Asset reconstruction mirage

A lender ought to recover his dues himself because he is the one who processed the loan application and has in his possession the dossier on the borrower.

The Reserve Bank of India's disquiet over the performance or the lack of it of India's first asset reconstruction company ARCIL is only an official and hence more authentic criticism, as it were, of the seemingly impossible business of dealing in impaired financial assets — skeptics were acutely aware of the pitfalls inherent in the business, in fact of the futility of being in that business in the first place.

Apart from the ethics of allowing SBI, IDBI and ICICI Bank, which between them own more than 50 per cent of the equity of ARCIL, to palm off their bad debts quietly to the company they have sired, there are other fundamental issues that call into question the very substratum of the business of asset reconstruction companies (ARCs) — either the ARC must be having the magic wand to recover the dues or he must be flush with funds to pay off the harried lender.

The concept of ARC is relatively new to India and is one of the attempts made by the Securitisation Act, 2002 to address the festering problem of bad debts, euphemistically called NPAs by the ever upbeat American world of finance. One doesn't know how ARCs in the UShave been faring, but intuitively it would appear that their performance would have been as dismal at a time when all products of financial engineering have been floundering and flailing. In the Indian context, ARCs at best help the beleaguered banks and financial institutions buy time even though to the public, it appears that their NPLs (non performing loans) have been bought off by ARCIL because in the books of these institutions and banks, loans are only replaced by receipts issued by ARCIL.

These receipts obviously do not reflect the realisable value of the NPLs understandably because it is an unknown quantity and ARCIL would pay them off only if and when a recovery is made after deducting its service charges. This then raises a fundamental question that strikes at the root of the concept — why bring in an intermediary and not address the issue yourself?

Why intermediary?

The apologists of the discredited American world of financial engineering aver that the chaps sitting in ARCs are specialists and know their jobs. Really? If that were the case, aren't banks and financial institutions guilty of being in the business of lending without expertise in recovery? The truth is all of them have recovery cells, but lack the will to go after the habitual defaulters many of whom are guilty of diversion of funds for personal aggrandizement, leaving the banks and financial institutions holding the can. A mutual fund is a necessity given its raison d'etre — lack of expertise on the part of small investors in the obtuse world of markets, but banks and financial institutions are not innocent of the tricks of the trade so as to need the crutch of an intermediary.

Which is why the concept of ARC is as farcical as the idea of securitisation under which mortgage loan companies, for example, sell their receivables to Special Purpose Vehicles which in turn issue bonds on the strength of these very receivables to pay off the former. Everyone knows the convoluted process, together with indiscriminate issuance of insurance cover for such bonds, was at the back of the US financial debacle in 2008.

But more to the point — why not issue bonds yourself. This is a throwback to the earlier question — why not recover the NPAs yourself. Cleaning up balance sheets and unlocking illiquid assets are the alibis for securitisation, but the truth is a lender ought to recover his dues himself because he is the one who has processed the loan application and has in his possession the dossier on the borrower, as it were.

Factoring or forfaiting, the idea born of the desire to help small businessmen in managing their credit customers, might have some justification at that level, but large organizations simply have no need for resorting to their services for two reasons — one, their own recovery cells and two, the availability of bill discounting facilities in India, indeed all over the world.

Back to ARCIL, one wonders how the RBI has all along countenanced the farce of its promoters parking their NPAs in an act of financial incest. The solution to the problem of bad debts is not to disown the disagreeable assets or dropping them off like hot potatoes but to pursue them tirelessly. Better still, by preventing them from becoming bad in the first place. A lender who lends with gay abandon smug in the thought that there is someone down the line to refinance him is bound to be slack in his appraisal and no amount of insurance or rating can stem the damage to the system inflicted by such an attitude of abandonment. An informed credit insurance would be any day better, provided the insurer has access to the credit history and other vital statistics of the borrower. But even this would only be a lesser evil because the lender after all is going to jack up the interest rate so as to factor in the cost of insurance. Passing the buck is dishonourable even if it is in the course of a honourable business.

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

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Published on July 21, 2011

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