Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Lessons from IDBI’s experiment with a bad bank-like structure

The experience of IDBI Bank will be a useful guide in how to better execute a bank-sponsored stressed asset fund should it be set up

The country’s lenders and the government are discussing the idea of a bank-sponsored stressed asset resolution mechanism, Reserve Bank of India (RBI) governor Raghuram Rajan confirmed on Tuesday.

While the structure of the fund is still to be determined, past experience may offer some clues on what the government should not attempt to do. One route to avoid would be the setting up of a bad bank-like structure. An experiment undertaken at the erstwhile Industrial Development Bank of India (IDBI), a development finance institution, nearly a decade ago tells you why.

Later IDBI turned itself into a limited company namely, IDBI Ltd to keep up with reforms in the financial sector. In 2004, when IDBI Ltd converted itself to a bank, the government had decided to set up a Stressed Asset Stabilization Fund (SASF) to hive off 636 stressed and non-performing cases with aggregate loans of over 9,000 crore.

A complex structure was worked out, under which the government would extend a loan of 9,000 crore to the fund, which would then buy long-term securities of the government, which had a tenure of 20 years. These securities would then be exchanged with stressed and non-performing assets (NPAs) of IDBI Ltd before it was converted to a bank. The new bank would continue to hold these securities till maturity in 2024.

Once the transfer happened, SASF was to focus purely on recovery of funds from these assets, while the bank would continue to function as an entity free of any large bad loans.

While there was no immediate outgo of capital when the fund was created, the government would have to redeem the securities to the extent of the assets that remain unrecovered at the end of the 20-year period in March 2024. As such, the government had effectively created a future liability by taking over the NPA burden from IDBI Bank.

It all sounded good on paper but SASF’s track record in recovering funds from the stressed assets has not been great.

According to a 2014 audit report by the Comptroller and Auditor General of India (CAG), SASF was able to recover only about 4,000 crore as of end-March 2013. More recent data was not readily available as CAG is yet to conduct another audit.

Of the 319 cases that SASF had settled since its inception, 300 were small cases with outstanding loans under 25 crore each. According to the CAG audit report, SASF has only been able to successfully resolve small-ticket cases, while large cases remained unresolved.

“Obtaining personal guarantee (PG) at the time of giving the loan became a meaningless exercise in the absence of the property and income details of the guarantors. Only 4.99 crore could be recovered by invoking PG," the audit report said.

One major reason for the slow pace of recovery, as the CAG report noted, was the lack of adequately trained manpower at the fund. About 121 IDBI employees had been appointed at SASF at some point in time in their careers between 2005 and 2013. And 62 of these 121 employees had worked for only two years at the fund, while only 16 possessed any recovery experience.

A senior banker who has worked with SASF in the past said that the fund’s outstanding cases are sticky in nature.

“The cases remaining with the SASF are those which are very sticky in nature. In some of these cases, the companies don’t exist or the borrowers have moved to other parts of the world. After the CAG audit, the focus of the fund has been shifted to full recovery from every asset. This meant that those who wanted to do at least a one-time settlement after getting parts of the interest waived off have been denied an opportunity. To recover full amounts from such assets is a difficult task and that is why the fund has not been able to turn things around," said this official requesting anonymity, since he is not authorized to talk to the media.

Kishor Kharat, chief executive and managing director at IDBI Bank, did not respond to a phone call on Wednesday morning.

To be sure, you could argue that IDBI Bank’s experience may not be relevant today as recovery mechanisms such as Debt Recovery Tribunals and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, have been strengthened. The recently passed Bankruptcy Code, which will come into effect over the next 12-18 months, may also help in the recovery of stressed assets a few years down the line.

Still, the experience of IDBI Bank will be a useful guide in how to better execute a bank-sponsored stressed asset fund should it be set up.

The need for a solution to stressed assets has become urgent due to the surge in bad loans on bank books after RBI conducted an asset quality review last year. As of March 2016, gross NPAs of 40 listed banks were at 5.82 trillion, up 93% from 3.02 trillion in the same period a year ago. Net NPAs stood at 3.39 trillion, more than double the 1.68 trillion a year ago.

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