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Opinion - Non-Performing Assets
Money & Banking - Insight


The ARC bridge to performance

Ashwani Puri

Asset reconstruction companies can help banks realise better value from their non-performing loans, says Ashwani Puri

AS ON March 31, 2003, non-performing loans (NPLs) in India were officially reported to be around $22 billion.

Over the past couple of years, the Government has taken various steps to facilitate resolution of NPLs and strengthen the financial sector.

In addition to putting in place corporate debt restructuring, to enable creditors and debtors to achieve informal workouts, and the Companies Act (Second Amendment), 2002, which aims to strengthen the existing corporate rehabilitation mechanism, the Government enacted the Securitisation of Financial Assets and Enforcement of Security Interest Act, 2002 (SRFAESI Act).

This Act strengthens creditors' security enforcement rights; secured creditors holding more than three-fourths of the outstanding amount have been permitted to enforce security interest without reference to the court.

It has also provided the legal framework for setting up asset reconstruction companies (ARCs), the specialised vehicles focused on acquisition on NPLs from banks and their resolution.

Three of India's largest lenders — State Bank of India, IDBI Bank and ICICI Bank — took the lead in setting up the Asset Reconstruction Company of India Ltd (ARCIL), currently the only operational ARC in the country. ARCIL completed first year of its operations on August 29.

Till date, ARCIL has acquired 164 distressed cases at an acquisition cost of over Rs 1,760 crore and is in the process of formulating their resolution strategies.

ARCIL is reported to have resolved 6-7 cases through settlement with existing borrowers.

As a first mover, ARCIL had to make significant efforts in convincing lenders of overall benefits of NPL transfers to ARCIL.

In the absence of any track record of higher value realisation by ARCs in India, some lenders appear to question the benefit of transferring NPLs to ARCs, especially because both lenders and ARCs have access to a similar set of resolution strategies, that is, financial/operational restructuring, re-schedulement/settlement of loans or security enforcement. It is expected that ARC would become adept at NPL resolution in due course.

What are the possible benefits to lenders in outsourcing realisation of their NPLs to an ARC?

Internationally, two bank-based NPL resolution approaches — Workout Units and Bad Bank model — have been used with varying degree of success. In the case of Workout Units, the NPLs are moved to a separate bank department, but remain in the bank's books. In the case of the Bad Bank model, the NPLs are transferred to separate affiliated organisations, usually wholly or majority-owned subsidiaries of the transferring banks, which specialise in managing distressed assets.

In India, almost all lenders have separate departments for managing their NPLs. Though a degree of success has reportedly been achieved in resolving NPLs through these separate departments, it is recognised that more focused action is required for speedy resolution of NPLs.

The Bad Bank model allows separate entities to focus more on their primary objectives, at various points of time, concerns regarding expertise, objectivity and incentives have been raised. Second, lenders still continue to remain exposed to NPLs transferred to their subsidiaries or associate companies.

Over the years, central banks of various countries have required consolidation of NPLs transferred to the banks owned AMCs with banks' financial statements, especially for regulatory reporting and capital adequacy computations.

Further, in the Indian context, NPL ownership is quite fragmented and debt aggregation is a key requisite for achieving an early and effective NPA resolution.

The current banking and commercial environment requires consent of three-fourths of the lenders (by value) for taking any security enforcement action, or effecting any financial/operation restructuring plan — whether through the CDR route (that is, informal workout platform), or under Sections 391-394 of the Companies Act.

Bank based NPL resolution approach does not address the NPL fragmentation and inter-creditor issues.

This has the potential to delay the entire NPL resolution process.

There are instances in which defaulting borrowers are regular in debt servicing of one of the lenders in the consortium and have successfully used him to defeat lenders' efforts for settlement/restructuring.

There are clear benefits to Indian lenders in outsourcing realisation of their NPLs to ARCs:

Aggregation and consolidation of different lenders' stakes would enable ARCs to adopt a co-ordinated approach for NPL resolution.

Collective bargaining and strengthening of lenders' negotiating position would enable ARCs to effect complex and better restructuring scheme from the lenders' perspective.

Internationally, independent NPL investors have contributed significantly to the NPL resolution process. The Indian NPL opportunity is sufficiently big to attract these NPL investors in case there is a demonstrable deal flow. Involvement of international NPL investors will not only bring in fresh funds but also turnaround expertise.

Usually, these NPL investors have a panel of turnaround specialists who are able to unlock value from the distressed assets.

Freeing up lenders' management time, enabling lenders to focus on their core activity — banking.

Thus, an ARC, after aggregation of financial interest, is better placed to carry out a speedy and effective implementation of the appropriate NPL resolution strategy. This should enable the lenders to realise better value from their NPLs, the final objective of any NPL resolution exercise.

With the passage of time, as ARCIL and other ARCs, currently at the registration stage, move forward and carry out NPL resolution, Indian lenders would, perhaps, not hesitate to tap the benefits of outsourcing NPL realisation.

(The author is director PricewaterhouseCoopers Pvt. Ltd.)

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