R Gandhi: Asset reconstruction and NPA management in India
Keynote address by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the
"The Economic Times ReModel in India - Asset Reconstruction & NPA Management
Summit", Mumbai, 15 September 2015.
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Assistance provided by Shri A K Choudhary, Smt. Chandana Dasgupta and Shri B. Nethaji is gratefully
acknowledged.
Ladies and Gentlemen, Very Good Morning.
2. It is indeed a pleasure to be present here and interact with you on the important
issue of management of non-performing assets in India. Such events are quite important
especially when there is a surge in stressed assets in banking in the recent times.
Current Position
3. However, if we look a little far back, the asset quality of the Indian banking system
was not like this; it had actually been improving significantly since the implementation of
reforms in the banking sector and introduction of prudential norms, enactment of the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
Act 2002, Credit Information Companies Act, etc. The gross NPAs ratio steadily declined
from 15.7 per cent in 1996-97 to 2.36 percent in 2010-11. However, the amount of
nonperforming assets witnessed spurt subsequently and as on March 2015, it was at 4.62 per
cent of the gross advances of the banks in comparison with 2.36 per cent of the gross
advances as at March 2011. The growth in NPAs was much higher than the growth in
advances during the last four years. In addition, the ratio of restructured standard assets to
gross advances grew to 6.44 per cent as at the end of March 2015 from 5.87 per cent of
gross advances as on March 2014. The total stressed assets (i.e., NPAs plus Restructured
Assets) as on March 2015 were 11.06 per cent of gross advances.
4. The sharp increase in stressed assets has adversely impacted the profitability of the
banks. The annual return on assets has come down from 1.09 per cent during 2010-11 to
0.78 per cent during 2014-15. Considering the effect it has on both capital and liquidity
position of the bank, there is an urgent need for banks to reduce their stressed assets and
clean up their balance sheets lest they become a drag on the economy.
5. Managing asset quality is always very important and becomes a prominent objective
especially during a period of economic downturn. Recognising the importance of effective
asset quality management, Reserve Bank has issued various guidelines to banks, from time
to time, on various aspects of asset quality management.
Preventive Management
6. Reserve Bank has advised banks that the management of credit risk should receive
the top management's attention and the process should encompass:
a) Measurement of risk through credit rating / scoring;
b) Quantifying the risk through estimating expected loan losses and unexpected loan
losses
c) Risk pricing on a scientific basis; and
d) Controlling the risk through effective Loan Review Mechanism and portfolio
management.
7. Further, Reserve Bank has also advised the banks to put in place a robust credit risk
management system which is sensitive and responsive to various factors affecting credit risk.
The guidelines entail involvement of top Management, including the Board of Directors of the
bank in actively managing the credit risk of the banks. Banks are required to put in place
proactive credit risk management practices like annual / half-yearly industry studies and
individual obligor reviews, credit audit which entails periodic credit calls that are documented,
periodic visits of plant and business site, and at least quarterly management reviews of
troubled exposures / weak credits.
Recent regulatory initiatives
8. Recently, In January 2014, the Reserve Bank of India had released a
comprehensive "Framework for Revitalising Distressed Assets in the Economy". The
Framework outlines a corrective action plan that will incentivise early identification of problem
cases, timely restructuring of accounts which are considered to be viable, and taking prompt
steps by banks for recovery or sale of unviable accounts. In addition, to address the issue of
information asymmetry as also to identify the problem early, a Central Repository of
Information on Large Credits (CRILC) to collect, store, and disseminate credit data to
lenders, was set up. Under this arrangement, banks are reporting credit information,
including classification of an account as SMA to CRILC on all their borrowers having
aggregate fund-based and non-fund based exposure of ₹50 million and above with them.
9. While having a proper credit risk management is very important for managing asset
quality, another issue which is equally important is proper structuring of the credit facilities
extended to various borrowers. While granting credit facilities, banks should set realistic
repayment schedules on the basis of a proper analysis of cash flows of the borrowers. This
would go a long way to facilitate prompt repayment by the borrowers and thus improve the
record of recovery in advances. A "one size fits all" approach and providing plain vanilla
loans to all clients may not be in the interest of banks as well as its customers.
10. In order to effect a structural change in the way project loans are granted by banks,
and considering the need to facilitate banks to offer long term project financing, which may
ensure long term viability of infrastructure and core industries sector projects by smoothening
the cash flow stress in initial years of such projects, Reserve Bank has issued guidelines on
flexible structuring of long term project loans with periodic refinancing option. Reserve Bank
has also introduced the concept of "standby credit facility" to fund cost overruns in projects.
Such "standby credit facilities" are sanctioned at the time of initial financial closure; but
disbursed only when there is a cost overrun. At the time of initial credit assessment of
borrowers / project itself, such cost overruns are assessed, agreed to be disbursed in the
eventuality of cost over runs, and the Debt Equity Ratio, Debt Service Coverage Ratio, Fixed
Asset Coverage Ratio, etc. are determined accordingly. Thus, there may not be any need for
the borrower to approach the banks at a later stage for additional finance.
Restructure / rehabilitation
11. However, despite proper credit appraisal and proper structuring of loans, slippages
in the asset quality may not be unavoidable, especially when the economic cycles turn
worse. Hence, once a weak account is identified, banks need to consider various remedial
actions. One of the remedial options is restructuring. In spite of their best efforts and
intentions, sometimes borrowers find themselves in financial difficulty because of factors
beyond their control and also due to certain internal reasons. For the revival of the viable
entities as well as for the safety of the money lent by the banks, timely support through
restructuring in genuine cases is called for. The objective of restructuring is to preserve the
economic value of viable entities that are affected by certain internal and external factors and
minimize the losses to the creditors and other stakeholders.
12. Such support to borrowers who are in temporary financial difficulties need not be
contingent upon retention of asset classification status as "standard". There is a tendency
among banks to withdraw their support once an account is classified as NPA. Mere
classification of an account as non-performing asset need not result in withdrawal of support
to viable borrowal accounts. The purpose of asset classification and provisioning is to
present a true picture of bank's balance sheet and not to stigmatize accounts / borrowers.
However, while considering their support to accounts under stress, banks should make
proper distinction between willful - defaulters / non-cooperative / unscrupulous borrowers on
the one hand, and on the other hand, borrowers defaulting on their debt obligations due to
circumstances beyond their control.
13. As you may be aware, Reserve Bank has withdrawn special asset classification
benefits available to restructuring of assets with effect from April 1, 2015 to align our norms
on restructuring with international best practices. Subsequent to that there is a sudden drop
in the assets being "restructured" and it seems that banks have become very choosy in
restructuring loans to borrowers who are under stress. One of the reasons cited for drop in
restructuring of assets is that "banks have no incentive in restructuring". We feel that decision
of the banks in restructuring should be driven by their motivation to revive an account which
is under temporary financial difficulties and preservation of the economic value of viable
entities in the interest of both the creditors and borrowers, rather than merely concentrating
on asset classification and provisioning benefits.
Recovery / exit
14. As a first step towards effective recovery / exit framework from accounts which are
beyond revival, banks should have a well -defined loan recovery policy which sets down the
manner of recovery of dues depending upon the circumstances of each account. Banks may
resort to either opt for legal avenues or non-legal avenues for exiting the account. Banks may
enter into compromise settlements in terms of their Board approved policy for compromise
settlement of NPAs. However, adequate care should be taken to ensure that the compromise
settlements are done in a fair and transparent manner. Banks may also sell their NPAs to
other banks (which happens outside the SARFAESI Act). There are a few banks which have
better recovery expertise and we have seen instances of them purchasing NPAs from other
banks.
15. In the event of failure of the above mentioned measures, banks could resort to filing
suits with Debt Recovery Tribunals or invoke the provisions of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. An
alternate option to enforcement of security interest is that of selling the NPAs to securitisation
companies / reconstruction companies (SCs / RCs) registered under the SARFAESI Act.
SCs / RCs are expected to do a specialized task of recovering and reconstructing the NPAs
thereby reducing the NPAs in the system. The purpose of creation of SCs / RCs was to
resolve NPAs of banking system by using their expertise.
Asset reconstruction companies
16. As on date 15 SCs / RCs are registered with Reserve Bank. Sale of NPAs to
SCs / RCs which was relatively sporadic has picked up substantially during the last two
financial years.
17. However, only a few of them appear to be successful in acquiring assets from
banks. Of 15 registered SCs / RCs, asset size in respect of top three SCs / RCs (viz., ARCIL,
"JM Financial" and "Edelweiss") account for more than two thirds of total assets of all
SCs / RCs.
18. An analysis of purchase of NPAs by SCs / RCs indicate that acquisition cost as a
percentage to book value of assets increased sharply from 20.8 per cent as on March 2013
to 44.5 per cent as on March 2015. In other words, the discount rate at which SCs / RCs are
acquiring NPAs from the banks / FIs decreased considerably, possibly on account of
(i) developing of improved NPA recovery methods by banks (ii) selling of relatively fresh
NPAs (iii) outsourcing the valuation of NPAs (iv) presence of competition among SCs / RCs
while auctioning NPAs.
19. On the recovery side, the performance is not very encouraging. As on March 31,
2015, the average recovery rate (assets resolved as a % to assets acquired) of SCs / RCs
was at 31.0 per cent. One of the reasons for a dip in the average recovery rate is due to the
fact that substantial part of the assets under management of SCs / RCs is acquired recently.
Further, a wide variation in recovery rates among SCs / RCs is also observed for the same
reason.
20. An analysis of investor class in security receipts (SRs) does not depict any
divergence. It is observed that seller banks / FIs have been subscribing majority of SRs. On
an average seller banks / FIs have been subscribing 74 per cent of total SRs issued during
the period March 2010 to March 2015. In past two years, seller banks subscribed around
80 per cent of total SRs.
21. The aggregate asset size of SCs / RCs witnessed sharp growth of 64.8 per cent
during 2014-15 on top of 21.3 per cent growth witnessed in the previous year. In numerical
terms, aggregate asset size of SCs / RCs stood at ₹ 6920 crore as on March 31, 2015. The
reported average Return on Assets of SCs / RCs was at 3.48 per cent while the average
Return on Equity stood at 4.48 per cent during the period March 2010 to March 2014.
22. RBI has recently taken various steps to improve the system's ability to deal with
distressed assets of banks and financial institutions. Reserve Bank has issued various
guidelines relating to the operations of SCs / RCs as also to make transactions between
them and banks more transparent. These guidelines were further strengthened with floors on
transaction prices and prevention of collusions with promoters in buy back deals. The
modified guidelines mandated SCs / RCs to have an increased skin in the game by making it
compulsory for them to invest and hold minimum 15% (as against 5% hitherto) of the security
receipts issued by them.
23. In order to promote the business of asset reconstruction in India, foreign direct
investment cap on SCs / RCs has been increased from 49 per cent to 74 per cent under the
automatic route. While foreign institutional investors have also been allowed to participate in
the equity of the SCs / RCs, the maximum shareholding by FIIs cannot exceed 10% of the
paid up capital of the SC / RC. With a view to facilitate debt consolidation, SCs / RCs are
now permitted to acquire debt from other SCs / RCs. SCs / RCs have also been permitted to
convert a portion of the debt into shares of the borrower company as a measure of asset
reconstruction. Consent threshold for security enforcement actions has been brought down
to 60 per cent of the amount outstanding to a borrower as against 75 per cent hitherto.
SCs / RCs with acquired assets in excess of ₹ 500 crore can float a fund under a scheme
and utilize upto 25% of funds raised from the qualified institutional buyers for restructuring of
financial assets acquired. Promoters of the defaulting company / borrowers or guarantors are
allowed to buy back their assets from the SCs / RCs subject to certain conditions that are
helpful in the resolution process and minimization of cost. Guidelines on Uniform Accounting
Standards for SCs / RCs has been issued for reckoning Acquisition cost, Revenue
Recognition, Valuation of SRs, etc. to induce transparency in the books of SCs / RCs. Norms
for calculation of management fee has also been rationalised. Management fee will now
have to be based on the net asset value of the SRs rather than the outstanding SRs issued
24. With these regulatory changes, SCs / RCs will need to focus on actual redeeming of
security receipts as it is no longer possible for them to base their profit model on the basis of
management fees. In the near term, SCs / RCs may find it difficult to align their pricing to the
expectations of the selling banks and the selling banks also may not have yet reconciled to a
realistic sale price expectation for the assets that they want to offload, resulting in the
reduction in sales. The rationale behind these regulatory changes was to incentivise the
process of recoveries / restructuring, as net asset values of SRs is calculated on the basis of
the likely rate of recovery of stressed assets.
25. The RBI has also advised that the banks using auction process for sale of NPAs to
ARCs should be more transparent, including disclosure of the Reserve Price specifying
clauses for non-acceptance of bids, etc. If a bid received is above the Reserve Price and
also fulfils the other conditions specified, acceptance of that bid would be mandatory.
26. It is expected that these amendments to the regulations will improve recovery
prospect for SCs / RCs. Membership of JLF, lower threshold for consent to enforce the
SARFAESI Act, more time set to conduct due diligence and greater disclosures will enhance
transparency and lead to better resolution of NPAs. It would also result in lower vintage of
NPAs being sold by banks and quicker debt aggregation.
NPA Management - New Thoughts
27. Let me now share with you some of the thoughts we have been discussing on NPA
management.
Enhancing Credit Appraisal Capacity
28. One of the fundamental issues that hampers NPA Management is the inadequacies
in the credit appraisal capacity of banks, more specifically on project appraisal. As we know,
there is just one technical consultancy firm, besides some specific desks in some banks.
With the requirement of independent evaluation for JLFs and the number of JLFs, there is a
crying need for emergence of additional technical capabilities to undertake evaluation of
projects, restructuring schemes, etc. Banks will have to strengthen their in-house desks as
well. Reserve Bank through the Centre for Advanced Financial Research and Learning has
taken initiative to organise capacity building program for bankers.
Number of members in a consortium
29. Another suggestion that has come relates to limiting the number of banks and
financial institutions that should be permitted in a consortium or even in a multiple banking
arrangement. It is said that the banks with very meagre share neither have incentives nor
inclination to independently assess the proposal and they typically and blindly go by one that
has bigger share. Even if the bank has in-house technical capabilities, with a small share its
voice is not strong enough. Therefore, the suggestion is to have a regulatory limit on the
number of members in a consortium or multiple banking arrangements so that every member
has at least 10% of the exposure and therefore will have serious independent credit
appraisal and credit monitoring. There are counter views about this suggestion, especially
with regard to the freedom to be available for a bank or borrower to take the commercial
decision on a loan.
Ready list of management and technical experts / specialists
30. Yet another suggestion is to prepare a ready list of management and technical
experts and specialists whose services can be availed by banks, financial institutions or the
asset reconstruction companies whenever the JLFs decide to change the management
under a CAP. Perhaps IBA can prepare and update such a ready list.
31. All these suggestions need further exploration and discussion before we take a final
view.
Issues faced by SCs / RCs
Capital
32. There is no denying the fact that SCs / RCs need capital and that too on continuing
basis to be able to grow and be meaningful players in the sector while avenues of raising
capital is limited. The networth of 15 ARCs is only around ₹4000 crore whereas stressed
assets in the system run into lakhs of crore. The industry being a capital intensive one,
SCs / RCs are struggling to raise capital. Deep-pocket investors are interested in the
business but cautious on account of slow pace of judicial and administrative environment.
While there is limited appetite among the existing sponsors and shareholders, the limit of
50 percent on individual shareholding and the stipulation that the sponsor should not have
any controlling interest in the SCs / RCs (as stipulated by the SARFAESI Act) are proving to
be stumbling blocks in this regard. However, it needs to be mentioned here that it would not
be an easy option for SCs / RCs to raise funds through IPO for the reason that while on the
one hand, there is an apparent lack of investor appetite in the domestic market in the
distressed space, the performance of SCs / RCs has, so far, remained dismal for a variety of
reasons and this may prove to be a road block. SCs / RCs that can raise capital in a timely
manner will be better positioned to play an active role in the field. SCs / RCs need to explore
more in this regard especially through FDI route. There has also been a demand from the
industry that subordinated debts like loans from the sponsors should be designated as Tier II
capital and should be taken into account while calculating the capital adequacy of the
SCs / RCs.
Pricing of NPAs
33. The other important issue is pricing of NPAs. Currently there is no meeting point
between price expectation of sellers and bid price by SCs / RCs, which is also evident from
the low success rate of auctions. This also proves to be a hindrance while bringing in more
investors willing to invest in the SRs being issued by the SCs / RCs to raise funds for
acquisition of NPAs. Investors in stressed asset portfolios expect high returns, based on
high-risk, high-reward principle which SCs / RCs find impossible to offer if the assets being
acquired are not realistically priced. Equilibrium in offer and bid prices is essential for revival
of the NPA market. This issue is best resolved by market forces and participants. Indian
Banks Association in consultation with Association of Asset Reconstruction Companies may
draw contours of mutually acceptable methodology for reserve price valuation. Discovery of
fair price for NPAs may definitely help in more deals going through auctions and also
generate interest from secondary investors like distress asset funds which can participate via
SCs / RCs.
Need of secondary market for SRs
34. In the absence of third party investor money which is an automatic fall-out of a
virtually non-existent secondary market, the bank that sells NPAs doubles up as investor in
SRs. A meaningful solution would have been to delink investment in security receipts from
only a select group of qualified institutional buyers (QIBs) (as mandated under the
SARFAESI Act) and throwing it open for all institutional players in debt trading. Further, as
pointed out by the SCs / RCs, in terms of Guidelines issued by SEBI, High Networth
Individuals (HNIs) are already allowed to participate in the SR market as Alternate
Investment Funds (AIFs) have been notified as QIBs, eligible for investment in SRs issued by
SCs / RCs. One possibility is that they may be allowed to participate directly in the
SR market, as they have necessary risk capital and risk appetite. This measure may help
widen investor base and infuse greater depth to the secondary market for SRs. An active
secondary market for SRs will attract special situations funds and QIBs to this market.
Reserve Bank has already suggested to the Government of India that Section 7 of the
SARFAESI Act may be amended by giving power to RBI to specify the category of the
investors from time to time in consultation with SEBI.
Debt Aggregation
35. While sale of NPAs by banks depend on various factors like security package
available, best price, etc., and therefore many times sale with respect to debt of a single
borrower to a single SCs / RCs may not be possible, sale of entire debt of one borrower to
single SC / RC would help in effective and efficient resolution. Piece meal sale of an asset
particularly with turn around potential by different lenders defeats the purpose itself as it
results not only in delays but also pricing hiccups and derails resolution process.
Alternatively, SCs / RCs may also need to evolve mechanism to coordinate in successful
resolution of those assets, in the best interest of all stake holders.
Judicial delays
36. An important factor affecting recovery performance of SCs / RCs is the delay in
judicial process: be it under SARFAESI Act or at the level of debt recovery tribunals. A fast
and efficient judicial system is a sine qua non for effective resolution of NPAs. Realising the
importance of having a strong bankruptcy framework in improving the ease of doing
business, Government of India has constituted a Bankruptcy Law Reforms Committee to
study the corporate bankruptcy legal framework in India. The Committee has submitted an
Interim Report in February 2015 for immediate action and its Final Report is expected to be
submitted within 12 months, recommending a Bankruptcy Code. Reserve Bank expects that
recommendations of the Committee, when implemented, would result in significant
improvement in the bankruptcy framework of the country and enable banks / SCs / RCs to
resolve their stressed assets in an effective manner.
Conclusion
37. I am sure that with the efforts of the Government in bringing in a strong bankruptcy
framework and various regulatory initiatives being taken by the Reserve Bank of India, the
effectiveness of the SCs / RCs would improve to a great extent. At the same time, I hope that
the market participants iron out the frictions which are best resolved among themselves,
without looking for regulatory solutions to such issues.
38. I find that you have a technical session on regulatory limitations on unlocking the
potentials of NPAs, solutions for managing NPAs and even preventive measures. I wish the
event a great success and will look forward to receive your considered suggestions and
comments.
39. Thank you very much for your patient attention.