NPAs: Why RBI’s flexibility may not be an optimal solution

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New Delhi | September 26, 2015 2:15 PM

The Reserve Bank of India has accorded flexibility to banks to deal with the stressed asset problem in the absence of a functioning bankruptcy code. This, however, is far from an optimal solution.

npaThe ARCs, which are expected to play a pivotal role in recovering and reconstructing the NPAs and thereby resolve the sticky assets of the banking system, are clearly short of the task at hand.

Reserve Bank of India Governor Raghuram Rajan seems to be of the conclusive view that the central bank has progressively made it easier for banks to recognise and deal with loans extended to distressed projects.

During his term, the RBI Governor has introduced flexibility for those who recognise and deal with stressed assets early, including an early warning database of large loans, the Joint Lenders’ Forum, the Strategic Debt Restructuring process, the 5/25 mechanism — measures that are indicative of the flexibility that RBI has accorded to banks in dealing with the stressed asset problem in the absence of a functioning bankruptcy code.

This is, however, far from an optimal solution. For one, the asset reconstruction companies (ARCs) registered under the SARFAESI Act, which are expected to play a pivotal role in recovering and reconstructing the non-performing assets (NPAs) and thereby resolve the sticky assets of the banking system, are clearly short of the task at hand. The networth of 15 operational ARCs in the country is only around Rs 4,000 crore whereas stressed assets in the system run into lakhs of crore rupees. For the record, gross NPAs of commercial banks are estimated at Rs 3.02 lakh crore as of March 2015, up 26 per cent from Rs 2.40 lakh crore as of March 2014.

So, the first line of defence against the NPAs is appearing to be shaky. While there is no denying the fact that securitisation companies and reconstruction companies (SCs / RCs) need incremental capital, and that too on continued basis to be able to grow and play a useful role in the sector, the avenues of raising capital are clearly limited.

Investors may be interested in the business, but are cautious on account of slow pace of judicial and administrative environment, as pointed out by R Gandhi, RBI Deputy Governor, at a summit in Mumbai on September 15. Then the other important issue is pricing of NPAs. Currently, the gap between price expectation of sellers and bid price by securitisation and reconstruction companies is too wide to be bridged, which is also evident from the low success rate of auctions. This also proves to be a hindrance while bringing in more investors willing to invest in the security receipts (or SRs) being issued by the securitisation and reconstruction companies to raise funds for acquisition of NPAs.

An analysis by the RBI of purchase of NPAs by securitisation and reconstruction companies indicate that acquisition cost as a percentage to book value of assets increased sharply from 20.8 per cent as on March 2013 to 44.5 per cent as on March 2015 — which essentially means that the discount rate at which these companies are acquiring NPAs from the banks and FIs has decreased considerably.

On the recovery side, the performance is not very encouraging either. As on March 31, 2015, the average recovery rate (assets resolved as a per cent to assets acquired) of securitisation and reconstruction companies was at 31 per cent. According to the central bank, one of the reasons for a dip in the average recovery rate is due to the fact that substantial part of the assets under management of securitisation and reconstruction companies is acquired recently.
One solution is for the Indian Banks’ Association in consultation with Association of Asset Reconstruction Companies to draw contours of mutually acceptable methodology for reserve price valuation. Discovery of fair price for NPAs may definitely help in more deals going through auctions and also generate interest from secondary investors like distress asset funds which can participate via securitisation and reconstruction companies.

An RBI analysis of investor class in security receipts (SRs) does show that seller banks and FIs have been subscribing majority of the SRs. On an average seller banks and FIs have been subscribing 74 per cent of total SRs issued during the period March 2010 to March 2015. In past two years, seller banks subscribed around 80 per cent of total SRs, a disconcerting figure. So, in the absence of third party investor money, which is a direct fall-out of a practically non-existent secondary market, the bank that sells NPAs ironically doubles up as investor in the SRs. An active secondary market for SRs will clearly attract special situations funds and QIBs to this market.

Then, there is the issue of the judicial process. An important factor affecting recovery performance of securitisation and reconstruction companies, according to the RBI, is the delay in judicial process: be it under SARFAESI Act or at the level of debt recovery tribunals. While realising the importance of having a strong bankruptcy framework in improving the ease of doing business, the Centre has constituted a Bankruptcy Law Reforms Committee to study the corporate bankruptcy legal framework in India. The committee has submitted an interim report in February 2015 for immediate action and its final report is expected to be submitted within 12 months, recommending a Bankruptcy Code.
The thrust on NPAs, though, was missing from the Indradhanush policy action announced by the government last month. The seven-pronged strategy for public sector banks fails on at least three crucial aspects — setting up a ‘bad bank’ to address the issue of NPAs, disproportionately higher upfront capital infusion, and tackling human resource problems in mid-to-senior levels, according to a Crisil Ratings note.

At the same time, in recent months, the sharp increase in stressed assets has adversely impacted the profitability of the banks. The annual return on assets has come down from 1.09 per cent during 2010-11 to 0.78 per cent during 2014-15.

Considering the effect it has on both capital and liquidity position of the bank, the need for banks to reduce their stressed assets and clean up their balance sheets is the most compelling if they are to help sustain growth in the economy.

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