Home / Politics / Policy /  RBI’s attempt to strengthen role of ARCs foundering

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan’s attempt to get asset reconstruction companies (ARCs) to play a larger role in managing stressed assets at banks seems to be foundering amid differences over pricing and perceived opacity in the process of bad loan disposals.

In the April-September period, banks sold only 6,000 crore of stressed assets—just about 10% of the total up for grabs, according to two senior officials from the asset reconstruction industry who spoke on condition of anonymity.

This is far lower than the 15,000 crore worth of assets that these companies, which typically buy bad loans at a discount and enable banks to take them off their books, purchased in the April-September period last year.

About 1,500 crore worth of the assets were sold through bilateral deals between a bank and a single ARC and not through the commonly used auction process, one of the two persons quoted above said. Both spoke on condition of anonymity.

Bad loans have piled up at India’s banks in recent years in the face of an economic downturn, stalled government approvals and delays in land acquisition that stalled industrial projects and crimped corporate cash flows, making it difficult for borrowers to repay debt.

At 39 listed banks, gross non-performing assets amounted to 3.21 trillion at the end of June, up 27.69% from 2.51 trillion a year earlier.

Releasing its new stressed assets resolution framework in 2014, RBI said ARCs should be “construed as a supportive system for stressed asset management".

The idea was to make sure these firms are well-capitalized and brought into the restructuring process at an early stage so they can help revive assets. To ensure that bad assets are not simply parked with ARCs, RBI increased the upfront payment needed to buy assets to 15% of net asset value from 5% earlier.

While that was one factor that slowed the sale of bad assets, the reluctance of banks to accept a so-called haircut—a discount on the face value of stressed loans—has been another. And the bidding process being followed by banks at bad-loan auctions has become increasingly opaque, according to officials in the asset reconstruction industry.

One example of this is the practice of banks announcing their reserve price for assets only minutes before the start of bidding.

According to the two officials quoted above, this prevents ARCs from taking a view on whether they want to bid for the assets or not.

“We spend anything between two to three weeks behind an asset during the due diligence process. The idea behind informing us about the reserve price in advance was to ensure that we do not waste time studying an asset where we won’t be interested in bidding in the first place," said the first person, who is the chief executive officer of a leading ARC.

The last-minute announcement of the reserve price means very few bids are placed at most auctions and many have failed.

“Banks have to be realistic in these auctions. These are bad assets, not Picasso art," the first person said.

But bankers defend the practice.

“If the reserve price is announced beforehand, a number of ARCs may not participate in the bidding in the process. If it receives only one bid, it can’t be accepted, as vigilance departments may then raise a concern," said a senior public sector banker on the condition of anonymity.

To be sure, not all banks are equally opaque and larger banks follow more transparent processes, said the first ARC official.

Apart from the process, both ARC officials cited the high reserve price set by banks as the key reason behind the decline in asset sales.

To this complaint, bankers say that they have to try and ensure they get the most out of an asset.

“It is easy to blame banks in such cases, but the truth is that the level of returns through the ARC route has historically not been very high. We have to ensure that we get maximum returns when we sign a sale agreement. As far as banks are concerned, the pricing is reasonable," said the senior official at a public sector bank.

Under RBI norms issued in August 2014, ARCs pay up to 15% of the net asset value in cash and the remaining in security receipts, which are redeemed over a period of time as recoveries from the asset pick up. However, the ARCs don’t have a great track record on this. According to an August 2014 report by Crisil Ltd, the redemption ratio of securities receipts for the entire ARC industry has been just about 53% over the past 10 years.

The high reserve prices have pushed up the acquisition costs for ARCs.

According to data available with RBI, the acquisition cost for ARCs as a percentage of the book value of assets increased sharply to 44.5% as of March 2015 from 20.8% as of March 2013.

In other words, the discount at which reconstruction companies acquired non-performing assets (NPAs) from banks and financial institutions has decreased considerably.

“It would be favourable for banks if they conclude sales at realistic market prices as their recoveries will be better in the medium term, as in most cases banks continue to hold a majority residual stake in these assets in the form of security receipts," said Nikhil Shah, managing director, Alvarez & Marsal (India), a company that specializes in corporate turnarounds.

“On the ARC side, performance on driving turnarounds and security receipt redemptions needs to improve so that banks see the rationale of selling to them. Overall, both these industries need to work together if there is an improvement expected in the stressed asset situation," Shah said.

In a speech on 15 September, RBI deputy governor R. Gandhi noted that while selling bad loans to ARCs, banks need to be more transparent through timely disclosure of the reserve price and by specifying clauses for rejection of bids.

The deputy governor also pointed out that if any bid is higher than the reserve price and the ARC fulfils all necessary conditions, a sale would be mandatory.

Before this, Rajan pointed out that for effective management of stressed loans, participation of all major stakeholders, including ARCs, would be key.

Over the course of last two years, the banking regulator has been easing conditions around bad loan sales, making it more conducive for banks to sell. Announcing the framework for revitalizing bad assets in February 2014, RBI said that all losses made by banks on bad loan sales up to March 2015 could be spread over two years till March 2017. In May 2015, the regulator extended this provision to March 2016.

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