No bad bank yet: Govt plans reforms in asset recast space

The government first wants to ensure that structural reforms are initiated in the asset reconstruction space to boost the performance of existing companies.

The government is unlikely to endorse, just yet, the proposal by Indian Banks’ Association for setting up a bad bank to tackle a potential spike in non-performing assets (NPAs) in the wake of the Covid-19 crisis. Instead, it first wants to ensure that structural reforms are initiated in the asset reconstruction space to boost the performance of existing companies.

“There isn’t much to gain by adding a sort of public-sector asset reconstruction company (ARC) to the dozens that already exist. The more important issue is to see what ails them and what can be done to improve the efficiency of the whole ARC eco-system. That’ s what the government is more interested in — structural reforms. Otherwise, the bad bank, even if it is set up, will also suffer from the systemic issues,” a source told FE.

Separately, chief economic advisor Krishnamurthy V Subramanian recently told FE that several “important considerations need to be kept in mind” while assessing the desirability of a bad bank.

In its proposal submitted with both the finance ministry and the Reserve Bank of India (RBI), the IBA has suggested that the government offer Rs 10,000-crore capital initially for the setting up of the bad bank. It proposes an ARC, along with an asset management company and an alternate investment fund to cover the entire gamut of resolving the bad loan issues. The ARC, it proposes, will be owned by the government, a senior banker said. The AMC will be run by professionals from both the public and private sectors, while the AIF will be aimed at creating a secondary market for security receipts. Lenders would want to park around Rs 70,000-80,000 crore with the proposed bad bank, he added.

The debate about a bad bank has gathered pace since it was mooted in the Economic Survey for 2016-17 by then chief economic advisor Arvind Subramanian, albeit with a different structure.

Since the seeding of the first ARC in 2003, the country now has 29 of them. Assets under management of these ARCs, which typically buy bad loans from banks and make money by recovering them, crossed the Rs 1-lakh-crore mark for the first time as of March 19, up 7% from a year earlier, according a Crisil estimate. In a report late last year, the agency projected an 8-10% compounded annual growth rate in the AUM until March 2021. Still, they make up for only a fraction of the gross bad assets (Rs 9.35 lakh crore as of September 2019) in the banking system, which is only going to spike due to the pandemic.

While several large funds like Blackstone, Bain Capital, SSG and Lone Star have set up ARCs to take advantage of the growing promise of the Indian market, especially after the enactment of the Bankruptcy Code and approval for 100% FDI in ARCs via automatic route in recent years, the segment hasn’t yet grown as it should. The problem is that ARCs have found it difficult to recover much from the debtors, so they have only been able to offer low prices to banks–prices that banks have found difficult to accept.

ARCs have long been cribbing about the RBI norms, which require them to invest a minimum of 15% in the so-called security receipts (SRs) or pass-through certificates that are issued against such stressed assets. This upfront investment was just 5% before 2014 before the regulator decided to increase their skin in the game. This 15:85 norm also poses other complications, such as disagreements between bankers and ARCs over valuations, because the larger the value, the higher the upfront payment they have to make.

Last year, the finance ministry had asked public-sector banks (PSBs) to submit details of their sales of stressed assets to ARCs between FY12 and FY18 to scan for potential irregularities. According to bankers, the move came amid suspicion that some bad assets were sold to ARCs below market value due to collusion of bankers and promoters of the stressed firms.

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.

The 2016-17 survey had made a case for a centralised Public-sector Asset Rehabilitation Agency (PARA) that would purchase stressed loans (especially the largest and most difficult ones) from banks and then work them out, either by converting debt to equity and selling the stakes in auctions or by granting debt reduction, depending on professional assessments. Arvind Subramanian had then said: “There has to be serious political cover (for PARA) if you’re writing off 50-70% of debt.” Outlining the possible architecture of PARA, he had said it could be 49% government-owned (to give it the operational freedom it needs); there could be another 10-11% LIC-type of holding to give it the government character and the rest could be private.