Skewed approach to bad debt

There is growing concern over stressed assets in the banking system. Public sector banks have been affected most. According to an ICRA report, the gross non-performing assets (NPAs) and 30 per cent of standard restructured advances in the banking system stood at ₹3.5 to ₹3.7 lakh crore at the end of June 2014.

It is now reported that the stressed assets — comprising both bad (so-called NPAs) and those hovering on the border of becoming NPAs, according to the income recognition, asset classification and provisioning norms of the Reserve Bank of India (RBI) — could be around 14 per cent of banking credit. Such stressed assets (including NPAs) could be anywhere around ₹8 lakh crore.

Capital adequacy norms In view of Basel III, the need to adhere to capital adequacy norms would pose a huge challenge to the banking sector, which is plagued by unabated growth of stressed assets. The Government does not have ₹3 lakh crore to pump in by 2019 to meet this challenge.

This might just not cause balance sheet problems for the banks, but could be demanding for the bank managements, diverting their energy and focus away from their core business.

The Government had set up a specialist committee on banking sector reforms in 2001. The Narasimham Committee recommended setting up an asset reconstruction fund (ARF) and asset reconstruction companies (ARCs) to specifically address the issue of NPAs. The Sarfaesi Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act) is an offshoot of the same, under which ARCs have come into existence.

In the last decade, about 14 ARCs have been set up. There has been a steady growth in acquiring bad assets from the banks. By June 2014, it had grown fourfold. This signifies the pace of growth of NPAs, and the expediency with which banks have begun cleaning up their balance sheets.

The new order Let’s examine the ability and efficacy of ARCs to address the resolution of NPAs. The reconstruction according to the Sarfaesi Act (Section 9) constitutes: (i) management of the asset after take-over by changing or instituting a new team and (ii) providing a longer repayment period for recovery of the underlying debt, among others. It does not specifically talk about ‘sustaining the value’ of the asset or its ‘turnaround’, in due course.

A careful reading of the Act’s provisions reveal that the objective is akin to ‘holder in due course till the recovery’ and not ‘reconstruction’.

The objective of sustaining or improving the value of the acquired asset does not depend upon merely changing the management or extending the debt repayment tenure. The operational ability of the asset needs to be preserved, and then improved. That’s possible only when needed financial support in terms of operational funds and working capital are provided to the company, whose debt is acquired by the ARCs.

Just changing the management and extending the debt repayment tenure would only depreciate the assets over a period of time. This has no meaning and defeats the very purpose of reconstruction.

Norms inadequate Now the real question is whether the current regulatory framework and capitalisation of ARCs would allows for reconstruction of the assets. The answer is ‘no’. The latest RBI regulation requires ARCs to have a capital adequacy of just 15 per cent.

If NPAs of ₹2.43 lakh crore have to be addressed through the ARCs’ resolution, the capital required at the ARCs works around ₹36,450 crore. The current combined net worth of all the 14 ARCs is under ₹3,000 crore (as in FY13). One may argue that the entire domain of current NPAs with the banking system may not be required to be addressed by the ARCs. But even 50 per cent of it would be a tough call for them.

Moreover, the restriction that no one single investor could invest more than 49 per cent in an ARC, though the doors were opened to 100 per cent of FDI, is restrictive and inconsequential. One has to make this business attractive by removing such roadblocks.

It’s also vital for ARCs to check if they have the requisite industry knowledge, sectoral expertise and skill-sets to select a proper management team to manage bad assets. Their need to invest in professionals with the right expertise in engineering, valuation of infrastructure projects, finance and legal issues is much higher than that of banks.

Compromising the value Looking into the future, the change in the asset classification norms from April 1, 2015 might further discourage banks to undertake any restructuring, thereby rendering the assets as NPAs. Any attempt by banks or at the CDR forum to restructure the debt would automatically turn them into substandard assets.

If the objective of resolution is recovery through liquidation, there is a risk of driving such a process at rapid pace, compromising the intrinsic value of the asset. One needs to look into this aspect more pragmatically.

The immediate need is to take concrete and constructive steps to strengthen this framework both in its intent and content, facilitate the ability of ARCs to garner more capital, as well as expand the forms of raising it (quasi equity, debt and so on). Further, it might be a good idea to revisit the setting up of the national level ARF to support the revival of ailing industries, and encourage Special asset funds with various incentives, so that they possess the finances and human capital.

The writer is the CEO of Brescon Corporate Advisors

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