The government has initiated a slew of policy measures for a vibrant asset reconstruction industry and to resolve the festering sore called bad loans.

And the best part of the proposed remedy is that by burying the very idea of a national bad bank or a state-run asset reconstruction company (ARC), it does not offer a moral hazard to lenders.

The proposals to allow 100 per cent foreign ownership in ARCs and offering them tax-breaks apart from allowing single ownership in the trustee firms are in the right direction. The government should walk the talk on bad loan resolution and build a vibrant corporate bond market.

The private ARC business in our country has been around just 13 years with the first ARC coming into operations in 2003; over the years, the number has touched 16. But there wasn’t much progress in the first decade; it’s only from 2014 that their footprint began to enlarge, following a spike in NPAs.

These 16 players together are likely to have an aggregate asset under management to the extent of ₹61,000 crore by June 2016, up from ₹9,500 crore in June 2010.

ARC issues

One of the biggest problems they face today is low recoveries with their cumulative redemption ratio standing at 53 per cent as of June 2013. But due to the massive rise in security receipts (SR) issuances in FY14 and FY15, this ratio crashed to 22-24 per cent, if Crisil data is to be believed. The low recovery was mostly due to higher vintage of assets acquired in the past, longer time for debt aggregation, and inefficiency of the legal system. Crisil estimates that incremental NPAs of ₹60,000 crore will be put for sale in FY16. But only around 20 per cent are expected to be bought by ARCs, due to their low absorption capacity.

With NPAs being where they are — close to 13 per cent of the system and is set for more deterioration in the March quarter there is no more opportune time than now to get things rolling. As of the December quarter, gross non-performing assets of 39 listed banks surged to ₹438,000 crore from ₹340,000 crore in the September quarter as per the Capitaline data. Most of this is contributed by state-run banks.

Another big problem that ARCs have been facing since April 2014 was a serious resource crunch after the Reserve Bank hiked the mandatory upfront payment by three-times to 15 per cent of the asset on the block on one hand and a massive spike in NPAs on the other.

No nationalised structure

The biggest step, however, is that the idea of a national ARC has been eschewed. With a national ARC, bankers especially those owned by the government, could again be short on due diligence while granting loans because they have the comfort of transferring bad loans to this ARC. This could also make them complacent at initiating fundamental reforms needed in their credit evaluation process.

Of course, there are many examples in South Korea, Singapore, Malaysia, Indonesia and Thailand among others, of how such national ARCs had helped resolve the NPA problems in the aftermath of 1997 currency crisis. But our own state-run banks do not evoke confidence.

One of the major reasons for the weak NPAs resolution process are the weak and ordinate delays in our debt resolution legal framework. So, on an enabling legal side, the government should seriously work to ensure that debt recovery tribunals are staffed with qualified judges and lawyers.

Also, the proposed amendments to the Sarfaesi Act, the provisions of which are not equitable when it comes to asserting the rights of the creditors, should be done in such a manner that this missing part is well enshrined in the new piece of legislation.

However, when read together with the intent of the proposed Bankruptcy Code, it looks we are well on track in ameliorating the problem of dud loans.

ARCs can play a very important role as they are experts in managing stressed assets.

Foreign capital

Many have expressed doubts whether the ARC sector can attract foreign capital, considering the malaise in our banking system. If media reports are to be believed, the doubt is misplaced, as already the noted American billionaire investor Wilbur Ross’ private equity firm WL Ross & Co, the Los Angeles-based Oaktree Capital Management, the Hong Kong-based SSG Capital Management, Apollo Global Management and several other global funds focused on stressed assets are looking at India.

One of the biggest advantages of a vibrant ARC market is that companies can avoid the painful strategic debt restructuring. Since the introduction of the SDR provisions in June 2015 lenders have converted debt to equity in nearly 20 firms, including Electrosteel Steels, Ankit Metal & Power, Rohit Ferro-Tech, IVRCL, Gammon India, Monnet Ispat & Energy, Visa Steel, Lanco Teesta Hydro Power, Jyoti Structures and Alok Industries, among others.

The writer is MD and CEO of IndoStar Capital Finance

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