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Wednesday, Aug 21, 2002

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Money & Banking - Non-Performing Assets

Will ARCs fare any better?

S. Murlidharan

The creation of Asset Reconstruction Companies would not ensure that the festering problem of NPAs is better addressed. In fact, empowering institutions to recover their dues without the aid of the courts would be enough. The concomitant move to create ARCs would weaken the resolve of the institutions in reading the riot act to the defaulters.

THOUGH a mouthful, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Bill, 2002 (the security law) accurately sets out three principal aims of the intended law:

  • To enable banks and financial institutions with NPAs to sell the assets of the defaulting borrowers without the sanction of the courts as hitherto and to enable banks and financial institutions assume the management of the defaulting borrower by displacing the existing management;

  • To enable harried and unharried banks and financial institutions, whether nursing NPAs or not, to unload the receivables due from the borrowers in favour of specialists in recovery, popularly known as Asset Reconstruction Companies (ARCs); and

  • To enable banks and financial institutions recycle their funds better by resorting to the process of securitisation.

    The first move would make life easier for banks and financial institutions that have had to bear the cross of the inefficiencies and misfortunes of their borrowers.

    In the cosy regime enshrined in a law called Sick Industrial Companies (Special Provisions) Act, 1985, that obtained for industrial company borrowers, there was a perverse premium on inefficiency and defaults much to the chagrin of banks and financial institutions. Now, in the wake of the security law, they can either encash their securities without court approval by selling them, or take over the management of the defaulting enterprises. This is as it should be. An institution that has taken care of the true quality of the assets offered as security can indeed read out the riot act to the defaulting borrower. In such a regime, where indiscipline and diversion of funds are the norm, borrowers will not thumb their noses at their lenders.

    However, what one is bound to be sceptical about are the two other features of the security law — setting up of ARCs to facilitate debt recovery and securitisation. Will the ARCs achieve what the financial institutions themselves could not? An ARC is supposed to take over the debts together with the security of defaulting borrowers at concession and either recover the full amount, or a greater amount than what it paid, from the defaulting borrowers or sell the security for a higher price than what it paid for the related debt and thus make a tidy profit. In their salad days and even later, ARCs can put the denouement off because they do not have to pay up upfront but can issue debentures instead. What use are bonds when the hapless institutions are looking for cash. The trick is similar to how oil companies were fobbed off with bonds when they demanded their dues from the Oil Pool Account. But then, in fairness to the securities law, it must be conceded that the institutions have been given the right to settle for nothing save upfront payment.

    Be that as it may, but more fundamentally, what explains this touching faith in ARCs? How can they achieve something, which could not be achieved by the institutions themselves? The weak alibi trotted out is that the ARCs are specialists which focus on the activity of recovery and thus develop core competence in this esoteric trade. However, there is no reason why this competence cannot be developed in-house. After all, each institution has an elaborate debt-recovery department. It seems the creation of an ARC would only be a cosmetic, and not a seminal, change.

    The contagion of industrial sickness first spread itself to financial institutions. Now, the creation of the ARCs would perhaps result in transfer, if not the spread, of sickness further down — to these companies. What one apprehends is that in trying to clean up the balance-sheets of banks and financial institutions, a lot of muck may stick to the ARCs. The buck must stop with the institutions that have the wherewithal to do the job themselves. At any rate, resorting to ARCs would mean expensive outsourcing.

    Thus, the creation of ARCs would not ensure that the festering problem of NPAs is better addressed. In fact, empowering the institutions to recover their dues without the aid of the courts would be enough. The concomitant move to create ARCs would weaken the resolve of the institutions in reading the riot act to the defaulters. Besides, the mere presence of the ARCs would embolden borrowers to go slow on repayments, secure in the knowledge that they can ultimately work out a scheme that is to the mutual advantage of the borrower and the ARC but detrimental to the institution that initially forked out the funds.

    The advice proffered by high-profile American consulting outfits to constitute ARCs is of a piece with the advice given to housing finance companies, among others, to constitute SPVs (special purpose vehicles) to recycle their funds more efficiently. A housing finance company, one is told, would be better advised to take the bulk of its long-term loans off its balance-sheet through what is known as securitisation. Typically, under the securitisation mechanism, the housing loans, which are invariably secured and beget a steady stream of payments, are sold to an SPV for a discount. The housing finance company thus unlocks its illiquid funds and is able get the funds it would have got only in the distant future. The SPV mobilises funds for the purpose by issuing debentures to the public on the strength of the security of high-quality mortgages. The exercise, therefore, is tom-tommed as win-win for all.

    Impressive? This again brings into the question the America's morbid fascination with SPVs. Can not the housing finance company itself raise loans directly on the strength of its balance-sheet? Can not the high quality mortgages instead of being assigned to an SPV be used internally to raise more loans to recycle the funds? In other words, illiquid funds can be unlocked even internally. The only plausible advantage of this mechanism is that with assets pruned to manageable levels, the pressure on the housing finance company to meet the capital adequacy norms would be lower. But this is passing the buck. What is not required to be done by the housing finance company will now have to be done by the SPV, which will have to fulfil the capital adequacy norms.

    Once again in fairness to the security law it must be conceded that securitisation is not mandatory. But given the Indian proclivity to take American prescriptions as holy writ, one fears that the enabling regime would give a leg-up to this inane process.

    (The author is a New Delhi-based chartered accountant.)

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