The Reserve Bank of India (RBI) panel, undertaking \u201ca comprehensive review\u201d of the working of the asset reconstruction companies (ARCs), has invited views and suggestions from market participants and other stakeholders. I don\u2019t belong to either group but let me make a few observations.<\/p>\n
The ARCs are in the business of buying bad loans from banks and\u00a0financial institutions\u00a0and\u00a0making money by recovering them.\u00a0Generally, they acquire the bad financial assets\u00a0using a trust structure; they do not own the assets but manage them.<\/p>\n
Their origin is a 1991 report on financial sector reforms by a panel chaired by former RBI governor M Narasimham after the central bank issued its first set of norms to classify bad loans. After the Board for Industrial and Financial Reconstruction achieved little success in tackling industrial sickness, debt recovery tribunals were established for speedy recovery but they, too, could not speed up the process. We went for ARCs as a panacea for all ills.<\/p>\n
How have\u00a0they fared in the past 18 years since the first such entity\u00a0was set up by three banks? There are\u00a028\u00a0ARCs but they haven\u2019t done much, neither for the banks nor themselves. In the financial year 2020, 26.5 per cent of banking industry\u2019s bad loans were with the ARCs, lower than the chunk with insolvency courts that came into being in 2016. The recovery rate for ARCs is 28.7 per cent. Again, lower than insolvency courts\u2019 41.5 per cent.<\/p>\n
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, cleared the decks for setting up the ARCs\u00a0when the gross bad loans of the banking system were 10.4 per cent, sliding from 19.5 per cent in 1995. They dropped to 2.2 per cent in 2008 before rising all the way to 11.2 per cent in 2018, but the assets under the management of the ARCs haven\u2019t shown any correlation with the industry\u2019s bad loan trend. Barring a brief spurt in 2014, when gross bad loans were 3.8 per cent, the ARCs are hardly active.<\/p>\n
Why? Neither the ARCs nor the banks have taken the business of resolving the bad assets seriously. In the initial days at least, the focus was on just \u201cmanaging\u201d them.<\/p>\n
The banks have been selling bad loans and receiving securities receipts, or SRs, in return. Under norms, ARCs must offer at least 15 per cent cash while buying the bad loans; the rest can come in the form of SRs. The ARCs themselves\u00a0must subscribe to 15 per cent\u00a0of\u00a0SRs, increased in August 2014 from the earlier\u00a0limit of 5 per cent.<\/p>\n
This is fine\u00a0but no one bothers much\u00a0about the redemption of the SRs. The banks\u00a0have generally been shifting the toxic assets\u00a0from their loan books to the investment books (in the form of SRs), while the ARCs are happy enjoying the management fees. It\u2019s a cozy relationship.<\/p>\n
There have been instances where sponsor banks were \u201cparking\u201d the bad assets at the ARCs and the defaulters were buying\u00a0back\u00a0the assets\u00a0from the ARCs at a price negotiated for the transaction! Such \u201cback-to-back\u201d arrangements may not be rampant but they do happen.<\/p>\n
Why aren\u2019t the SRs redeemed? Are there genuine reasons behind this or are acquisitions of\u00a0<\/strong>assets at an inflated price being driven by consideration for management fees? Why would the ARCs bother about resolution? They have\u00a0five years for that, which can be extended to eight years.\u00a0After this, it gets written off both by the seller bank and the ARC.<\/p>\n If you ask the ARCs why they are not aggressively buying assets, they may blame\u00a0the RBI norms that have tripled the minimum investment to 15 per cent in SRs. They will also say that the value of underlying security often doesn\u2019t justify the seller banks\u2019 price expectations.<\/p>\n Their fees are linked to the net asset value (NAV) of the loans and not the outstanding value of the SRs. Six months after buying bad loans, the ARCs must get the SRs rated. Based on the rating\u2014which takes into account the progress in recovery\u2014the NAV is calculated. The SR investors\u00a0(including the ARCs)\u00a0book losses when the NAV drops.<\/p>\n What are my suggestions?<\/p>\n #\u00a0\u00a0Cash transactions are always preferable as banks do not have to deal with uncertainties about redemption of SRs, and the ARCs can buy assets at deep discount, paying upfront. But they don\u2019t have the money to do so. At the same time, SRs signify the so-called skin in the game. Let\u2019s raise the limit of ARC\u2019s subscription to SRs from 15 per cent to 25 per cent (even though the government\u2019s bad bank in the making has envisaged retaining the 15 per cent norm).<\/p>\n ## Along with this, the requirement of capital\/owned funds for ARCs may be raised to, say,\u00a0Rs500 crore to strengthen their ability to buy bad assets. This is to ensure that ARCs remain focused on resolution and not recovery. ARCs with dollops of patient capital can play a bigger role in the reduction of non-performing assets.\u00a0<\/strong><\/p>\n ### The Securitisation Act and the insolvency code should have uniform norms. The ARCs must be allowed to put in equity to turn companies around. Now they cannot do so and those who bring in equity dictate the terms of resolution. Indeed, the Act allows ARCs to change or take over the management and sale, or lease, of the business of the defaulting borrowers, but the RBI has taken\u00a0long\u00a0to empower them, that too in a\u00a0piecemeal\u00a0manner. They can take over the management, but cannot lease the business as yet.<\/p>\n #### Even though they are not listed entities, the ARCs must have the right number of independent directors on boards and a professional management\u00a0besides independent\u00a0audit and risk management committees for accountability, compliance and governance.<\/p>\n ##### Both the RBI and the capital markets regulator must together create a secondary market for SRs to reflect the true valuation of such receipts. Even after 18 years of their existence, the SRs are not traded.<\/p>\n ###### The recommendation of a 2019 RBI task for setting up an online platform for asset sale for price discovery is yet to be implemented. The alternative investment funds could be allowed to bid for bad loans directly along with the ARCs and others.<\/p>\n ####### We can also think of a recovery rating of such assets before they are sold, instead of rating them six months later. Recovery ratings reflect a fundamental analysis of the underlying relationship between financial claims on an entity and potential sources to meet those claims. Once the pricing is based on such ratings, even if the banks are settling for high discounts, they will not be afraid of being hounded by investigative agencies.<\/p>\n ######## We need consolidation. Let the smaller ACRs focus exclusively on retail and\u00a0SME\u00a0loans that have gone bad, while the big boys\u00a0with higher capital buy corporate loans and resolve them.<\/p>\n ######### Finally, one question: Why can\u2019t we have a sunset clause for the ARCs, which is a global norm?<\/p>\n","protected":false},"excerpt":{"rendered":" The Reserve Bank of India (RBI) panel, undertaking \u201ca comprehensive review\u201d of the working of the asset reconstruction companies (ARCs), has invited views and suggestions…<\/p>\n","protected":false},"author":1,"featured_media":2991,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-2990","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-articles"],"acf":[],"_links":{"self":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/2990","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/comments?post=2990"}],"version-history":[{"count":1,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/2990\/revisions"}],"predecessor-version":[{"id":2992,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/2990\/revisions\/2992"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/media\/2991"}],"wp:attachment":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/media?parent=2990"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/categories?post=2990"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/tags?post=2990"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}