The Hindu Business Line : ARCs: Answer to bank NPAs?

The most important long-term measure in containing the growth of NPAs is radically altering the bankruptcy and recovery laws and procedures. Setting up asset reconstruction companies will mean precious little given the state of bankruptcy and recovery procedures in India. The legal framework is critically linked to the success of ARCs.

THE setting up of asset reconstruction companies (ARCs) is finally set to become a reality, providing banks and financial institutions another weapon to tackle the problem of non-performing assets (NPAs).

It has been reported that the Government plans to rope in the private sector and multilateral agencies to contribute to the capital of the first ARC to be set up early this year. The Government feels that private participation in the ARC would go a long way in making it an efficient tool in tackling NPAs and sustaining the viability of the proposed entity.

Since the banking sector reforms were set in motion in 1991, the Reserve Bank of India and the Government have been harping on the idea of setting up of a special agency to assist banks in cleaning up sticky assets at a discount. The first Narasimham Committee (1991) suggested that Asset Reconstruction Funds buy out troubled loans from banks and make special efforts at recovering value from the assets, if necessary by special legislation, with special powers for recovery.

The implementation of the ARF concept remained mired in conceptual confusion and put into the freezer for years, until it was revived when the second Narasimham Committee report in 1998 recommended the transfer of NPAs to an ARC.

The committee suggested that the ARC could be set up by one bank or a set of banks or even in the private sector. The private sector part was not highlighted and got lost among other recommendations. The committee suggested that the private ARCs be enabled to file suits in debt recovery tribunals (DRTs) and be treated as a venture capital fund and given tax incentives.

The Verma Committee report (1999) on restructuring of weak banks also mooted the idea of setting up ARCs to divest the bad loan portfolio — essential for a comprehensive restructuring strategy of weak banks. The committee considered this an acceptable solution to the problem of the accumulated NPAs and strain on the profitability of weak banks.

With gross NPAs of the banking system touching Rs 63,883 crore, the Government has been left with no option but to provide banks more avenues to clean up their balance-sheets. The use of a special vehicle such as asset reconstruction funds or asset management companies is a common practice worldwide to relieve banks of the bad debts in their books and relieve them from chasing recovery and collections.

Whatever the structure of the proposed ARCs, only the core NPAs of banks over a certain size will be taken over in exchange of NPA swap bonds representing the realisable value of the assets transferred. It is envisaged that the Government will guarantee these bonds. This arrangement will be benefit the banks as they will hold interest-bearing marketable bonds in their balance-sheets instead of making provisions for NPAs which affects the profitability of banks calling for re-capitalisation with the taxpayer's money in the case of public sector banks.

Earlier the RBI had suggested that ARCs would not be allowed to nibble at the fresh NPAs added by banks on an ongoing basis, but be restricted to past NPAs. The RBI had also suggested a maximum life span of seven years for the ARCs. Whether the ARCs will be of fixed tenure has yet to be resolved. A fixed tenure will force the ARCs to be more selective in their approach to loan resolution and recovery.

There are fears that the ARC will only prove to be a short-term measure and not solve the NPA problem. The IBA Chairman has said that it would not benefit banks as delinquent assets would be transferred from one institution to another.

As the ARCs will have only one responsibility, and that is to realise assets, there may accrue some benefits in terms of the specialisation of such institutions. They would not only be responsible for giving loans, but also recovering them.

An important issue that may crop up here is the issue of pricing, or fixing a realisable value on the assets. As a book value transfer will result in huge losses to the ARCs, transferring the assets at a discount at realisable market prices will aggravate problems related to fixing a market price.

The realisable value of the NPAs should be a fair discounted value arrived at through consensus between the valuers acting on behalf of the banks and the ARCs in a transparent manner. For loans that have been NPAs for several years, especially working capital loans, without collateral worth recovering, the realisable value of the assets will be practically negligible.

Subject to RBI stipulations on minimum net worth, it should be possible to set up more than one ARC in the private sector. The scope for conciliation and negotiation to settle the realisable value of NPAs would be better in private sector ARCs. Private sector ARCs can be selected by banks on the basis of competitive bidding if more than one ARC is interested, otherwise the bank management should be free to negotiate a suitable value for the assets and terms of the bonds to be issued by the ARCs. The most important long-term measure in containing the growth of NPAs is radically altering the bankruptcy and recovery laws and procedures. Setting up ARCs will mean precious little given the state of bankruptcy and recovery procedures in India. The legal framework is critically linked to the success of ARCs. Only time will tell whether the ARCs will be able to take up the recovery aspect seriously as they will be burdened with too many accounts and hampered by the vastness of the geography.

A lasting solution to the problem of bank NPAs can be achieved only with proper credit assessment and risk management mechanisms, avoiding adverse selection and not compromising on asset quality.

(The author is Manager, Corporate Finance Department, Federal

Bank, Aluva.)

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