Business News/ Opinion / Celebrate credit quality transparency initiatives

One of the less-noticed but remarkable aspects of the recent Financial Stability Report of the Reserve Bank of India (RBI) is the alacrity with which the central bank has seized upon the implications of banks selling large quantities of assets to asset reconstruction companies (ARCs).

The facts first. A loan selldown is perfectly legal: it is in fact governed by the SARFAESI Act, 2002. Securitisation of retail loans is one form of selldown that has been there for years. Corporate loan selldowns to ARCs in Asia too became commonplace after the Asian crisis of 1998. The main difference between the region and India is that in most other countries, ARCs were entities set up for a fixed time period to resolve bad assets and then wound up, whereas in India, they have been going concerns. And in India, unlike other countries, ARCs were set up as private, and not government-sponsored entities.

For many years, the selldowns were meagre, due to some well-publicised technical issues, as well as banks’ belief that they should either get a better price, or that they were better at resolving the asset themselves than the ARCs. But since they had their backs to the wall with stifling non-performing loans (NPLs) by last year, banks ended up selling four times more in 2013-14 than in 2012-13. With the bulk of these assets being sold against the issue of ‘security receipts’ to the selling bank itself and subject to the same old investment risks, RBI is justified in worrying whether it is true risk transfer or not, especially as the numbers are now large.

This caution is a fallout of the rampant mala fide restructuring that took place after a special dispensation was given in 2009, and continued thereafter with gusto after its withdrawal. It is strange why RBI chose to look the other way when even ordinary folks knew that restructuring was actively misused (one banker privately mentioned, with a tinge of indifference, that restructuring was “old NPLs"). Restructuring rules were tightened only when the situation became unbearable and signs of impropriety were all too evident to RBI. So, a perfectly legitimate facility became a fertile breeding ground for forbearance to influential borrowers. Clearly, RBI does not want a repeat of that fiasco with security receipts now.

The very fact that references for restructuring in the last few months have cooled off whereas asset sales to ARCs have ballooned itself should have raised eyebrows in RBI, as to whether one form of masking has given way to another, particularly since asset sale norms too have been eased recently. Déjà vu?

There is another concern that may not have been highlighted. Unlike even three years ago, ARCs, now 14 in number, have become extremely competitive; there are several instances of grabbing business at absurd prices. Whereas earlier, banks were cagey about selling for fear of having to take a loss on sale, for some recent transactions, ARCs have offered banks even more than the book value. At these levels of aggression with high chances of collaterals being overestimated, those ARCs may underperform on the resolution, consequently affecting the bank holding the security receipts.

Along the same lines, RBI’s move to force banks to detect stress early (and penalise if not done) has to be specially commended, though this too should have been done years ago. There is no reliable estimate of what fraction of bank loans fall under SMA2, i.e. borrowers who pay between 61 and 90 days and technically avoid being called non-performing, and banks are understandably tight-lipped about this (many have not bothered to record this properly before). But RBI should mandate banks to disclose that number on a quarterly basis. And then, some unpleasant truths will be out: experienced bankers will tell you that there is a large number of companies habitually addicted to the SMA2 status, that they dutifully pay only on the 89th day and some take pride for that as well. All of these need not be a mark of stress, but the disclosure is vital.

The central bank has, belatedly though, indirectly admitted that the past-due system of recognising NPLs is hopelessly outdated. It should be scrapped and replaced with a properly defined and regularly disclosed stressed assets. Stressed assets till 2009 were just NPLs as reported, then came restructured assets, and now, security receipts and SMA2. There are many other minor tricks that banks adopt to hide stress, but as of now, these four items should suffice.

The author has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.

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Updated: 02 Jul 2014, 12:36 AM IST
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