ARCs to play limited role in clearing banks’ bad loans

Due to rising acquisition costs and capital constraints, asset reconstruction companies (ARCs) will at best have the ability to purchase non-performing assets (NPAs) worth around ₹1.20 lakh crore, which is a mere 17 per cent of the total stressed assets in the system, according to India Ratings and Research (Ind-Ra).

The rating agency observed that ARCs will play a limited role in absorbing NPAs of banks. Banks’ stressed loans (NPAs + restructured assets) as of March-end 2015 stood at 11.1 per cent of the outstanding credit of ₹65.25 lakh crore, while all ARCs put together have a capital base of just ₹4,000 crore.

Ind-Ra said capital of ARCs is constrained due to higher investment requirement by them in security receipts and due to a shareholding ceiling for sponsors at below 50 per cent.

Investment requirement by ARCs of the total security receipts issued has increased to 15 per cent with effect from August 2014, from 5 per cent earlier. However, this guideline has also helped ARCs to refrain from aggressive bidding, bringing in the discipline needed in the industry.

“ARCs are now tapping debt markets to raise funds, which is a shift to leverage from the near-zero debt model earlier. Also, interest coverage may be a concern due to the lack of predictability in ARCs’ cash flows,” Ind-Ra said. 

The agency noted that acquisition costs have also risen, given that bankers are now selling stressed loans at an early stage post changes in regulations. Acquisition cost has now gone up to around 60 per cent, from the earlier 40 per cent.

“Also earlier, banks would offer NPAs that were more seasoned, while of late they have even resorted to offering fresh NPAs. “This shift has pushed up acquisition costs and led to bankers asking for higher amounts due to higher probability of recovery,” it said.

Referring to the fact that banks are unwilling to sell NPAs at a significant discount even if looking to clean up their books, the agency felt that headline stressed loans on balance sheets are unlikely to decline. Credit costs will also remain elevated due to amortisation charges arising out of the losses on sale.

Public sector banks are more aggressive in cleaning up their books compared with their private sector counterparts. The 10 largest public sector banks sold 6,040 accounts to ARCs in FY15 with a book value of ₹11,140 crore, up 64 per cent year-on-year.

The top five private banks have sold a much smaller quantity of assets, at 1,100 accounts sold to ARCs in FY15 with a book value of ₹1,110 crore, little over double the amount sold in the previous year.

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