Capitalising the ARC with the provisions banks have set aside already will leave them enough capital for growth
The experience with ARCIL and other asset reconstruction companies (ARC) has been bad. (Representative image)
It is a huge relief the government is not going to fund the proposed Asset Management Company (AMC) that will house the bad assets of banks before they are sold to buyers like alternative Investment Funds (AIF). A bad bank is a bad idea at any time, even in these difficult circumstances, but had the government capitalised the AMC, it would have amounted to a bailout creating a moral hazard. From all appearances, the idea is to capitalise the AMC with the capital provisions that banks have already set aside for the bad loans and then transfer the loan exposures. That seems to be a good way to do it since it would not cost the banks growth capital; the shareholding of each of the banks in the ARC would be proportional to the stressed assets that they transfer.
The advantage of pooling the toxic loans is that it would be easier to negotiate with a prospective buyer. Else, it takes consortiums forever to come to a decision with one bank or another dragging its feet. For the moment it is not immediately clear whether the bad loans will be immediately sold to a buyer or whether, as some experts have suggested, the businesses will be turned around with the help of professionals before the sale. The experience with ARCIL and other asset reconstruction companies (ARC) has been bad.
To begin with, the haircuts were steep—as high as 30-40%—with the ARCs striking a tough bargain. Worse, banks received very little cash upfront—at one time just 5-10%—and were left holding the security receipts (SR) for the remaining amount. Most of the time, they ended up recovering very little money. The fact is the ARCs found it extremely profitable to pay a small sum upfront as cash and little thereafter; the economics worked for them.
In September 2016, RBI made it mandatory for banks to frame a pre-defined policy to manage NPLs and widened the pool of buyers to include other banks, NBFCs and FIs that had capital and expertise. RBI amended the rules to remove a key arbitrage; banks were delaying provisions by selling NPLs, especially doubtful loans, to an ARC, and writing down the value of investments over a much longer period. RBI asked them to ensure the outstanding SRs held by banks on loans that had been sold was not more than 50%.
DFS secretary Debashish Panda has suggested the model would be a 15:85 one; with 15% cash upfront and 85% as SRs. That does not sound promising. To begin with, prospective buyers typically look for attractive prices, which means banks will need to take stiff haircuts even if they are negotiating as a team and not individually. To be sure, taking a big haircut is not a crime; it is perhaps the best way out for lenders whose capital is blocked.
However, it is important the government ensures the lenders are protected from the 3Cs, and like, with the Insolvency and Bankruptcy Code (IBC) no questions are raised. If possible the stressed companies should be revived, at least partially, with the help of professionals and in the absence of the promoters before the debt is sold. Obviously, a cost analysis of each company would need to be done to assess whether such an exercise is worth it.