The Hindu Business Line : Good business from bad loans?

With recent RBI regulations paving the way for the sale of bad loans, banks seem set to offload their heavy burden of NPAs, and make some hot cash in the process.

THE much-maligned non-performing assets (NPAs) of Indian banks are poised for a major makeover with the RBI paving the way for the sale of bad loans between banking and non-banking financial institutions.

The barter of NPAs for securities was already being done, albeit in a limited fashion, via the euphemistically named Asset Reconstruction Company (India) Limited (ARCIL). Now the gates have been thrown open for banks, non-banking financial corporations (NBFCs) and other financial institutions to create a thriving secondary market for bad loans.

Some NBFCs, especially multinationals, have already started hovering around and swooping in on Indian banks, looking to relieve them of their NPAs. These developments rasie several questions:

Why do some banks, especially those in the public sector, appear all-too-eager to offload their bad loans?

How do asset reconstruction companies such as ARCIL fare vis-à-vis other financial institutions entering the bad loans business?

Since no "for-profit" organisation would acquire a portfolio of bad loans unless it fetches good returns, what draws the NBFCs, especially multinationals, to bad loans, somewhat like vultures to cadavers?

How do these buyers of bad loans expect to extract their pound of flesh?

What is it that these institutions can do which the original creditor bank could not, that they are hopeful of salvaging value out of such assets?

Meeting NPA targets and circumventing a protracted, pothole-ridden legal resolution process for debt recovery are only a few reasons for banks to dust NPAs off their books by taking recourse to ARCIL or NBFCs. There are other reasons as well:

The adoption of the Basel II framework by the RBI requires banks to provide for more capital to cover the cost of defaulted loans. Banks can immediately lower their regulatory capital requirement by jettisoning such non-performing loans from their portfolios.

Most NPAs stem from large-scale commercial borrowings rather than such retail borrowings as home-loans or farm-loans. Some of them are of a vintage nature, hangovers from the erstwhile socialist regime, where debt rather than equity was the primary mode of raising capital for an industry starved of venture capital and as yet lacking a risk-taking stock market philosophy.

The banks that shouldered the cost of development in such an economic environment can now shake themselves free of some deadweight and use the proceeds to offset some of their costs.

Anecdotal evidence suggests that a sizeable share of NPAs originates from people with political clout, including business families, celebrities and cricketers who siphon off funds borrowed via a complex web of corporations. In such instances it is an innate lack of willingness to pay rather than an inability to pay that leads to NPAs.

While we have seen the many facets of debt collection on retail consumer products such as credit cards and car loans, commercial loan recovery has been an elusive proposition for a while. Public sector banks were more or less paralysed by low empowerment levels, the glacial pace of our legal processes and political intervention.

Even today, horror stories abound where officers initiating action on wilful defaulters are exiled overnight on transfer to a god-forsaken location, scuttling the recovery process at the very outset. Thus public sector banks stand to gain in many ways from the creation of a market for bad loans.

However, a part of those gains will likely be at the expense of the unfortunate entrepreneurs of the socialistic era whose ventures did not pan out as expected.

While it is not easy to conclude that the creation of a secondary market for commercial loans is an unmixed blessing for India, such a course of action is perhaps understandable, if not inevitable.

By selling off NPAs to NBFCs, banks can not only wipe their slate clean of bad loans and cut their credit risk exposure, but also get hot cash in return for them.

Thus the new RBI regulations present a far more attractive proposition to banks compared to what is on offer from asset reconstruction companies, such as ARCIL, which issue security receipts with incomes subject to uncertainty and spread over a long period.

The buyers of bad loans, on their part, are eager to enter the business because it holds the promise of rich rewards in return for the risk of investing in loans given up by creditors that come labelled non-performing' from the word go.

For starters, the buyers will pay as price only a fraction of the face value of the loans they purchase. They will aggregate assets so acquired from different banks and assemble a portfolio that will comprise a wide spectrum of NPAs of differing qualities, from low-hanging fruits for easy plucking to hard nuts that defy cracking.

They will then actively pursue options for making recoveries through restructuring or liquidation. Although they may not be successful in every instance, their bet is that at they will manage enough returns on the portfolio as a whole to recoup their costs and make a tidy profit in course of time.

While ARCIL can create a niche for itself by consolidating multiple and conflicting claims on the same debtor and streamlining the recovery process, multinationals enter the market with their own advantages.

Multinationals are in a better position than public sector banks in turning around bad debts, not just because they are more resilient to power-play and political pressure but also because they can draw on their expertise and experience from other parts of the world.

Commercial loan rehabilitation is a mature industry in countries like the US where lenders employ specialist "loan workout officers" for transforming non-performing multi-million dollar loans into productive assets by negotiating with borrowers.

Being a loan workout officer is a highly remunerative profession for which courses and training programmes are conducted.

Students of that peerless chronicler of contemporary America, Tom Wolfe, would remember his modern epic, A Man in Full, which immortalised such "workout artistes" through Harry Zales, whose stock-in-trade is the art of deflating the ever-ballooning egos of big and mighty defaulters, like the protagonist Charlie Crocker, and making them eat out of his hands.

Given that the bad loans business in India is of the order of thousands of crores of rupees, it may not be outlandish to expect multinational NBFCs to emulate our airlines importing CEOs and bring in expatriate workout officers from abroad to work on their portfolio acquisitions here.

If and when that happens, India's Charlie Crockers can look forward to something like a blind date with their comeuppance.

(The author, an alumnus of IIT Madras and Massachusetts Institute of Technology, is a risk-management specialist and can be reached at niranjan.krishnan@gmail.com)

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