Fixing asset reconstruction processes

Are distressed assets being dealt with effectively?

Non-performing assets, or NPAs, have become a huge burden for the banking system at a time when its need to raise capital is increasing. Bad assets not only eat into internal accruals that might otherwise be used to enhance capital, they also weaken the ability of banks to attract fresh capital from outside. In the Indian context, if the government wants to preserve its majority shareholding in the public-sector banks, it will need to commit an even larger amount of funds because of this. Finding ways to both reduce the burden of existing NPAs and contain their rise in the future has clearly become a regulatory imperative. In its annual report for 2013-14, published last week, the Reserve Bank of India (RBI) highlighted this issue and also referred to a number of steps that have been taken on one part of the solution - asset reconstruction. Asset Reconstruction Companies (ARCs) have been in existence for more than a decade now, but their record in helping banks get the best value from repossessed assets has been far below expectations. But, in recent months, banks, mostly from the public sector, offloaded a significantly larger amount of assets to them, raising concerns that this was just a way to reduce the NPA load on their balance sheets, without genuinely realising their resale value. From such sales being negligible for a long time, they suddenly shot up to Rs 3,200 crore in the quarter ended December 2013 and further surged to over Rs 12,000 crore in the quarter ended March 2014.

In the meantime, the RBI took a number of initiatives to increase the effectiveness of the restructuring process. In January, a new Framework for Revitalising Distressed Assets was put in place, which was intended to facilitate early recognition of problematic assets, more effective debt restructuring and better recovery. One aspect of this was to set up a central repository of large exposures of banks, allowing all banks access to information about stressed or potentially stressed borrowers. Another was a set of guidelines for the operations of ARCs, making transactions between them and banks more transparent, and trying to ensure that the real resale value of the assets was actually realised by banks. These guidelines were further strengthened in August, with floors on transaction prices and prevention of collusion with promoters in buy-back deals. ARCs are now also required to enhance their capital, increasing their skin in the game.

Overall, the new framework, as it evolves, does constitute a significant improvement in the asset reconstruction process. There is, of course, room for improvement, particularly in breaking the organisational and ownership links between banks and ARCs, and in enhancing the capital base of ARCs - in which foreign investment may play an important part. Fully fleshed out, this model could provide a significant source of relief for bank balance sheets as they strive to limit NPAs. But beyond this, the larger emphasis on widely accessible information, penalties on wilful defaulters and other components of the framework, diligently enforced, will increase the banks' abilities to resist the build-up of new NPAs. Empowering their boards to make truly independent credit decisions is the next step in the process. This will need significant governance reforms, a blueprint for which has been laid down in a recent committee report.