New ARC and AMC to manage stressed assets of PSBs
Transfer of Bad Loans to ARC
I.
What is the Proposal?
When Hon'ble Finance Minister Smt. Nirmala Seetharaman (FM) announced in her budget speech that a new Asset Reconstruction Company (ARC) and Asset Management Company (AMC) will take over the existing stressed assets of Public Sector Banks (PSBs), everyone, including me, heaved a sigh of relief, as the PSBs will be able to concentrate on their credit portfolio, which paves way for the growth of the economy as well. After reading the statements of FM, Banking & Finance Secretary, (full details of the reports appeared in the newspapers given in annexure), my understanding is as under:
1. The assets that will be transferred might have been stressed in the books of the banks for a long time. Majority of them may relate to stalled infrastructure projects also. (According to the Banking and Financial Secretary (BFS), in some of the projects, 100 per cent provisioning has been done, while in some other projects 80-90 per cent provisioning has been done. This implies that major portion of the stressed assets to be transferred are already identified)
2. The asset transfer will take place at the net book value (NBV). (Outstanding minus provision held). Since this is at book value, the issue of mismatch between the valuations done by the bank and ARC is avoided.
3. Cash Neutral for the banks and ARC: The banks that transfer the stressed assets to the new ARC will be contributing to its equity, the aggregate of which will be equal to 15% of the consolidated stressed assets to be transferred to the ARC by the banks. This satisfies RBI stipulation that the minimum Capital adequacy Ratio (CRAR) of the ARC should be 15%
The equity, so brought in, will be used as cash component from ARC to issue the Security Receipts (SR) against the asset to be acquired. Hence the contribution to the SR will be 15:85 by the ARC and the bank, which sells the stressed asset. (This satisfies RBI stipulation that the ARC should make a cash payment of at least 15% in purchase of stressed assets)
So the equity contributed by the bank comes back to it from ARC as cash payment for the stressed asset transferred at net book value. (Cash neutral for the bank as well as ARC)
4. Provision Requirements on SRs issued and subscribed: After the transfer entries are passed, stressed assets appearing under advances in the books of the bank concerned, will appear under investments - (i) as Investment in the equity of new ARC (15% of stressed asset NBV) and (ii) as Investment in SR (85% of stressed asset NBV)
At present, provision requirements in respect of SR are as under: The SR shall be valued by credit rating agencies at half yearly intervals and provision should be made, if the NAV as per valuation is less than the book value of the SR valued. Also, if a bank concerned has invested more than 10% in the SR representing the assets sold by the bank itself, then progressive provisioning shall be done as per conditions stipulated by RBI.
To obviate any provision requirements resulting from the
above stipulations of the regulator, the government might consider issuing
guarantee for redemption of SR.
My Views: Recapitalisation bonds involving
simultaneous purchase of bonds by the banks and equivalent amount contributed
by the government as equity into the banks concerned was the first cash neutral exercise undertaken
in the last four years to spruce up CET1, increase provisions and reduce NNPA of select PSBs. The
move to create an ARC, on the lines indicated above, appears to be the second ingenuous
exercise (RWA comes down and thereby CeT1/CRAR ratio goes up) to achieve the
same objective, with an added advantage of removing the stressed assets also
from the books of the banks concerned.
II. Issues to be addressed:
Ø What type of guarantee is envisaged? ARC is not responsible for the redemption except to the extent of realisation from the underlying financial assets. SR expires automatically after the said period for which it is issued, unless there are provisions to extend the tenure. The chances of invocation is higher, as some of the assets are dragged in the books of the banks without any resolution for years and finding a resolution might not be easy, especially the infrastructure projects.
Ø If the asset is to be transferred at book value from a consortium of banks, how the book value is going to be determined. The asset classification is based on the recovery of instalment and interest in each bank and classification might vary in different banks. Accordingly, provisions will vary. Some banks adopt accelerated provision while others may adopt regulatory provision only. Hence there should be clarity on how the net book value will be arrived at.
Ø The transfer of asset is going to be based on net book value which is - amount outstanding less provisions already available. But fair value of the asset as a ‘going concern’ and as a ‘gone concern’ should be conducted periodically till resolution is in place. ARC should be given clear mandate on this vital aspect, as otherwise there is the danger of three C’s coming into play once again, (CVC, CBI and CAG) since the alternative investment fund or any other, who is going to purchase, will be from the private sector.
Ø When valuations on the assets are to be made periodically, there will be issues of valuing the SR as per NAV in the books of the bank concerned and ARC, irrespective of the net book value at which the asset is transferred. Even with guarantee from government on SR, this issue will remain.
Ø Enforcing the security interest in accordance with the law or taking possession of the assets taken as security is last in the priority of options for resolution, as realisation is normally much less in such cases. So if the ARC adopts other options like change in management or sell the business as a going concern or reschedule the debts etc. additional/adhoc funding might be needed to continue the business as a going concern. Once an asset is sold to an ARC, instructions are clear that the same asset should not be purchased by the same bank and no exposure is permitted with the same borrower. How this will be handled?
The proposed set up of a new ARC to take over the stressed assets of PSBs reminds one of a similar arrangement made in respect of the bad debts of IDBI, prior to converting it into IDBI Bank in 2004. Stressed Asset Stabilisation Fund (SASF) was created by the government (GoI) to take over 636 stressed assets of IDBI, aggregating Rs.9004 cr. Through cash neutral transfers, GoI gave a loan of Rs.9000 cr. to SASF, which in turn invested the amount in nil interest bearing government securities maturing in 2024. The securities issued in the name of SASF were assigned favouring IDBI Bank, which in turn, transferred the stressed assets to SASF. The understanding was that SASF should recover the stressed assets and adjust it towards securities issued by the government, so that the government is not required to fulfil its redemption obligation in 2024. As per the Public Accounts Committee (2018-19) report, Rs.4654 cr. was remitted by SASF to GoI for redemption of securities and IDBI Bank committed to remit a sum of Rs.1065 cr., as some NPA cases exchanged between the bank and SASF were found inadmissible. Thus, a total amount of Rs.5719 cr. has been received by GoI against its security redemption commitment of Rs.9000 cr. From the report, it appears that majority of the recoveries happened before 2010 and the progress since then is sluggish.
Notwithstanding the limited success of the above experiment, which is being replicated in some other form now, the aim of the government to clean up the balance sheets of the PSBs through one time removal of bad debts from RWAs, may succeed. However, occurrence of bad debts has become a regular phenomenon in the Indian Banking System, which may necessitate take over of bad loans by this ARC at regular intervals. As per the FSR of the regulator released in January 2021, the GNPA of SCBs (Scheduled Commercial Banks) is likely to go up from 7.5% in September 2020 to 13.5% in September 2021, under baseline scenario. The GNPAs of PSBs as on 31.03.2020 was Rs.6.78 lac cr. (10.3%) and if the assessment of RBI as per the above report proves right, PSBs are likely to add at least GNPA in the range of Rs.2.50 lac to Rs.3.0 lac cr. From the news reports, it appears that the present proposal aims at transferring the existing bad debts from the PSBs in the range of Rs.1.5 - Rs.2.25 lac cr., which has nothing to do with the resolution/recovery issues arising out of new NPAs.
Hence there is a need to develop the overall ecosystem to manage the stressed assets prevalent in the banking system as a whole and some of the problems that need to be addressed are as under:
ü GNPA issues: Except Personal Segment, incidence of NPAs is on the high side across all other segments. Even under Personal Segment, education loan portfolio carries significant level of stressed assets. Business failures, diversion and frauds contribute almost equally to the NPA malaise. Even the GNPA of 8.2% (Rs.9.0 lac cr.) reported as on 31.03.2020 (pre COVID lockdown) by the banking system, both in terms of per cent as well as quantum, is quite high. A banking system which reported a return on advances at 8.94% cannot be solvent, if the incidence of NPA is not contained within a reasonable level say less than 3%. (Though 100% investment in ARC sector by FPIs is allowed, special situations funds were raised/being raised by some ARCs to acquire stressed assets, the funds brought in are hardly adequate to match the increase in NPAs added by the banks every year). Appraisal, sanction, disbursal, monitoring, follow up and recovery standards practiced (policies may be robust, of course) by the SCBs, especially PSBs needs to be critically reviewed and stringent enhancement measures are to be put in place. While the above issue is one of the root causes for increase in NPAs, the banking system is a mirror reflecting the state of the economy. The repayment culture in the non-personal segment along with reasons for failure of business across all segments like agriculture, MSMEs and corporate needs a thorough study.
ü ARC related issues: As per Report on Trend and Progress of Banking in India 2019-20 released by RBI, the progressive levels of assets acquired, SRs issued by ARCs, SRs redeemed and outstanding are as under: (Rs. in cr.)
|
Details |
Mar 18 |
Mar 19 |
Mar 20 |
|
Book Value of Assets Acquired |
327400 |
379383 |
431339 |
|
SRs issued by ARCs |
118351 |
142885 |
151435 |
|
SRs completely
redeemed |
8413 |
12240 |
17947 |
|
SRs Outstanding |
98203 |
112651 |
107877 |
It may be observed,
from the above, that on an average Rs.50,000 cr. stressed assets were acquired
by the ARCs in the years 2018-19 and 2019-20. SRs completely redeemed works out
to 10.3% and 12.6% of the total SRs issued. The average SRs outstanding to
total SRs in the last three years is in the range of 75-80%.
Experts attribute low
level of acquisition of stressed assets (in relation to total stressed assets
available in the banking system) to
§ limited capital
resources of ARCs,
§ reluctance of banks (which
sell the stressed assets) to subscribe more than 10% of the SRs to be issued
for the purpose, due to stringent RBI norms on progressive provisioning and
§ non-availability of QIBs
to subscribe to SRs, as the calculated IRR is not attractive, considering the
actual period taken to redeem a SR and the value of SR as compared to the
outstanding amount under the related stressed asset.
The low level of
redemption at around 10-12% of total SRs issued is related to two factors: (i)
the holders of SRs (mostly the banks which sold the assets) have to be
consulted by the ARCs, if they aim resolution other than recovery by legal
means and (ii) the inordinate delay in recovery through legal means.
(The above issues
relating to the existing ARCs is bound to haunt the new ARC also as it is going
to operate in the same ecosystem)
IV.
CONCLUSION:
While setting up of a new ARC cum AMC to
acquire bad debts of PSBs is a step in the right direction, it shall be
accompanied by
(i) corporate governance enhancement practices, with particular reference to improving quality
of assets in PSBs
(ii) urgent measures to addresses the existing issues of ARCs and
(iii) initiatives to reduce recovery period through legal means (a speedier legal system will compel
the borrowers to come to the table and discuss with the bankers on workable resolutions plans so as to avoid recovery steps)
V.Viswanathan
2nd April
2021
Source:
1. RBI - Financial Stability Report January 2021 and Report on Trend and Progress of Banking in India 2019-20
2. Various Newspaper Reports
Annexure:
VARIOUS NEWSPAPER REPORTS
Hon’ble FM’s
Budget Speech:
The
high level of provisioning by public sector banks of their stressed assets
calls for measures to clean up the bank books. An Asset 16 Reconstruction
Company Limited and Asset Management Company would be set up to consolidate and
take over the existing stressed debt and then manage and dispose of the assets
to Alternate Investment Funds and other potential investors for eventual value
realization
Financial Service Secretary:
There are some legacy NPAs
of approximately Rs 2.2 lakh crore and the banks are not able to extract the
money. They are all stressed assets, around 70 assets of more than Rs 500
crore. Most of existing ARCs are thinly capitalised – necessitating to set up a
new structure to resolve these stressed assets urgently Financial Services Secretary said in
a post-Budget interaction with the media.
The ARC would be set up by both public and private
banks, and the government will not hold any equity in it. Banks will be able to
transfer their assets to the ARC at net book value (value of asset-provisioning
done). About 15 per cent would be cash deals and 85 per cent through security
receipts. It would be a cash-neutral deal for banks. The regulator may require
some provisioning for this arrangement, for which the banks may request the
government for some guarantee which may satisfy the regulator.
Then, the asset management company with a set of experienced
professionals will operate the asset for some time, find an investor or an AIF
through which it can be disposed through market price discovery mechanism. It
will be a win-win for all banks in terms of getting their money back.
IBA: In preparing for the formation of a
so-called ‘Bad Bank’, the Indian Banks’ Association has asked lenders to
furnish data on stressed accounts with principal outstanding above ₹500 crore,
both under consortium and multiple banking arrangement. Specifically, banks have been asked to submit details of
their stressed accounts exposure (fund and non-fund based as also debt
investment) above ₹500 crore as on December-end 2020 under consortium/multiple
banking arrangement (MBA). The data include both IBC and non-IBC cases.
Excluded entities: Fraud accounts, those in sight of resolution under the
IBC and those under liquidation, accounts of financial service providers (such
as NBFCs, mutual funds and broking firms), and quasi equity/equity and
unsecured exposures have been excluded from the reporting format.
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