Bad debt: Budget set to remodel ARCs – The Financial Express

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Earlier this fiscal, chief economic adviser Krishnamurthy V Subramanian had told FE that several “important considerations need to be kept in mind” while assessing the desirability of a bad bank.

Union Budget 2021-22 Expectations for bad bank: While the government has kept alive the option of setting up a state-backed bad bank despite initial reluctance, it is learnt to be in talks with the central bank over a raft of proposals – including further recapitalisation of state-run lenders and reforms in the asset reconstruction space – to bolster the ecosystem of bad debt resolution. The proposals may find place in finance minister Nirmala Sitharaman’s Budget speech on February 1.

The Budget proposal for capital infusion into public-sector banks (PSBs) in the next fiscal is still being worked out but the amount could be at least the same as in FY21 (Rs 20,000 crore), a source told FE. While PSBs have stepped up efforts to raise capital from the market, they will still require government support, the source added. At the same time, the privatisation of a few small and sick PSBs is being vigorously explored.

As prospects of a Covid-induced spike in defaults loom large, both the finance ministry and the Reserve Bank of India (RBI) believe PSBs need to remain adequately capitalised next fiscal to be able to absorb the bad loan shock and boost lending to spur economic activities, the source said.

Similarly, while the government has started weighing the idea of a bad bank, supposed to be modelled after an asset reconstruction company (ARC), though with a difference, it may impress on RBI to address certain irritants in this space, including the so-called 15:85 norm. The idea is to enable even existing ARCs to better contribute towards NPA resolution, another source said.

Under this rule, ARCs – which typically buy bad loans from banks and make money by recovering them – are required to invest a minimum of 15% in the so-called security receipts (SRs) or pass-through certificates that are issued against the stressed assets.

This upfront investment for ARCs was just 5% before 2014 before the regulator decided to increase their skin in the game. This norm also poses other complications, such as disagreements with bankers over valuations, because the larger the value of the stressed assets, the higher the upfront payment they have to make.

In December 2019, the regulator tightened the rules further, stipulating that ARCs cannot acquire financial assets from a bank or financial institution, which is the sponsor of the ARC, on a bilateral basis.

While several large funds like Blackstone, Bain Capital, SSG and Lone Star have set up ARCs, especially after the enactment of the insolvency law and approval for 100% FDI in ARCs via the automatic route, the segment hasn’t yet grown as it should and still accounts for a fraction of the total bad loans. Growth in assets under management of the ARCs slowed to just 7% in 2019 to $14.6 billion from 25% in the previous year, according to a Crisil estimate.

The problem is that ARCs have found it difficult to recover much from the toxic assets, so they have only been able to offer low prices to banks, which banks have found difficult to accept. Bankers, too, have remained wary of selling to ARCs for possible investigations later over their decisions on haircuts.

According to a latest RBI report, the acquisition cost of ARCs as a proportion to the book value of assets declined to less than 36% as of March 2020 from about 38% a year before, suggesting lower realisable value of the assets. Banks’ sale of assets to ARCs also dropped.

The Indian Banks Association (IBA) had in May last year submitted a proposal for setting up a bad bank with the finance ministry and RBI, recommending equity infusion from the government and the banks. However, the government wasn’t very keen on just adding to the 29 existing ARCs, without being convinced that any such move will actually bear the intended result.

Earlier this fiscal, chief economic adviser Krishnamurthy V Subramanian had told FE that several “important considerations need to be kept in mind” while assessing the desirability of a bad bank.

While the government explores several options, it also expects that a fair amount of stress can be resolved through a “pre-pack” insolvency scheme, a draft proposal of which is now floated, and the usual bankruptcy process once the suspension of insolvency proceedings against Covid-related defaults is lifted from March 25.

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