Why a “bad bank” could be a good idea for India

Who will fix India’s bad loan mess?
Who will fix India’s bad loan mess?
Image: REUTERS/Rupak De Chowdhuri
We may earn a commission from links on this page.

One of the worst victims of the ongoing economic crisis in India is the country’s already wounded financial sector. With businesses struggling to survive, bad loans are expected to rise, denting Indian banks’ health.

But someone’s loss is another’s gain.

Asset reconstruction companies (ARCs)—that buy bad loans of banks and try to recover money from defaulters—are expected to be in demand in India going forward as the economic slump leads to a surge in non-performing assets (NPAs).

Even global players are smelling an opportunity. Canada-based asset management firm Brookfield is reportedly going to set an ARC in India.

“Naturally, lenders will be looking for resolution of bad loans. Hence, some of those cases may be put up for sale to ARCs. Going forward, there will be additional opportunity for us,” said RK Bansal, managing director and chief executive officer, Edelweiss ARC, one of the segment leaders in India.

This doesn’t mean ARCs are devoid of problems. The economic crisis, which provides them with a huge opportunity, has also adversely impacted their business. From raising capital to recovering money, ARCs are fighting on multiple fronts.

Also, the Indian Bankruptcy and Insolvency Code (IBC), which was implemented in 2017, has smoothened the process of recovering money from defaulters, which makes lenders at times prefer this route over going to ARCs.

In an interview with Quartz, Bansal spoke about the challenges ahead and how the issue of burgeoning NPAs can be solved. Edited excerpts:

Can you explain how an ARC functions in India?

Initially, ARCs had a fee-based business model. Banks would pay ARCs a fee to handle bad loans. But then the Reserve Bank of India (RBI) introduced the 5:95 concept, that is, if an ARC was buying a stressed asset, it had to invest a minimum of 5% of the acquisition price. Later, when Raghuram Rajan was the governor of RBI, this was increased to 15% as the central bank believed that this would lead to ARCs having more skin in the game. 

Has the Covid-19 slump increased business opportunities for ARCs?

There are two sides to the current economic slump. It has adversely impacted the recoveries of bad loans as people are unable to pay. Some of our clients from whom we have to recover money are facing operational difficulties due to the lockdown. So, they are asking for more time to repay their dues. Some of the asset sales, which were in the process of getting completed, have been postponed. Similarly, IBC cases have been delayed as the National Company Law Tribunals (NCLTs) are not fully functional.

However, some of the borrowers of banks and non-banking finance companies (NBFCs) can turn into non-performing assets as the moratorium has ended and the economic downturn continues. Naturally, lenders will be looking for resolutions of bad loans. Hence, some of those cases may be put up for sale to ARCs which is an opportunity.

What are the challenges to an ARC business in India?

Raising capital for acquiring more assets is one of the biggest challenges.

How useful are ARCs to India’s financial system as the NPAs are set to rise?

ARCs cannot single-handedly solve India’s NPA problem. You need the option of restructuring of stressed assets and IBC. The biggest advantage of having ARCs is that they can aggregate the debt. In the past, many resolution plans have failed because lenders couldn’t agree among themselves. If ARCs can aggregate debt, then they can solve the problem.

ARCs also provide the option of restructuring of an asset. The third option is that ARCs can give additional financing, which banks won’t because that additional amount also has to be recognised as NPA thus attracting provisioning.

Have ARCs benefited from the implementation of IBC?

IBC has helped ARCs to recover money faster. For example, we went to IBC along with Bank of Baroda for recovery from Binani Cement. We recovered the full money in a year, which otherwise would have taken five to seven years. The laws of the recovery model were too tedious before the implementation of IBC. It would take five to 10 years to recover money from a defaulter.

But now a promoter has to cooperate under the new law. If lenders or ARCs go to NCLT under the IBC, the promoter loses control of the company on the first day itself. This has completely changed borrowers’ behaviour.

Is there a difference between how ARCs work in India in comparison to other countries?

There are very few countries that have a private sector model for ARCs like in India. Globally, there are big stressed asset funds like Brookfield. The primary reason for this is that globally the corporates borrow through the bond market rather than from banks. It makes it easier for stressed asset funds to buy bonds and then work with managements or change them.

There is a private equity model, which is also popular globally. They invest in a stressed asset, improve it, and then sell the unit or even run it. We will reach this level eventually but right now we don’t have a developed bond market.

In India, it’s completely different. Currently one can’t buy stressed assets directly from debt markets. One has to go through ARCs. After buying the asset, ARCs work with borrowers or find a new investor and improve the company by restructuring and give additional funds required for revival. Following which, over a period of time the recovery of the money takes place, and then it is paid back to banks.

Should there be a bad bank? Should the government intervene in the recovery market?

A bad bank is basically an ARC. It’s a good idea. The Indian government hasn’t gone through with the implementation of this idea so far. Many countries like Korea and Thailand have adopted this model and their governments have invested money in a bad bank. If a bad bank is to be set up in India, the government will have to invest large amounts. For instance, a bad bank in India would need to invest 15% of the purchase price in a stressed asset as we discussed earlier.

There is also a direct conflict of interest. The state-owned banks will sell assets to a government-owned bad bank. It means the price discovery isn’t transparent.