Asset Reconstruction Companies

Systemic response to NPL Management

Hari Hara Mishra

Indian Banking -Perspective
z RBI report
report- Trend and Progress of Banking 2013
released on 21st November 2013
At the present juncture, the key issues related to the Indian
b ki
banking sector
t include:
i l d
z effective reduction in NPAs and improvements in the loan
recovery process;
z need to achieve sustainable financial inclusion through suitable
business and delivery models;
z need to stimulate and foster competition in the banking sector
and liberalize licensing policies; and
z need for decisive changes in the present banking structure to
enable it to grow in size, resources, efficiency and inclusivity
Stress in the banking
g system
y ((1/2))

Rs in crore

2010 2011 2012 2013

Gross NPA (all banks) 84,747 97,922 1,42,300 1,94,000

Increase in NPA YOY 15,774 13,175 44,378 51,700

Restructured Advances (RA) 1,36,426 1,37,602 2,18,608 3,01,000

I
Increase in
i RA YOY 61 122
61,122 1 176
1,176 81 006
81,006 82 392
82,392

Gross NPA as % Gross

2.5 2.3 2.9 3.6
Advances (A)

RA as % to Gross Advances
4.2 3.5 4.7 5.8
(B)

Total Stress as % to Gross

6.7 5.8 7.6 9.4
Advances (A+B)
Stress in the banking
g system
y ((2/2))

z Gross NPAs of banking system have gone up by around 2 times

i 2 years from
in f M h 2011 to
March t March
M h 2013
z Restructured Assets also have gone up by more than 2.times in
2 years from March 2011 to March 2013
And the trend continues
z During H1 of FY14, Gross NPAs have grown by 38%. At this
rate, the NPAs are expected to go up by Rs 75,000 crore during
the year 2013-14
z As pper CRISIL- Restructured Assets expected
p to go
g upto
p Rs
4,00,000 crore as on March 2014 i.e an increase of Rs 1,00,000
crore in one year alone.
z Total Stress in the system (GNPA%+RA%) is estimated to have
exceeded 10% now in Sept 2013 a record high in recent times
Implications
p (1/2)
( )

z Increase in Gross NPAs will require additional provisioning

z For restructured assets , provisioning norms have changed

effective current financial year

z 5% on Fresh restructuring (flow) in 2013-14 and 3.5% as on March

2014 for existing stock- up from 2.75% as on March 2013

4.25% from March 31,2015/ 5% from March 31,2016 spread quarter wise

z Most banks have reported sharp decline in profitability and some

banks have started reporting losses in Sept 2013 (Central Bank
of India -1509 crore/ United Bank of India -489 crore).

z For the listed banks as a whole there has been a fall in profit of
24% vis a vis last half.
Implications
p (2/2)
( )

z Impact of additional provisioning:

z Capital locked in sticky assets

z Hampers credit creation and playing effective role in economic growth

z Rating downgrades! Leading to rise in cost of funds

z Constrains banks ability to raise capital (with

( ith implementation
i l t ti off BASEL
III norms, capital requirement of banks to go up significantly)

z Dampens overall investment climate of the economy

Structural options
p

LEGAL VOLUNTARY
z SARFAESI 2002 comprehensive z Corporate Debt Restructuring
foreclosure law
Forum of lenders under the aegis of
Provides for setting up of ARCs
z Debt Recovery Tribunals dedicated RBI
recovery courts z Banks own workout
z proposed repeal of SICA/ BIFR -to be
replaced by NCLTs

Enhance Effectiveness of Encourage lender driven

enforcement rights restructuring
Creation of ARCs - background
g

20.0% Gross NPA %

15.7%
14.4% 14.7%
15.0%
12.7%
11.4%
10.4%
10 0%
10.0%

5.0%

0 0%
0.0%
FY1997 FY1998 FY1999 FY2000 FY2001 FY2002

z The huge NPA levels in the late 90s set alarm bells ringing.

z Two committees, Narasimham Committee I & II and Verma

Committee were set up to study the problem . A separate vehicle
to address rising NPA was envisaged
envisaged.

z In 2002, SARFAESI Act was passed enabling creation of ARCs..

SARFAESI Act,, 2002

Provides for setting up of Asset Reconstruction Companies (ARCs)

Enables recovery of money without intervention of the Court of Law
Grants
G a ts po
powers
e s to lenders
e de s to foreclose
o ec ose secu
security
ty interest
te est with
t a 60 days
Notice on receipt of consent of 75% (now changed to 60%) of the
concerned Lenders by Value,
Grants powers to lenders to reconstruct/ resolve NPAs through
Selling or leasing a part or whole of the business of the borrower
Settling dues
d es payable
pa able by
b the borrower
borro er
Taking possession and disposing the underlying security interest
Effecting change or takeover of management of the business of the
borrower
ARC advantage
g

Ch
Characteristics
t i ti off Indian
I di Banking
B ki landscape
l d
z Large NPAs with Banks/FIs - mostly multiple/consortium lending

z Different categories of charge and security profile

z Most of the resolution strategies require consent of 75% of lenders by value

z Inter Creditor Issue - major

j stumbling
g block in driving
g effective resolution

z Legacy issues hinder value maximization for banks originating NPAs

z Resolution requires specialized skill sets, may not be available with the banks

Implication ---> Debt aggregation is key to successful resolution

Transaction Structure

Banks/ FIs ARCs as Asset

Manager

4 Sale of Reconstruction
loan assets 3 through
5 Restructuring /
Purchase
Asset sale /
Consideration
M&A
Trusts / 6
Scheme Cash
realization B
Borrower
of ARCs

Issuance
1 of SRs 2 7
Payment for Redemption
Subscription to of SRs
SRs
Investors
Security
y Receipts
p ((1/2))

SARFAESI Act 2002 (Section 2(1)ZG) define Security

Receipt as under:

Security Receipt means a receipt or other security, issued by

a securitization company or reconstruction company to any
Qualified institutional buyer pursuant to a scheme, evidencing
th purchase
the h or acquisition
i iti b the
by th holder
h ld th
thereof,
f off an
undivided right, title or interest in the financial asset involved in
securitization
Security
y Receipts
p ((2/2))

z RBI Circular dated May 28

28,2007
2007 further elaborates the concept of
SRs :

SRs issued by SCs/RCs are predominantly backed by impaired assets.

assets SRs
have the following unique features as compared to other types of securities
issued on securitization of normal assets
a) SRs cannot be strictly characterized as debt instruments since they
combine the features of both equity and debt. However, these are
recognized as securities under Securities Contracts (Regulation)
Act, 1956.
b) The cash flows from the underlying assets cannot be predicted in terms
of value and intervals.
c) The investment in SRs is restricted to QIBs only.
d) These instruments when rated would generally be below investment
grade. These instruments are generally privately placed and presently
not listed.
 NPA Auctions FY 2012-13

Rs in crore

Category No of No of Amount No of assets Book % of

Banks Assets sold to ARCs Value of closure of
put on Assets transactio
block sold to ns
ARCs
Public Sector 15 985 7900 77 480 6%
Banks
Private Sector 9 210 1650 94 479 29%
Banks
Total 24 1195 9550 171 959 10%
The primary reason for low consummation of NPA auctions is due to price
expectation mismatch between banks and ARCs, contributed largely by the discount
f t and
factor d pricing
i i off risks
i k associated
i t d with
ith recovery which
hi h include
i l d estimate
ti t off
realizable amount and period of realization.
- Data compiled by ARC Association
 Flow of NPAs to ARCs

Rs in crore
250 000
250,000
194000
200,000
142,300
150,000
97,922
100,000 84,747 88,500
74,088 80,500
68,973 62,217
51,542
50,000

0
2009 2010 2011 2012 2013

Gross NPAs Book Value of Assets transferred to ARCs

ARCs were created as a systemic response to address growing NPAs. However,

recent experience suggests that while NPAs are accelerating, flow of Assets to
ARC has
ARCs h rather
th been
b l kl t
lackluster.
 Issues before ARCs (1/6)
( )

z Government of India had appointed a Key Advisory Group

(KAG), consisting of all stakeholders for strengthening the functional
effectiveness of ARCs
z The measures suggested and their present status:

Recommendation To be effected Initiating Priority Present

through Authority Status
NPA auction sale p process & p price Notification RBI/ IBA/ Essential Done
discovery ARC
Association
Gradual write off of loss on transfer Notification RBI Essential Awaited
t ARC
to
Permission to acquire debt from Amendment / Govt of India/ Essential In process
other ARCs Notification RBI
Investment in SRs byy insurance Clarification IRDA Essential Awaited
companies
 Issues before ARCs (2/6)
( )

Recommendation To be effected Initiating Priority Present

through Authority Status
Mark to Market based on ARC Notification RBI Desirable Awaited
price offer
Broadening of Market by inclusion Amendment / Govt of Essential Awaited
of NBFCs Notification India/RBI
Modification in FII investment Notification RBI/Govt of Essential Done
India
Removal of sub-limit of FII at Clarification RBI Essential Done
tranche level
Secondary Market making for SRs Amendment/ RBI/Govt of Essential Awaited
Notification India
Conversion of debt into equity Clarification RBI Essential Permitted
in recent
SARFAESI
Amendme
nt
 Issues before ARCs (3/6)
( )

Recommendation To be effected Initiating Priority Present

through Authority Status
Issuance of Guidelines on Notification RBI Essential Awaited
Sale/Lease of Business
Restructuring Support finance
finance- Clarification RBI Essential Awaited
participation by investor
Securitization of Assets Clarification RBI Essential Awaited
Pledged Shares-substitution
Shares substitution Clarification RBI Essential Awaited
/Notification
Exemption from Takeover code Clarification SEBI Essential Awaited
Uniform Assignment Agreement Notification IBA/ ARC Essential Done
Association
Allowing ARCs to go public Notification RBI/SEBI Desirable Awaited
Immunity for Nominee Directors Notification Govt of India Essential Awaited
Stamp duty payable on Assignment Amendment in Govt of India Essential Awaited
Agreement legislations
 Issues before ARCs (4/6)
( )

Recommendation To be effected Initiating Priority Present

through Authority Status
Priority to secured creditors over Amendment in Govt of India Essential Awaited
statutory dues legislations
Reduction in bottlenecks in Various Govt of India Essential Awaited
functioning of DRTs initiatives /
Guidelines
Consent level for Security Amendment in Govt of India Essential Done
enforcement actions Act
Substitution of ARC in place of Amendment in Govt of India Essential Done
lender banks legislations
Registration of Assignment Amendment in Govt of India Desirable Awaited
Agreement to be dispensed with legislations
Delegation of powers to officials Amendment in Govt of India Essential Done
below DM/CMM Act
 Issues before ARCs (5/6)
( )

Recommendation To be effected Initiating Priority Present

through Authority Status
Legal Forum for pursuing cases Amendment in Govt of India Essential Permitted
acquired from Coop Banks Act through
recent
SARFAESI
Amendme
nt
Modification of charge in respect of Notification Govt of India Essential Awaited
dormant companies
Transfer of financial assets from Notification RBI Desirable Permitted
Co op Banks
Co-op through
recent
SARFAESI
Amendme
nt
Income Tax Treatment of Trusts set Notification Govt of India Desirable Awaited
up by ARCs
 Issues before ARCs (6/6)
( )

Recommendation To be effected Initiating Priority Present

through Authority Status
TDS on interest payments received Notification Govt of India Desirable Awaited
from borrowers
Income Tax benefits on provisions Notification Govt of India Desirable Awaited
Accounting treatment at Banks on Clarification RBI Essential Awaited
sale of NPAs to ARCs
Uniform Accounting Standards at Notification ICAI/ARC Essential In
ARCs Assn progress
Constraint in effective delivery-legal
y g

z DRT/DRATs created to fast track cases involving secured creditors

face delay as
z Posts of presiding officers and other officials remain vacant for months
z Applications
pp for stayy of action byy secured creditors for securityy enforcement are
entertained by other courts including High Courts
as a matter of routine
z For any objection raised by borrower against action by secured creditors, DRT is
required only to examine whether the creditor has acted in due process
prescribed in SARFAESI Act
z However, in many cases extraneous issues are taken up which cause delay
z Security
y enforcement with assistance from District Magistrates
g and
Chief Metropolitan Magistrate also get delayed often
z Different states follow different practices
z Requests for security enforcement are not treated as priority by the Magistrates
Way
y forward*

z Goingforward, Four Institutional structures have to play

forward
a more concerted & effective role in tackling the
menace of growing NPAs
z DRT/DRAT

z ARC

z CDR

z CIC

*Based on Address of Dr K.C. Chakrabarty, DG, RBI at Bancon

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