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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

How sound are the stressed asset ventures of banks?

RBI has no objections with banks setting up ARCs but bilateral deals are a strict no-no

There is some irony in the fact that banks, some of whom have a large chunk of bad loans on their own books, are now rushing to set up stressed asset ventures. We don’t really know what the thinking behind this is, but it would be reasonable to guess that they either see an opportunity in investing in stressed assets (which they partly helped create), or they think that they are best placed to resolve these stressed assets given adequate availability of capital and the correct structures.

Earlier this week, ICICI Bank Ltd announced that it has signed a memorandum of understanding with Apollo India Credit Opportunity Management Llc and AION Capital Management Ltd (which is an existing joint venture between ICICI Bank and Apollo, which invests in ‘special situations’). The idea is to possibly look at three different ventures as part of the partnership. The first of these will be an asset reconstruction company (ARC), the second would be a fund which can provide capital to stressed assets, and the third could be an entity which specialises in operating and managing stressed assets where banks have taken charge.

ICICI Bank intends to hold 30% in the ARC, it said. It is pertinent to mention here that ICICI Bank already holds 13% stake in the Asset Reconstruction Co. of India Ltd (ARCIL). It also holds about 10% in International Asset Reconstruction Co. Pvt. Ltd (IARC), according to the company’s website. It is not clear whether it intends to sell this stake to US-based private equity firm KKR, which is acquiring a majority stake in IARC.

Now ICICI Bank is looking to set up another ARC, where it will have a significant minority stake. The ARC will be run independently, said the bank. On 2 August, Mint reported that the ARC would start with investing in assets available on ICICI Bank’s balance sheet, citing a person with direct knowledge of the plans (http://bit.ly/2axcI5T). On the same day, Bloomberg News reported that the bank intends to sell four of its large loans to the ARC. Both reports said the ARC would also look to buy bad loans from other banks.

Are these plans kosher?

In response to an emailed query from Mint, the Reserve Bank of India (RBI) said that it has no objections with banks having a significant stake in ARC but cautioned that bilateral deals between the bank and the ARC are not allowed.

“The Reserve Bank has no objection in banks having a significant stake in securitisation companies/reconstruction companies (SCs/RCs). However, there are limits for equity investments in subsidiaries and financial services companies. The general restrictions on banks regarding investments also apply," said an RBI spokesperson.

“…in terms of extant guidelines of RBI, SCs/RCs are not permitted to acquire any non-performing financial asset from their sponsor banks on a bilateral basis, whatever may be the consideration. However, they may participate in auctions of NPA (non-performing assets) by their sponsor banks provided such an auction is conducted in a transparent manner, on arms-length basis, at prices determined by the market factors," the RBI added.

To be sure, ICICI Bank is not the first bank to sponsor an ARC. Phoenix ARC, which was registered with the RBI in June 2008, is an associate company of Kotak Mahindra Bank Ltd. ARCIL and IARC, too, were sponsored by banks but the shareholding pattern is diversified across different lenders. Along with ICICI, State Bank of India (SBI) has also ventured into the stressed asset business. SBI has announced a joint venture with Brookfield Asset Management Inc. to set up a stressed asset fund, the bank said last month. Brookfield has agreed to commit 7,000 crore, while SBI will invest up to 5% of the total investment made by the fund.

When asked whether the RBI restricts the investment a bank can make in a stressed asset fund, the regulator said that it has no such restrictions since credit and investment-related issues are largely deregulated. The regulator, however, had some advice for banks.

“Reserve Bank believes that banks may set up different funds for equity investment in stressed assets and for providing last-mile debt funding, respectively. While a stressed assets equity fund may invest in the equity of stressed borrowers and may take controlling stake either directly or through strategic debt restructuring, the stressed asset lending fund may provide last-mile funding or working capital funding to stressed assets. However, stressed assets equity funds are not allowed to be leveraged," said the RBI.

The final question is whether banks will be more successful in resolving stressed assets than existing ARCs and stressed funds?

One view is that the combination of deep-pocketed global stressed-asset specialists and domestic banks is the best possible combination. The banks will bring the local knowledge, while the funds will bring in capital and the expertise to restructure these accounts. But remember that the biggest problem in resolving stressed assets so far has been the fact that banks and promoters don’t want to take significant haircuts.

It’s tough to see that changing quickly, particularly since state-owned banks, who account for a bulk of the bad loans, continue to live in fear of undue scrutiny should they take any dramatic decisions. It is also important to remember that not all stressed assets are viable. As such, the track record in reviving these assets may remain chequered.

Ira Dugal is deputy managing editor, Mint.

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