Banks have not been very successful in selling off their bad loans because they have already provided for them to the satisfaction of the central bank and, according to audit and consulting firm PricewaterhouseCoopers, of issues related to how such sales are structured.
Thus far, 10 months into 2007-08, only Bank of Baroda’s auction of bad loans worth Rs410 crore has been completely successful. The auction, announced in December and completed this month, was one of the 11 auctions of bad loans worth Rs3,000 crore conducted since April.
The Bank of Baroda auction comprised 99 accounts— mostly Maharashtra-based small and medium-sized enterprises—and was won by a relative newcomer in the asset reconstruction business, International Asset Reconstruction Co. Pvt. Ltd (IARC). According to people familiar with the development, who did not wish to be identified, IARC paid Rs65-67 crore for the portfolio.
Banks sell bad loans by offering them at a discount. Under the Reserve Bank of India norms, banks are allowed to auction bad loans to qualified institutional buyers, asset reconstruction companies, or ARCs, and other banks.
ARCs normally issue either security receipts (in the form of units) or pay cash to those who sell bad loans. Foreign banks and non-banking finance companies can also participate and they pay cash.
In 2007-08, most bad-loan auctions either fell through or were only partly successful. The banks themselves were not under any pressure to recoup the losses, having already provided for the bad loans in keeping with the guidelines of the central bank. This also meant they could insist on a higher price from bidders.
A recent newsletter from PricewaterhouseCoopers on non-performing loans says several issues have emerged in the sell-off of the bad loans. Smaller accounts that form part of the portfolio and “unpalatable” contractual conditions are the main reasons for the failure of these auctions, it says. “Lack of clarity in the sales process and inadequate time for due diligence” also hamper the auctions, it adds.
Analysts say cleaning up of non-performing assets (NPAs, banking parlance for bad loans) will serve banks well because it will free up capital and resources.
Also, clean books would give them a head start in the implementation of the international Basel II accounting standards, which stipulate that banks need to put aside more capital to guard against financial and operational risks.
Birendra Kumar, managing director and chief executive of IARC, said that going by “thorough due diligence” he was confident “the pricing was right” in the Bank of Baroda deal and the company would be able to resolve the accounts in “a reasonable time period.”
IARC started operations in September. Kumar said the company will be able to raise capital of at least Rs100 crore by March this year. It had previously participated in auctions conducted by Uco Bank Ltd and Punjab National Bank.
In the Bank of Baroda auction, IARC was pitted against two large ARCs, Asset reconstruction Co. of (India) Ltd (Arcil) and Asrec India Ltd. According to people familiar with the development, other ARCs and foreign banks did not participate and the time provided for due diligence was only two weeks. Arcil officials were unreachable for comment.