MUMBAI Dec 22 Set up over a decade ago to
absorb Indias mountain of distressed loans, asset
reconstruction companies have done little to recover cash or
relieve a debt-choked banking system.
Instead, at a time when regulators are pressing the banking
sector to clean up balance sheets, the so-called ARCs are
striking mostly paper deals that help lenders extend
provisioning by years, camouflaging the scale of their woes.
Banks are the risk takers of last resort. Its a vessel
that contains all the risk and it has no outlet – that is a
problem, said Harsh Vardhan, partner with Bain Co.
You have to create an outlet which allows at least part of
the risk to flow to ARCs.
Indias central bank has set a clean-up target for the
banking sector of March 2017, and has already started cutting
off what it calls forbearance, a sort of benevolent regulatory
tolerance, when it comes to bad debts and
That has placed under close scrutiny any measures or tools
seen to allow extra wriggle room for banks.
That includes the ARCs, originally designed to foster a
much-needed market for distressed debt in India, critical to
lowering the cost of capital and boosting investment. The market
remains in its infancy, as even ARCs face restrictions on
selling on bad loans.
ARCs make money from management fees and recoveries. They
typically pay 15 percent of the loan purchase price in cash,
with the rest funded by IOUs issued to the bank. The required
cash portion was increased by the central bank last year from an
initial 5 percent, in an effort to make ARCs more accountable
and control a spurt of overpriced bad loan sales.
As the bank finances 85 percent of the deal, the risk
remains with the bank – in its investment portfolio rather than
its loan book – a fact that also encourages lenders not to take
a hit to book value when selling loans.
At the same time, ARCs themselves have been choked by
restrictive ownership rules that have made them less attractive
investments, and kept them poorly capitalised. Their assets
under management more than a decade after they were created
amount to a paltry $8.3 billion, less than 10 percent of Indias
over $110 billion stressed loan mountain.
If little is recovered from the errant borrowers, ARCs will
struggle to make a return on their investment.
But banks, who have already moved the loans off their main
books, will have been allowed a period of up to eight years to
write them down: attractive for the bosses of Indias state-run
banks who rarely stay longer than three years and have little
incentive to take the pain.
(Under) normal provisioning norms … within a four-year
period you have to write off an entire (non-performing) asset,
said Anjali Sharma, who works with the Finance Research Group at
Mumbais Indira Gandhi Institute of Development Research, which
worked on Indias new bankruptcy code.
If you sell it to an ARC and you invest in the security
receipt of that same asset, you can get a much longer period to
write it off. It enables delayed provisioning on banks books.
ARCs, stung by regulatory demands for higher cash payments
upfront, say they can no longer afford what Birendra Kumar,
chief executive of International Asset Reconstruction Co, called
the luxury of accruing management fees to eternity, and are
being more careful.
Kumar, whose backers include KKR Co LP, estimated
400 billion to 500 billion rupees ($6 billion to $7.54 billion)
of bad debt was brought to auction by banks between April and
December: I dont think more than 15 pct will have been sold.
Thats bad news for lenders and Indias central bank, which
this month said it would encourage more foreign investment into
ARCs – but is struggling to get banks to take the hit of a
correctly priced loan sale.
Arcil, the oldest ARC, reports an internal rate of return of
low single digits – too low to secure a sustainable profit.
Its just that what is being traded in the market is being
looked at with two different pairs of eyes, said Vinayak
Bahuguna, chief executive at Arcil.
ARCs have, of course, been able to recover debt from some
Despite this, we believe that the recovery experience has
been below the expected potential of the industry, said Pawan
Agrawal, chief analytical officer at Crisil.
(Reporting by Devidutta Tripathy; Editing by Sam Holmes)