Budget 2019

Dealing with bad loans

Radhika Merwin BL Research Bureau | Updated on January 20, 2018 Published on February 29, 2016


The change

To deal with the growing menace of bad loans and to streamline the recovery process, the Finance Minister has made a few proposals in his Budget. To start with, the Budget has proposed to make necessary amendments in the SARFAESI Act 2002 to enable the sponsor of an asset reconstruction company (ARC) to hold up to 100 per cent from the earlier 49 per cent. This will help attract investors and bring in the much needed capital for ARCs. Accordingly, the Budget has sought 100 per cent FDI in ARCs through the automatic route against the earlier threshold limit of 74 per cent. Providing complete pass through of income-tax to securitisation trusts will also help increase investor interest. Given the existing issues and delays in the functioning of the Debt Recovery Tribunals (DRTs), the Finance Minister has also made a case for strengthening them.

The background

There are 15 Asset Reconstruction Companies (ARCs) formed under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, to acquire, manage and recover bad loans. But ARCs face a host of issues, insufficient capital being one of them.

Being a capital intensive business, insufficient capital has impeded the growth of ARCs. According to an RBI report, the networth of 15 ARCs is only around Rs 4,000 crore. Contrast this with over Rs 5 lakh crore of bad loans in the banking system. This would mean that all the ARCs together would require upwards of Rs 1 lakh crore of capital. While investors are keen on investing in the business, the cap on single ownership have turned them wary.

Earlier no single investor could hold more than 49 per cent, even the sponsor or promoter. The inability to have a controlling interest in the business has led to tepid investor interest. The increase in the sponsor ownership to 100 per cent proposed in the Budget can change this.

Providing complete pass through of tax to securitisation trusts is also a key positive. Currently, when an ARC acquires an asset, they create a trust to take on the asset. One trust can have a bulk of bad loans. The trust issues security receipts to the selling banks as well as other investors such as qualified institutional buyers (QIBs) who help raise the money for the trust. The Budget has now proposed to provide complete pass through of tax to trusts of ARCs. The income will thus be taxed in the hands of the investors. Removing the tax ambiguity can increase investor participation. Currently, seller banks/ FIs have been subscribing to the majority of SRs — an average of 74 per cent of total SRs issued during March 2010 to March 2015.

The v erdict

Some of the above mentioned proposals can help re-kindle investor interest and help capital-starved ARCs take on more bad loans from banks. This can help banks offload their toxic assets at a faster clip and clean up their balance sheets. But this in itself cannot ensure faster recovery of loans, unless the regulator and the government recognise the need to remedy the tardy legal and recovery process. The proposed bankruptcy law needs to be put in place quickly to hasten the insolvency resolution process.

Published on February 29, 2016
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