With the loans to Kingfisher Airlines (KFA) turning into a non-performing asset, the Reserve Bank of India (RBI) has asked banks not to treat “Kingfisher brand”, an intangible asset, as collateral. The issue is not that banks will now have to treat their exposure to KFA (at least that part which was given on the back of its brand, valued by a consulting firm at more than Rs.4,000 crore in 2010) as unsecured, thereby increasing their provisioning requirement from 15% to 25% of the loan value.
Much more is at stake here. Implicit in RBI’s instruction to banks is the principle of lending to and on the back of all intangible and knowledge assets. Contrary to the Kingfisher case, RBI recently permitted banks to finance telecom companies bidding for spectrum. This move followed the government’s decision to allow telecom companies bidding for airwaves to mortgage spectrum to raise funds from banks. By permitting banks to finance investments in an intangible asset such as spectrum and seeking bank’s recourse to it in the event of a default, RBI had moved forward on intangible asset financing.
Now, with the diktat in the Kingfisher Airlines case, what comes through is that the regulator itself is not clear about how to address the issue of funding intangible assets; not only the prudential norms or provisioning requirements but also the financing of these assets. This issue is important in light of the changing structure of the Indian economy and its new sources of growth. The Indian economy is moving from one based on physical assets to one that is increasingly driven by intangible assets. With the services sector contributing 55% (excluding construction) of gross domestic product (GDP) compared with 16% for manufacturing, large investments are being made in intangible assets.
Indeed, one of the biggest structural advantages that India is seen to have—demographic dividend—is based on an intangible asset: the worker skills of a young population. Globally also, investment and growth are increasingly being driven by knowledge capital than by physical capital. While this change has been recognized to some extent by the financial sector—intangible assets are factored into the stock prices and credit ratings of companies—its potential and significance has not been appreciated either by the policymakers and the regulators or by the lending institutions.
The policy frameworks and regulatory institutions are still tailored to a world in which physical capital drove growth. Attitudinally, banks and financial institutions are still driven by physical assets based lending. This despite the fact that the biggest assets of enterprises today are economic competence, including brand equity, firm-specific human capital, networks joining people and institutions, and organizational know-how that increases enterprise efficiency. Indeed, the value of some leading global companies resides almost entirely in their knowledge capital. It has been estimated that physical assets account for only about 5% of Google’s worth.
In spite of such stark changes, the government and the regulators have not worked out a proper functional and transparent set of guidelines for financing the creation of intangible assets or lending on the back of such assets. As of now there are no standardized lending norms or guidelines for lending to intangible assets such as brands, trademarks, licences, know-how and trade secrets, group synergies, assembled workforce, and formal intellectual property, such as patents and copyrights.
At a systemic level, the lack of a proper system is resulting in the loss of capital formation in the economy due to the inability of firms to create financial leverage for their productive but intangible assets. Till now, financing for intangibles has largely been through equity, with debt only coming into play once a track record has been established. But now, debt must be allowed to play a role in the monetization of intangible assets.
Unless ways are found to monetize the value created and embedded in intangible assets, the process of creation of these knowledge assets will peter away. And there can be no greater economic loss than this.
Just as physical assets have been used to finance the creation of more physical assets during the manufacturing phase of development, intangible assets should be used to finance the creation of more intangible assets in the age of the knowledge economy.
This will require innovative policies and new structures. Pending a holistic change, one that includes changes in the accounting policy and norms, reporting formats, valuation principles, and taxation policy, it is imperative to spell out the lending norms. In this there is need for clarity and consensus.
The former has to come from the regulator and the latter from the banking fraternity itself. Given the current issue arising out of spectrum financing and the Kingfisher case, perhaps the Indian Banks Association could start the consensus building process, starting with the resolution of the key issue of “value in use” and “value in liquidation” of intangible assets.
H aseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at firstname.lastname@example.org
To read Haseeb A. Drabu’s earlier columns, go to www.livemint.com/methodandmanner