Over the past three years, a sizeable chunk of the banking sector's profit has been used for making provisions to bring down the net non-performing assets so that the balance sheets look respectable. Yet, when it comes to actually selling the NPAs, banks have been far less aggressive.
Till March this year, buying and selling of NPAs remained a year-end game for commercial banks. A relatively-healthy bank (with less NPAs) would buy out the stressed assets of a relatively weak bank at a consideration before the year-end and the transaction would be reversed the next year. It was a win-win situation for both the parties involved. The selling bank cleaned up its balance sheet, and the buying bank made money on the deal.
For a long time, the Reserve Bank of India refused to take note of this, but last month it put in place a set of norms dealing with how NPAs were to be bought and sold. Now, an NPA can be sold only if it has remained a NPA for at least two years in the books of the selling bank. In addition, the transactions can take place only on a cash basis, with the entire sale consideration given upfront.
The buying banks must hold the NPA in its books for at least 15 months before it is sold to other banks. Further, it cannot sell these assets back to the same bank that had sold the sticky loan.
Finally, the NPA purchased will be classified as "standard" in the books of the buying bank for 90 days from the date of purchase and thereafter, the asset classification status of the financial asset, will be determined by the record of recovery. In other words, if the buying bank has not been able to turn around the asset within 90 days, it will have be make a provision for it.
This will kill the clandestine inter-bank market for year-end NPA transactions. So far, the buying banks have only been lending their balance sheets to ward off the impact of NPA on their compatriots but now they will have to hold the acquired NPAs with all the risks associated with them. There will hardly be any takers for such deals and the banks will probably find approaching an asset reconstruction company (ARC) a better idea.
What advantages do the ARCs enjoy over commercial banks in NPA transactions? Quite a few. For instance, a bank can sell an NPA to another bank only when it is at least two years old. In case of an ARC, there is no restriction on the age of an asset. Similarly, a bank cannot sell as asset before 15 months of buying it from another bank but an ARC does not have any time frame for such a sale.
Then, inter-bank transactions are to be settled in cash while ARCs can buy stressed assets through security receipts, which can later be redeemed. Naturally, when the payment is made upfront in cash, assets are priced at a steeper discount to their book value. In overall terms, an ARC has more flexibility in buying NPAs.
That's why, at least on the face of things, the lone ARC in the country, the Asset Reconstruction Company (India) Ltd, which turned two this month, has been doing a roaring business. ARCIL has so far acquired 368 NPA accounts at an SR value of Rs 3,722 crore. The subscribers to the SRs are the banks themselves.
In effect, they have replaced their non-standard loans with standard investments. Their treasury divisions have bought the SRs which will generate cash after the actual assets are sold. The SRs represent a hugely discounted value of the assets actually acquired by ARCIL.
The actual value of the assets has been to the tune of Rs 16,500 crore (Rs 165 billion) -- a principal debt of Rs 8,100 crore (Rs 81 billion) and accumulated interest of Rs 8,400 crore (Rs 84 billion). Theoretically, ARCIL claims to have reduced the entire banking system's NPA by around 13 per cent.
Yet, ARCIL is hardly a success story since it has been able to buy only between 26 and 80 per cent of an asset and not the entire 100 per cent of any asset as all members of a lenders' consortium are not willing to hand over the NPA to ARCIL.
This is because they are not comfortable with the low valuation at which the assets are sold. They are scared of taking a hit on their balance sheets. This problem can be solved if more ARCs are set up. Only then can a benchmark for valuation evolve. The biggest roadblock for setting up more ARCs is the regulator's reluctance to welcome FIIs in this business.
The Securitisation Act, which paved the path for forming ARCs, allows qualified institutional buyers to pick up equity in ARCs as well as buy SRs. The RBI has in principle accepted that the FIIs will be allowed to pick up 49 per cent stake in ARCs and within this, an individual FII's exposure will be capped at 10 per cent. However, the rules on the FII entry has not been formalised yet.
