The government, the Reserve Bank of India and the banks seem to be completely at a loss for ideas to handle the ₹8 lakh-crore of non-performing assets of banks.
This is evident from the decision to set up a new committee which will go into the possibility of creating an Asset Reconstruction Company and/or Asset Management Company for faster resolution of assets that have multiple banks involved.
Before venturing another separate ARC, it is important to evaluate the performance of existing ones.
The Narasimham Committee Report (1998) mentioned that an important aspect of the continuing reform process was to reduce the high level of NPAs. At that time it was (wrongly) expected that with a combination of policy and institutional development, NPAs in the future would be lower.
However, to reduce the huge backlog of NPAs, the Report suggested to create an Asset Recovery Fund to take the NPAs off the lenders’ books at a discount.
ARCIL was the first ARC set up by ICICI Bank, State Bank of India and IDBI. There are 24 ARCs now and Edelweiss is the largest one.
ARC is a company registered under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. The RBI regulates ARCs as Non Banking Financial Companies.
The mandate of ARCs
ARCs have been set up to provide a focused approach to non-performing loans resolution issue by:
(a) Isolating non-performing loans from the financial system,
(b) Freeing the financial system to focus on its core activities and
(c) Facilitating the development of a market for distressed assets.
To what extent has the main activity of ARCs been achieved? And what are the hurdles in achieving the goal?
Under the SARFAESI Act, a bank puts up stressed assets for auction after applying a haircut but with a reserve price and sells them to the highest bidding ARC.
ARCs acquire these assets by paying in cash or by issuing security receipts or ‘hope notes’ whose redemption is contingent on the recoveries made. Security receipts (SRs) are backed by impaired assets. Hence there is no definite cash flow.
An ARC considers a number of different routes to maximise realisation from the assets, including liquidation/settlement/restructuring or rehabilitation and turnaround to ensure payment from the improved operating cash flows of the company. Proceeds, if any, are distributed according to the shareholding of the SRs. As an intermediary recovering dues on behalf of SR holders, ARCs charge a management fee.
Capitalisation, the key
ARC’s operations can be fruitful only if they are adequately capitalised to meet the requirement of banks to transfer NPAs and also to turn around of the NPA accounts transferred from banks. Payment to SR holders is also a factor for funds generation.
ARCs issued SRs of ₹20,410 crore in 2014 and ₹22,440 crore in 2015. But redemption of SRs was only a fraction at ₹1,190 crore in 2014 and ₹1,650 crore in 2015.
It is disturbing to read the Finance Minister’s statement that funding from the National Investment and Infrastructure Fund could be one of the possibilities as this fund is for infrastructure development and not for NPA resolution.
There is also a fundamental flaw in transferring NPAs to ARCs. A mere transfer of NPA from one entity to another does not enable recovery. The transfer is just cosmetic without actual recovery and it is simply a transfer of the problem from one entity to another. At the time of transfer there is a haircut (around 40 per cent), which affects the bottomline of banks as the writing down a part is not recovery.
ARCs have the same rights to recourse as banks do, but they do not have any magic wand for recovery. In fact the financing bank will have more comfort while dealing with the borrower, as it has handled the borrower right from the time of the appraisal. ARCs do not have any special skill or judicial means to recover the money.
The only advantage with them will be that they buy the written down value and hence the recoverable NPA will be less.
NPA is not like a communicable disease that needs isolation and treatment.
The policy makers must attempt a meaningful resolution of this problem including stringent action on the defaulters and judicial reform instead of preaching banks to soft pedal with borrowers or to transfer the problem to another entity. Otherwise it is simply scratching the surface.
The writer is a retired banker