, helping to stimulate the economy.

It reduces the debt burden on citizens affected by the economic crisis.

Disadvantages:

There are limitations on the types of bad debts that can be purchased, as only debts that meet certain criteria can be bought.

There is a risk of governance issues if proper oversight is not in place.

2. Government-Supported Financial Mechanisms for Raising Funds to Purchase NPLs

1) Issuance of Bonds for Fundraising (Debt Securitization / Bond Issuance)

An example of this approach is the Financial Sector Restructuring Fund implemented by South Korea in 1997. After the financial crisis, South Korea issued bonds worth $65 billion to raise funds, which were then used to purchase bad debts from banks. This money was subsequently used to restructure the debts of the citizens.

Advantages:

This approach does not directly impact the national budget, as the government does not immediately rely on taxpayer money.

It allows for a swift reduction of bad debts in the banking system.

Disadvantages:

Raising funds through bond issuance incurs interest, which needs to be paid back in the future.

If the management of the funds is mismanaged, the government could end up with increased debt.

2) Establishing a Public-Private Partnership (PPP Fund)

An example of this model is the Public-Private Investment Program (PPIP), which uses a combination of public funds and private sector investments to purchase bad debt. This approach helps encourage private investors to share the risks involved.

Advantages:

It reduces the burden on the government budget, as private sector investments help create a more liquid bad debt market.

Disadvantages:

The private sector may prioritize profits over genuinely helping debtors.

If investors lack confidence in the market, there may be a lack of investment in the fund, hindering its effectiveness.

3. The Bad Bank Model: Separating Bad Debts into a New Entity

This approach involves creating a Bad Bank or a financial institution specifically established to absorb bad debts (NPLs) and low-quality assets from commercial banks. The objective is to reduce the burden on banks and enhance the stability of the financial system.

How the Bad Bank Model Works:

The bad debts are transferred from regular banks to the Bad Bank. The Bad Bank then purchases the bad debts from the commercial banks, allowing the banks to focus on their core business and issuing new loans. The Bad Bank is responsible for managing the non-performing loans (NPLs) by either restructuring the debts, selling non-performing assets (NPA), or selling the debts to investors. Sometimes, the Bad Bank may sell a portfolio of bad debts to specialized investors in high-risk assets.

Countries like Germany have supported the idea of separating bad debts into a new entity called a Bad Bank. This allows regular banks to focus on their regular business while the Bad Bank manages the bad debts.

Advantages:

Banks can resume issuing new loans quickly, as the Bad Bank focuses on managing bad debts over the long term without affecting the core banking system.

It helps improve the overall financial stability by isolating problem debts.

Disadvantages:

If the bad debts are too excessive, investors may lose confidence in the Bad Bank.

If mismanaged, the government might need to intervene again to address the bad debts.

Nonarit Bisonyabut, Senior Research Fellow at TDRI, stated that allowing market mechanisms to function remains the best approach, despite requiring time. The market already has asset management firms purchasing bad debts from banks, ensuring an efficient resolution process.

Thaksin's suggestion of using 100% private capital for bad debt purchases without relying on public funds or taxes is a market-driven solution that Nonarit agrees with. The government's role should be limited to facilitating debt resolution. Using state funds would mean taxpayers bear the burden, which is inappropriate.

However, full private sector acquisition of bad debts may be limited by capital constraints. The government could attract investors, including foreign and domestic funds, to increase competition in the debt management industry.

TDRI also warns that if the government intervenes in the market using public funds, inefficiencies may arise, potentially turning private sector bad debts into a fiscal burden for the state.

If the government converts private bad debts into public debt, it effectively bails out banks. Without market mechanisms, direct negotiations risk banks selling bad debt to the state at excessively high prices.

This could also create moral hazard, where debtors feel less obligated to repay, expecting government intervention—similar to past cases with farmer debt relief and student loans.

Such a move signals to the private sector that debt need not be repaid, encouraging future borrowers to rely on state bailouts instead of financial responsibility.

A better approach would be a model like the Thai Credit Guarantee Corporation (TCG), where the government partially guarantees bad debt but allows private entities to manage it. This maintains market efficiency while minimizing fiscal risks.

"While relying entirely on private capital may be difficult and small-scale, it is still preferable to direct government management of bad debt," Nonarit said.