Escalating bad loans have not yet made a strong case for banks to sell their distressed portfolios to asset reconstruction companies (ARCs). Almost every such company is struggling to get business from banks, whose repeated assurance does not translate into action. The bane of contention is the pricing issue. The ever lasting debate over it refuses to die.
“It is a commercial call that banks take,” B K Batra – DMD, IDBI Bank tells moneycontrol.com.
“There are other options. ARC is one of the options. Banks will adopt the option, which is more economically viable. Banks can also recover those loans of their own without reaching ARCs. A cash transaction gives liquidity to banks but it varies from case to case. It also depends on the availability of resources from a particular ARC. So, you make a comparison for what is more beneficial for a bank,” he says.
ARCs acquire stressed assets from banks at a mutually agreed upon price and then recover it from the loan borrowers and thereby earn commissions from such recoveries. While most banks desire to transact in cash, ARCs look to buy assets with a combination of cash and security receipts (SRs) in ratio of around 30:70 on an average. They raise funds from their promoters. There are around 14 ARCs in India. Arcil is the biggest one with around 80% market share. Mostly banks along with other financial institutions promote them.
SR is a kind of security to be subscribed by select qualified institutional buyers including banks. As and when an ARC recovers loans, it repays back to those SR holders. In case of more than expected recovery, the latter gets incentives and vice-a-verse.
“An ARC pays majority in SRs while buying distressed assets. If the net present value of those SRs is less than their face value, banks have to provide for mark-to-mark losses. Another issue is that ARCs themselves may be running short of money. They also need funds to pay banks in cash transaction,” says M Narendra, CMD, Indian Overseas Bank .
The counter argument as some ARCs give is that SRs are rated instruments wherein banks can always stick to higher ratings. For example, a rating grade of ‘RR1’ suggests 150% recovery chances while RR2 enjoys the possibility at 125%. SRs are considered as standard upto the rank of RR3 ratings (100%). However, RR4 is a poor rating wherein the chance of recovery is only 80%.
“In case of 100% cash transaction, any upside (recovery in excess of 100%) is retained by ARCs. However, banks keep to the tune of almost 80% of the excess recoveries when it comes via SRs. A combined recovery effort is made when a bank sells bad loan portfolio in a transaction with majority in SRs. It doubly enhances the chance of recoveries,” says P Rudran, MD & CEO of Arcil.
He suggests that the best route to weed out non-performing assets from the financial sector is through ARC mechanism. ARCs should be seen as an extended arm of banking system. It may not possible for banks to curb the menace of bad loans single handedly. The rising number of bad loans proves that.
In a recently held press conference, SBI boss Pratip Chaudhuri clearly made it clear that the lender was not interested to do business with ARCs unless they buy assets in cash transaction.
Rating agency Crisil estimated that restructured loans would rise to Rs 3.25 lakh crore for all banks by March, 2013. With increasing number of borrowers failing to repay their loans right in time, the ghost of bad assets keeps on rearing its ugly face.
“Banks will sell their bad assets to ARCs but at a later stage. The provisioning requirement for non-performing assets will rise as long as borrowers continue to fail repayments. In turn, this will hit banks’ profitability and then most lenders are likely to reach out ARCs. There is no threat to ARC industry in India,” says Nirmal Gangwal, MD, Brescon, an advisory firm.
Banks are mandated to make a provision of 15% for sub-standard assets, the first level of NPA wherein a borrower fails to repay for more than 90 days and then 30% for doubtful assets, no repayment for more than one year. Gradually, the provisioning requirement reach to 100% with the category of the assets turns fully bad.