A better way to manage NPAs

BL  Sidharth Birla 1 Aug 14

Mechanisms to deal with stressed assets need a relook. A national asset management company would help

Prolonged slow growth has adversely affected India’s financial sector. The banking system is sitting on a pile of stressed assets which, if not checked, will snowball into a larger problem. As of December 31, 2013, gross NPAs had reached 4.4 per cent of total loans in the banking system, with public sector banks such as the State Bank of India (SBI) reporting much higher levels (over 6 per cent).

If restructured loans are added, stressed assets are estimated at around 15 per cent of bank loans. Of the total stressed assets, the industrial sector (especially infrastructure) accounts for the largest stock of NPAs.

Restoring the capex cycle is essential for economic recovery. This will not be possible without restoring the health of the banking system.

Given the present levels of impaired assets in banks’ balance sheets and future credit requirements, Indian banks require capitalisation of about ₹5-10 trillion over the next five years.

Present system ineffective

The requirement is especially worrisome for government-owned banks: they account for over 70 per cent of total banking assets. Reduction in impaired assets helps lower the capitalisation burden to an extent.

Thus, finding a solution for faster recovery and/or rehabilitation of stressed assets is critical.

Despite the presence of an established legal and regulatory framework for resolution of stressed assets, the existing system doesn’t seem to be working effectively. There are 14 registered asset reconstruction companies (ARCs) in India, of which four are active.

However, the process of removing stressed assets from banks to ARCs is inefficient and ARCs have not been successful in quick recovery/rehabilitation. Despite a significant rise in NPAs over the last five years, the sale of stressed assets (in value terms) to ARCs has remained more or less stagnant.

Banks are under no pressure to clean up NPAs and thus they prefer to roll over debt rather than recognise an NPA and mark it down to its realisable value.

Lately, the pressure to build books has forced ARCs to make unrealistic valuations; the average acquisition price over the past 12 months has soared to 60 per cent of book value as against 25 per cent earlier, with over 90 per cent of transaction value being paid through security receipts (SRs). As a result, the secondary market for these assets has failed to take off.

Look at the specific issue

Quick recovery by ARCs is also affected by inadequate capital and inability to aggregate consortium debt. Moreover, the unrealistic pricing of underlying NPAs has kept foreign investors at bay, despite the Government allowing foreign investors to hold up to 74 per cent of the share capital of an ARC. No wonder, over 90 per cent of SRs are currently held by the selling banks, as most of these ARCs are bank-sponsored.

An effective resolution of stressed assets thus requires looking beyond the existing system and addressing the specific nature of the problem through a specialised ARC framework. A review of international experience in this regard reveals some common underlying principles in the approach towards the resolution of NPAs by most countries, regardless of different models being adopted.

The research reveals several things. First, it is much better, less expensive and less disruptive to establish a specialised AMC prior to a financial crisis as was done in the case of Malaysia and Taiwan. Establishing an AMC once the crisis has occurred results in the shrinkage of economy, and the process of recovery is longer and more painful.

Second, in most cases, direct government funding or government guaranteed bonds were used to inject the capital required for clearing a bulk of the NPAs, which was done through their one-time transfer from banks to the AMC.

Third, the successful AMCs had one core objective: the rehabilitation and restructuring of viable assets. Additional funding mechanisms were put in place for meeting working capital requirements of the AMCs for rehabilitation of viable projects. Finally, another common feature of successful AMCs globally has been fair valuation in asset pricing, which contributed in building investor interest and developing a secondary market for such assets.

Managing the assets

Based on these experiences, Ficci has suggested the creation of a specialised entity called the National Asset Management Company (Namco) to effectively tackle large NPAs in India. The proposed Namco framework is unique because it requires Government/RBI sponsorship but no capital injection or guarantees.

The Government shall encourage public sector banks (PSBs) to take up to 49.9 per cent equity in this entity and transfer large-scale stressed assets to it. The selling banks will agree to provide up to 25 per cent of the sale price as additional last-mile funding, for rehabilitation or completion, if required. No new legislation is required; some modifications would have to be made to existing regulations.

Namco’s focus would be on the rehabilitation of large-scale NPAs, restructured loans and other potential stressed assets, mainly in the infrastructure sector. Given the long-term nature of underlying assets, such specialised entities will be allowed to issue SRs with a tenor of up to 12 years. To encourage greater investor participation, Ficci has suggested the transfer of stressed assets at fair market value, determined by an independent valuer.

Given the importance of restoring the health of the banking system for supporting economic revival, the Government and the RBI should facilitate the creation of Namco by taking necessary administrative steps in this regard.

A pro-active, preventive approach is desirable if we have to ensure speedy revival of the economy. Of course, this should be a time-bound and close-ended framework to improve the overall hygiene of the system.

The writer is the president of Ficci