The word “asset reconstruction” in India owes its origin to Narsimham I which envisaged the setting up of a central Asset Reconstruction Fund with money contributed by the Central Government, which was to be used by banks to shore up their balance sheets to clean up their non-performing loans. This idea never worked: so Narsimham II thought of asset reconstruction companies, the likes of which had already been successful in Malaysia, Korea and several other countries in the World. To keep in tune with the original idea of asset reconstruction fund, and also to give an impression that ARCs are not merely concerned with realization of bad loans but try and resurrect bad loans into good ones, the word ARC has been used in India.
Would the ARCs to any “reconstruction” or merely realisation?
On the face of it, it is difficult to see the ARCs doing substantially more than mere realization of bad loans. Even the definition of the word “asset reconstruction” in the Ordinance talks of mere realization and not reconstruction. As ARCs would anyway not have the capital to do any further funding of bad loans, it is difficult to see them doing any such “reconstruction” to qualify for that term.
Why Asset management companies or ARCs?
Asset management companies have been set up in various countries internationally as an answer to the global problem of bad loans.
Bad loans are essentially of two types: bad loans generated out of the usual banking operations or bad lending, and bad loans which emanate out of a systematic banking crisis.
It is in the latter case that banking regulators or governments try to bail out the banking system of a systematic accumulation of bad loans which acts as a drag on their liquidity, balance sheets and generally the health of banking. So, the idea of AMCs or ARCs is not to bail out banks, but to bail out the banking system itself.
There are essentially two approaches to taking care of these systematic bail out efforts: one, leave the banks to manage their own bad loans by giving them incentives, legislative powers, or special accounting or fiscal advantages. The second approach is to do the same thing on a concerted, central level, through a centralized agency or agencies.
The former approach is called the decentralized approach and the latter approach is called centralized approach. AMCs arise out of the second approach – that is, a centralized agency for resolving bad loans created out of a systematic crisis.
Each approach has its own advantages and disadvantages and there is no clear evidence of any of the two being better over the other. Various countries have tried either of the two approaches with success stories and failures in either case.
What are the advantages of an AMC approach?
- 1. Centralization of bad loans in one or a few hands and therefore obviously more clout
- 2. It is possible to give special legislative powers to a few AMCs rather than to each bank
- 3. Banks are left with cleaner balance sheets and do not have to deal with problem clients. Regular banking relations with the group are not affected.
- 4. Because it deals with a larger portfolio, it can mix up good assets with bad ones and make a sale which is palatable to buyers.
- 5. It is easier to do a capital-market based funding for an AMC than for the banks themselves.
|Sr No.||Name of the Registered Company|
Address of the Company
|1||Asset Reconstruction Company (India) Ltd, (ARCIL)|
Shreepati Arcade, August KrantiMarg, Nana Chowk,
|2||Assets Care Enterprise Ltd.,|
IFCI Tower, 61, Nehru Place,
New Delhi -110019.
|3||ASREC (India) Ltd,|
UTI Tower, Gn Block,
BandraKurla Complex, Bandra (East),
|4||Pegasus Assets Reconstruction Pvt. Ltd.|
46,4th floor, Free Press House
|5||Dhir&Dhir Asset Reconstruction &Securitisation Company Ltd.|
D-54 (FF), Defence Colony,
|6||International Asset Reconstruction Company Pvt. Ltd.|
104, Ashoka Estate,
New Delhi-110 001.
|7||Reliance Asset Reconstruction Company Ltd.|
Reliance Centre 19, WalchandHirachandMarg, Ballard Estate
|8||Pridhvi Asset Reconstruction and Securitisation Company Ltd.|
123/3 RT, First Floor,
Sanjeeva Reddy Nagar,
|9||Phoenix ARC Pvt Ltd.|
240, Navsari Building, 1st Floor,
D N Road,
|10||Invent Assets Securitisation& Reconstruction Private Limited|
7,Raheja Centre, Ground Floor
214,Free Press Journal Marg
|11||JM Financial Asset Reconstruction Company Limited|
141,Maker Chambers III
|12||India SME Asset Reconstruction Company Limited (ISARC)|
SME Development Centre
Plot No. C-11, G-Block
BandraKurla Complex, Bandra (East),Mumbai-400051
|13||Edelweiss Asset Reconstruction Company Limited|
14, Express Tower
ARCs in India have been set up as non-government vehicles, not government owned/supported. Government is facilitator, not participant in ARCs. There is provision for multiple ARCs in the Indian model for value maximization.
Opportunities for investment in distressed assets have increased for investors since the demand-supply dynamics have become favorable. Further, a robust view is being taken on the operational nature of underlying assets and accordingly the demand for underlying assets is increasing. With the Indian economy in a capacity-additive mode and legal and regulatory framework becoming increasingly hospitable to resolution of NPAs, combined with the increasing interest evinced by new investors, ARCs have become the ideal vehicles to channel investment in distressed debt.
Factors impeding resolution of NPAs
Public Sector Banks (PSBs), which account for a major share of the NPAs, primarily focus on net NPA percentage and draw comfort from its improvement, which can happen, more often than not, by growth in their loan book. The focus on the reduction of the gross NPA block has emerged only recently.
Inter-creditor issues come into play between the term lenders and working capital bankers because of the borrowersâ€™ propensity to service the working capital bankers for a longer period of time, while letting the term loans go subserviced. Different security profiles of the term lenders and working capital bankers (because of the depletion in value of current assets), pose difficulties in achieving convergence of approach amongst the lenders required for the achievement of 75% debt acquisition (for invocation of the powers under SARFAESI Act provisions).
Due to logistical reasons, it is not cost effective for the PSBs to have a focused expert attention at a centralized point, leading to wastage of resources and delay in NPA resolution.
Transparent practices are important to encourage biddersâ€™ participation in the NPA auction undertaken by the banks/FIs. It has been observed that, at times, the price expectation of the selling banks is higher than the best bid price discovered through the auction process. It is the desire of the bid participants that more transparent practices be followed by the selling banks for evolving a mature market. In several cases, reserve price is not being disclosed. Bidders often spend substantial resources and monies to participate in the bidding process, however, sometimes deals are being called off by the sellers without citing convincing reasons. The end effect is that few deals of sale of NPAs on cash basis can be concluded, resulting in large quantum of NPAs (on gross basis) remaining in banks books.
Additionally, the factors which may still impede the working of ARCs and need immediate attention are inadequate transparency in accounting causing distortions in valuation and delay in recognizing the impending loss in value (due to non classification of assets so as to reflect their true value). Further, lack of up-to-date data on statutory and other liabilities, and high stamp duty and registration charges in certain states adversely impacts the value that can be offered to the selling banks/FIs.
ARCs in unique position to resolve NPAs
ARCs are required to take up the aforesaid challenges for effective and speedy action by invoking SARFAESI Act and other measures by bringing into play their expertise in asset resolution.
RBI guidelines for ARCs provide a strict time frame of 5 years (including 1 year planning period) for resolution, thus bringing in a sense of urgency for the ARCs, right at the acquisition stage itself. Debt aggregation in the hands of ARCs not only releases the bandwidth of the banks/FIs for their core activities and recycling of the capital available to the banking system, but also makes it worthwhile for the lenders to cooperate with the ARCs, given the position of strength and expertise with which the ARCs tackle the errant borrowers.
Given the industrial nature of most of the large NPAs and lack of significant exposure to the real estate sector, restructuring either with the existing promoters or business sale to strategic investors is the key for value maximization for which the ARCs are uniquely placed, given their expertise and tight time frame prescribed by RBI.
Accordingly, ARCs are in a strategic position to bring stability to the financial system and facilitate revival of economic growth. The conducive factors in favour of ARCs are legal empowerment and booming economic conditions potent with possibilities of unlocking the value of collateral based loans. ARCs with pragmatic approach towards debt restructuring and flexibility to explore multiple resolution strategies in a dynamic framework, can achieve successful resolution.
NPAs in banking system and the role of ARCs
NPAs in the Indian Financial system, though substantial, are still lower as a proportion of the GDP at current factor cost, as compared to other countries in the region. However, standard assets restructured by banks (including cases restructured through the CDR process) do not figure as NPAs. Assets that have been restructured continue to require significant amount of lender supervision. There is always a likelihood that some of these assets may turn into NPAs again. Net NPAs of Scheduled Commercial Banks as a percentage of Net Advances have steadily reduced from 8.1% in 1996-97 to 4.4% in 2002-03 and further to 1.1% in 2006-07 (Source: RBI Deputy Governorâ€™s speech at FICCI-IBA Conference on â€œGlobal Banking: Paradigm Shiftâ€ on September 14, 2007). However, the increase in Gross NPAs is continuing. Thus, there is ample scope in the current context for ARCs to add value to the financial system. With the present upturn in the economy, ARCs would be able to deliver value by resolution through a concerted approach, particularly in light of the fragmented debt structure in most large NPAs, where invocation of SARFAESI powers would be crucial for resolution.
Boost in Credit GDP Ratio will increase fresh flow of NPAs
India has a very low, though improving, Credit-GDP ratio (51% as on March 31, 2007 as compared to 30% as on March 31, 2000, as per RBI’s annual report for FY07). With the increase in this ratio, the flow of NPAs would also increase. NPAs are mostly industrial assets â€“ exposure to â€˜bubble sectorsâ€™ being minimal. Further, the resolution of larger cases (80% by value) requires intense workout by way of corporate restructuring, business sale or combination of both.
Accelerated provisioning norms (Basel II) for banks to result in increased flow to the NPA market
Indian Banking Industry has low provisioning coverage on account of time based provisioning as against cash flow based provisioning in developed countries. From FY 07 banks have to provide 100% provision in respect of doubtful assets over 3 years old, which will increase fresh flow of NPAs into the system. Tough provisioning requirement will enable banks to sell their NPAs without taking any hit in their P&L A/c. Stricter provisioning norms / write offs after 3 years will compel banks to shift towards “Write-Off and Sell” approach from the present â€œProvide and Holdâ€ approach.
With the implementation of BASEL II norms, the capital adequacy ratio of banks needs to be improved. As per the BASEL II accord, the minimum capital to be maintained by a bank for operational risk is 15% of the average gross total assets of previous 3 years. Additional capital will also be required to cover for credit risk and market risk. In order to raise this additional capital, a number of banks approached the capital markets in FY 2006 and FY 2007. Unlocking the capital locked in NPAs will help the banks to mobilize the required additional resources and also reduce capital requirements.
Banking statistics all over the world indicate that NPAs are a natural bi-product in any economy. In the developed economy of USA around 1% of the loan book is written off every year. Therefore, in the Indian context, given the growth rate of the economy, it is unlikely that the accretion rate will go down significantly in the near future.
Recent dispensations expected to facilitate induction of new investors
Inter-bank purchase/sale of NPAs has been allowed in July 2005, leading to significant portfolio buy-outs through competitive bidding process. Further, Foreign Direct Investment in equity of ARCs and participation of Foreign Institutional Investors (FIIs) in Security Receipts (SRs) of ARCs has been allowed by RBI in November 2005. The said dispensations are expected to facilitate cash buy out of NPAs through induction of third party investor money. The above measures are a welcome development for creation of a vibrant market for investment in NPAs, in the country.