Column: Utilising ARCs effectively

Written by Soumya Kanti Ghosh | Updated: Apr 23 2014, 08:48am hrs
Indian banks saddled with high NPAs are examining various options to clean up their books ahead of the stringent Basel III norms kicking in next year and, in the process, about 40 banks have recently invited bids from Asset Reconstruction Companies (ARCs) in the country for sale of bad loans worth R42,700 crore. This is almost four times the amount that was put up for auction in past quarters. The sudden eagerness on the part of banks to get junk loans off their books has also led to the rejuvenation of ARCs, which have been dormant for nearly a decade.

ARCs have been used worldwide (internationally, they are called AMCs) to resolve bad-loan problems, and have had a significant degree of success in both the developed and emerging economies. In the 1980s, US used a government-sponsored ARCResolution Trust Corporation (RTC)to overcome its thrift crisis. RTC acted as a bad bank and functioned as an effective sales mechanism for disposal of assets. In the early 1990s, Mexico and Sweden demonstrated successful use of ARC mechanism (Fobaproa and Securum respectively) as a bad banks to clean and re-privatise/re-capitalise the banks. Korea and Malaysia used Kamco and Danaharta as the nodal agencies for acquiring and disposing NPAs. Kamco used the securitisation and the joint-venture routes for investor participation in the assets sale. Interestingly, Japan, China, Thailand and Indonesia have all used ARC mechanism during the South East Asian crisis.

The successful experiences in these countries suggest that there exists a case for ARCs being used effectively for asset disposition. But achieving these objectives requires many ingredients, some of which are: easily liquifiable assets such as real estate, professional management, political independence, adequate bankruptcy and foreclosure laws and, transparency in operations and processes. For example, in the Philippines the success of the AMCs was doomed from the start as the government transferred a large amount of politically-motivated loans and/or fraudulent assets to the AMCs.

What lessons does this hold for India First, the security receipts (SRs) issued by ARCs against the asset sold may remain on the bank books if there is not sufficient depth in Indian bond market. Thus, there is an urgent need to broad base the countrys bond market that is dominated by highly-rated corporate entities. Interestingly, RBI guidelines on credit default swaps, introduced more than 2 years ago, has not even evinced sufficient interest as the guidelines are inhibited by several factors (including the absence of bankruptcy laws in India, among other things) and by the fact that they are restrictive. A proper market for credit default swap is a sine qua non for development of the junk bond/SR market in India.

Second, there must be a strong recovery mechanism, like for instance, dedicated assets recovery branches, special recovery cells, which can be strengthened further. In addition, other recovery mechanisms like Lok Adalat, DRTs and Sarfaesi can also be used effectively to recover value from NPAs.

Third, the ARC mechanism may be used sparingly as it involves a haircut that may be deep and, as such, a costly affair for the banks.

Fourth, the ARC instrument can prove to be very effective with respect to loans that have been written-off and for advances under collection accounts where chances of recovery are remote. However, for such accounts, NPA level may not come down as these have already been written-off but it will significantly improve the profitability of banks under stress due to increased provisioning for NPAs.

In the current auction session, ARCs may buy these assets on a case-by-case basis at 30-40% discount. Assuming a best price of R25,600 crore for assets worth R42,677 crore may fetch immediate cash inflow of R1,280 crore for banks and, to that extent, boost profit. The remaining amount however, may be realised over a period of time on, may be, a sharing basis, depending upon type of agreement entered into. Using the ARC instrument, we feel, can help the banks reduce NPAs by at least 15%, if not more.

To sum up, the use of ARCs is indeed an effective vehicle to clean up the banking system. However, for such to be successful in India, the primary focus should be on developing the securitisation market, tapping into a joint venture route for investor participation and, most importantly, resolution of assets. The focus should not be on rapid liquidation to third-party investors and expediting corporate restructuring. Additionally, with RBI recently operationalising a framework for revitalising distressed assets in the economy from April 14, now may just be the opportune time for banks.

Arun Chansarkar contributed to this article The author is chief economic advisor, State Bank of India. Views are personal