Just when many started believing that the idea of a bad bank or an alternate vehicle to offload non-performing assets (NPAs) was stillborn and buried, it has resurfaced—and it is alive and kicking, with the Sunil Mehta panel set up by the finance ministry recommending setting up of an asset management company (AMC) for NPAs above Rs 5 billion, or Rs 500 crore.
The concept of moving stressed assets to a special purpose vehicle is not new to India. The Asian Development Bank had commissioned a study on the subject at the request of the central government when the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFAESI) was enacted in 2002. The report provided a comprehensive analysis of similar initiatives in other parts of the world. In terms of experience, the Stressed Assets Stabilisation Fund (SASF) was set up pursuant to a provision in the Union Budget of 2004-05, as a special purpose vehicle trust for acquiring stressed assets and NPAs of the erstwhile Industrial Development Bank of India (IDBI). The SASF has few success stories to share. The over-a-dozen asset reconstruction companies functional under SARFAESI also have no incredible turnaround tales to tell.
It is imperative that India carefully studies and learns from the experiences of other jurisdictions before taking the leap of faith. There is no empirical evidence that a public sector AMC is an effective or sustainable solution for tackling the problem of NPAs. Some lessons can be learnt from the experience of countries in the East Asia region. The Asian financial crisis created a mass of stressed assets in countries such as Indonesia, South Korea, Malaysia and Thailand. All the four countries established a publicly-owned AMC—including the Indonesian Bank Restructuring Agency (IBRA) in Indonesia; Korea Asset Management Corporation (KAMCO) in South Korea; Danaharta in Malaysia; and the Thai Asset Management Company in Thailand. There are other examples from around the world. The Czech Republic established the Ceska Konsolidacja Agentura after the start of the corporate sector crisis in 2000. Turkey also set up an AMC after the crisis. Mexico’s FOBAPROA (Bank Savings Protection Fund) was established in 1995 and was funded fully by the Mexican Central Bank. There are some examples also available from Sweden.
The mandate of most AMCs was largely to support the banking system. The format was a mixture of bank recapitalisation, asset disposal and restructuring tasks. The intention was to minimise the direct role of the government in the restructuring of individual corporations and improve the likelihood of sustainable financial and operational restructuring. In practice, however, asset disposition was slow in most cases due to weak insolvency regimes, difficulty in valuing assets, thin markets for selling assets, fears of selling too cheaply, and social and political pressures.
Mexico’s FOBAPROA, for example, bought the subordinated debt of under-capitalised banks to restore their capital adequacy. In exchange, it acquired a claim on the possible recovery of non-performing loans, but the responsibility for recovering the loans remained with the bank. FOBAPROA undertook very little restructuring. The Czech experience was also not a great success. None of the above is a model worthy of replicating in India.
Were the Indian government to go ahead and set up a bad bank or an AMC, its policy and legal framework, architecture and design, and implementation will have to be carefully decided. While remaining public in character, the new body should be able to collaborate with the private sector, including the turnaround experts. The acquisition of stressed assets should be based on established market-based principles, including on valuation. If the bad bank/AMC acquires assets at book value and sells them at a discount, it would be a colossal waste of taxpayers’ money. The success of the proposed body would be in acquiring assets at an attractive discount, turning them around significantly over a period of 3-5 years, and offloading at a premium. While tax incentives and other immunities may be provided, the bad bank/AMC should be driven by competitive, market-based rules and principles. There should be formidable incentives for the management to perform and unflinching accountability on the failure to deliver. Transparency, no red tape and speed should be of essence for any form of bad bank.
The government should bear in mind that when the Asian financial crisis erupted, the insolvency law in most Asian countries was in shambles. Establishing the asset reconstruction institutions was not a choice but a necessity for most jurisdictions. The same was the case in Mexico, Turkey, Czech Republic and many other countries.
The turnaround of stressed assets by an AMC, public or private, needs an efficient insolvency law, infrastructure of top-quality restructuring professionals and other experts, a well-developed insolvency industry, and a market for stressed assets.
The conditions in India are favourable in this respect. An efficient insolvency law in the form of the world-class rescue-oriented Insolvency and Bankruptcy Code (IBC) has been enacted and is operational since December 2016. Indian banks are putting the IBC to effective use to resolve NPAs. The green shoots are starting to emerge, and it might be worthwhile to wait for 2-3 years to see the results. Even a bad bank will have to rely heavily on the IBC to turn around assets. The emphasis, therefore, should be on sustaining the impressive momentum that the IBC has gathered following the unprecedented implementation strategy put in place. In addition, the informal restructuring framework should be strengthened. Efforts are needed to develop the market for stressed assets. Many stressed assets investors are sitting on the fence, waiting for the outcome of big cases currently under the IBC, before they take the leap of faith.
The crux of the matter is that AMC or no AMC, the buck, aka stressed assets, will stop with the IBC. The central government, therefore, should stay focused on the IBC.