Financial Sector : Important Developments in 2002
What is an Asset Reconstruction Company?
An Asset Reconstruction Company (ARC) is a company that is set up to do exactly what the name suggests - reconstruct or re-package assets to make them more saleable. The assets in question here are loans from banks, card companies, financial institutions etc.
Why do we need ARCs?
Bad loans are essentially of two types: those that are a consequence of routine banking operations and those that are a reflection of a greater systematic rot, as in the Indian context where the bulk of non-performing assets (NPAs) is due to government interference/loan waivers/difficulties in recovering dues etc. There are essentially two approaches to tackling NPAs : one, leave the banks to manage their own bad. Two, do the same thing on a concerted, central level, through a centralised agency or agencies. ARCs are centralised agencies for resolving bad loans created out of a systematic crisis.
ARCs buy up distressed assets from banks/card companies and other financial institutions, re-package them and then sell them in the market. NPAs can be assigned to ARCs by banks at a discounted price, enabling a one-time clearing of the balance sheet of banks of sticky loans.
At the same time, the ARC can float bonds and recover dues from the borrowers directly. ARCs can have several alternate structures. They can either be publicly or privately owned or a combination of both, and can be either separately capitalised units or wholly-owned subsidiaries.
What are the advantages of setting up an ARC rather than leaving NPA recovery to Individual banks ?
Centralisation of bad loans in one or a few hands and therefore, obviously more clout.
Banks are left with cleaner balance sheets and do not have to deal with problem clients.
Because ARCs deal with a larger portfolio, they can mix up good assets with bad ones and make a sale, which is palatable to buyers.
It is easier to do a capital-market based funding for an ARC than for the banks themselves.
Are ARCs peculiar to India ?
Several countries have tried variants of the ARC. In the Czech Republic (1995), Sweden (1992) and Thailand (1998) the troubled bank was split into a `good' bank and a `bad' bank. This approach is probably best when only one or a few banks are in serious difficulty.
The alternative approach, used in the United States (1989) during the Savings and Loan crisis and more recently in Korea (1997) and Malaysia (1998), has been to establish a single asset management corporation to purchase NPAs from a number of banks; in effect, there will be one large `bad' bank for the whole banking industry. In case a large number of banks are in difficulty and the assets acquired have a certain degree of homogeneity, a single entity may reap economies of scale and make best use of scarce managerial talent.
Why are ARCs in the news now ?
ARCs are in the news today because after the passage of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, it has become much easier for ARCs to sell assets that they buy from banks.
Earlier ARCs had to go through the same lengthy court procedures before they could sell assets taken over and hence there was no interest in setting up ARCs.
The RBI has since framed draft guidelines for setting up and running of ARCs. Under the guidelines, the bank has specified things like a minimum paid up capital - Rs.2 crore, manner of valuation of assets taken over etc. As of now, there is one ARC set up by ICICI Bank on a pilot basis but in time we should be seeing a couple more.
ARCs must have Rs.2 cr minimum funds
The draft guidelines on Asset Reconstruction Company (ARC) pepared by the committee appointed by the RBI and released on December 18, 2002 have set Rs.2, crore of minimum owned funds for a recognised ARC, and made it mandatory for them to obtain a certificate of registration from the apex bank before commencement of business. The norms also propose that every securitisation company /reconstruction company (S&R company or ARC) shall frame, with the approval of its board, a'Financial Asset Acquisition Policy' within 90 days of grant of Certificate of Registration, which will clearly lay down policies and guidelines.
The acquisition of assets by an S&R company shall be in conformity with the principles of `true sale' whereby the risks and rewards associated with the assets stand transferred to the transferee. Asset acquisition should be made under the supervision of an Asset Acquisition Committee, which is a committee of the board with independent directors (who are not nominees of the sponsors) in majority. The norms for ARCs are issued in line with the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Second) Ordiance, 2002, promulgated by the Centre on June 21, 2002, which empowered RBI to frame the guidelines.
The directions to be called "The Securitistion Companies/Reconstruction Companies (Reserve Bank) Directions, 2002', also envisages that the existing ARCs would cease to do such business within one year from the commencement of the ordinance, i.e. by June 20, 2003. And S&R companies are not suposed to undertake any activity other than S&R activity without the prior permission of RBI. The draft allows ARCs to set up one or more trust which could issue security receipts to qualified institutional buyers (QIBs) under section 7 of the ordinance, and trusteeship of such trusts should vest in their board of directors. The security receipts issues are transferable/assignable only in favour of other QIBs.
ARCs cannot take over management or sell or lease, the whole or part, of the business of the borrower. They may, however, take recourse to any of the measures to recover the secured debt as provided for in sub-section (4) of section 13 of the Ordinance.
According to Shri M.R. Umarji, former ED of RBI who has helped draft the legislation on securitisation and reconstruction of assets, acquiring assets is a better alternative compared to acquiring management control of a business. "While acquiring management control the acquirer also has to take over the liability of the company, while this is not the case while acquiring assets.
Promoters wanting to get into the asset reconstruction business will have to set up a separate company, as according to the guidelines, only an ARC can undertake securitisation and asset reconstruction. RBI has prescribed aggressive provisioning requirements, with the ARC having to classify an asset as a non-performing if it is not able to resolve it throgh reconstructing or sale within 12 months. In terms of the guidelines, the asset acquired by the ARC will have to be written off at the end of 36 months from the date an asset becoming NPA in the books of ARC.
A company can do the composite business of asset reconstruction and securitisation. But in the case of securitisation, the securitised paper can be issued only to Qualified Institutional Buyers such as FIs, insurance companies, mutual funds and provident funds.
The norms also bar ARCs from purchasing the secured assets put on sale in exercise of its rights of enforcement of security interest through private treaty or by obtaining quotations from persons dealing with similar secured assets.
Rescheduling and/or settlement of debts should be done according to the rules framed by their boards and under the supervision of a committee formed by the board for the purpose, the draft norms say. However, new ARCs could be formed in joint venture.
An ARC, which is carrying on any other business, shall cease to do such business within one year from the commencement of the Ordinance i.e. by June 20, 2003. No S&R company could change or takeover the management of or sell or lease, the whole or part of the business of the borrower. They may, however, take recourse to any of the measures to recover the secured debt as provided for in the ordinance.
The guidelines have also specified the continuous disclosures to be made by ARCs, besides those relating to the issuer of security receipts and terms of offer. The continuous disclosures include declaration of NAV; defaults pre-payments, losses if any, during the period; change in credit rating if any, and change in profile of the assets by way of accretion to or realisation of assets from the existing pool.
The ARC to function as a trustee
ARC of India, which has been floated by ICICI Bank, IDBI, SBI, HDFC, HDFC Bank and a clutch of other banks.
The Company, has an equity base of Rs.10 crore. It's Chairman is Shri N. Vaghul, Chairman, ICICI Bank. Other Members are S/Shri Deepak Parekh, Chairman, HDFC, P.P. Vora, Chairman, IDBI and P.N. Venkatachalam, MD, SBI.
The independent Directors of the Board are S/Shri Ashok Ganguly, J.J. Irani and Y.H. Malegam. The ARC will function as a trustee and buy distressed assets from banks. "Globally, qualified institutional buyers (QIBs) buy the distress assets. Since this market has not developed in India as yet, banks will be issued units against the assets and these units can be encashed after the assets are recovered. In essence, the ARC will act as a fund.
"To start with, it will buy sticky assets of banks in small tranches. Unlike in other parts of the world, where the sticky assets are sold at a very steep discount - as much as 85 percent - in India the stressed assets are unlikely to be sold cheap as all assets here are backed by collaterals and most of them are productive assets. We expect them to fetch a price of around 35-40 per cent of the book value", sources said.
Trading Profits of banks rise
A significant rise in the trading profits of banks coupled with the containment of operating expenses has helped them improve their profitability during the year ended March 31, 2002. A softer interest rate regime has helped commercial banks record a rise of nearly 41.6% in their other income to Rs.24,056 crore. Among bank groups, the increase was 33.6% for public sector banks, reflecting the increased diversification undertaken by them for fee-based activities.
Old private sector banks recorded a massive increase in other income of 114% to Rs.2,221 crore while new private sector banks recorded an increase of 93.1%. Investments, especially in government securities, constitute a considerable portion of assets of commercial banks in India. As of March 31, investments accounted for nearly 20% of total assets of banks.
The net profits of scheduled commercial banks during 2001-2002 at Rs.11,572 crore, increased by 81% over the previous year.
The RBI has clearly indicated that the voluntary retirement scheme has helped banks to show a higher profitability. Treasury income aside, another factor which pushed up the profitability of public sector banks was voluntary retirement scheme (VRS) introduced in 2000-01. According to the Trend and Progress Report of RBI, VRS brought down the wage bill of PSU bank by 6.2% in the subsequent year. For PSU banks, the reduction in wage costs was Rs.1,884 crore on account of the VRS scheme introduced in the previous year.
With the lowering of wage costs, the ratio of wage bill to total assets of commercial banks declined from 1.8% in 2000-01 to 1.4% in 2001-2002.
The staff costs as a proportion of total costs declined during 2001-2002, despite apportionment for VRS. The business per employee and profitability (as measured by return on assets) for PSU banks has increased during 2001-2002; Net profit of PSU banks rose sharply to Rs.8,301 crore in 2001-2002 from Rs.4,317 crore in 2000-2001 mainly due to treasury income as well as due to VRS to some extent.
Home, retail sector bring about growth
The entire banking sector grew mainly on retail loans during 2001-2002. According to the figures released in the Trends & Progress Report, retail loans comprising housing, consumer loans and other personal loans together went up Rs.12,900 crore in 2001-2002, while loans to industry (small, large and medium scale) rose Rs.10,684 crore. The corresponding figures in the previous year were Rs.6,409 crore and Rs.18,706 crore for retail and industrial loans.
Report erring cases directly : RBI tells NBFCs
RBI has directed non-banking finance companies to ask their auditors to report directly to the regulator all cases of violations of norms noticed by them in the course of their audit. In 1998, the Central Bank had told auditors of NBFCs to directly report irregularities spotted by them.
The Central Bank has now said that NBFCs must specify this to their auditors, according to the Trend & Progress Report.
The aggregate assets of the NBFC sector as on March 31, 2001 was Rs.53,879 crore, after a 5% increase over the last year, despite a decline in the number of reporting companies to 981 from 1005.
Share of residuary NBFCs in the total assets has gone up 30.2% as on end March 2001. The quantum of public deposits reported by these companies stood at Rs.18,085 crore - about 1.7% of aggregate deposits of scheduled commercial banks.
National Company Law Tribunal set up
After Parliament has passed the Companies (Amendment) Bill, 2001 under which, the BIFR-High Court system is to be replaced by a National Company Law Tribunal that will combine the powers exercised by the BIFR and its appellate tribunal, the AAIFR, alongwith that exercised by the Company Law Board. More important, the jurisdiction and powers relating to winding up proceedings will now be given to the tribunal. All pending winding up cases before various High Courts will also be transferred to the tribunal. If companies that are beyond redemption are wound up quickly, it will leave the capital in them free to be reinvested elsewhere.
A sick company will now be detected earlier - while a firm had to have eroded all its net worth to be referred to the BIFR, a firm will now be referred to the tribunal much earlier, when its accumulated losses equal only to half the net worth, or when it fails to repay debt on demand within any of three consecutive quarters. And unlike the earlier scheme where you registered in the sick ward first, and only later came up with a revival plan, any firm that is referred to the tribunal will have to simultaneously come up with a revival scheme. Also, if independent agencies such as banks or financial institutions find a company is becoming sick, they can approach the tribunal directly.
However, healthy firms will now have to contribute 0.1 percent of their turnover to form a Revival and Rehabilitation Fund to pay the workers' dues from sick firms and to help revive the unit.
Govt. to permit Asset-Stripping of sick units
The govt. is to permit the National Company Law Tribunal to dispose of some assets of sick industrial units ahead of the finalisation of a scheme for rehabilitation of the company in the amended companies (Amendment) Bill, 2001.
This means if the NCLT feels that disposal of some assets is necessary even as it is considering a scheme of rehabilitation and revival of a unit, the tribunal can during the course of inquiry allow sale of certain assets.
The original bill however, states that tribunal could direct a company not to dispose of any assets during the period of preparation or consideration of the rehabilitation scheme.
The NCLT would also be empowered to direct the company to hold an extraordinary general meeting to seek shareholders clearance to issue fresh shares at discount in the scheme of rehabilitation and revival of the company.
The NCLT will have the power to direct convening of the EGM concurrently with the Central government, according to the amendments to be incorporated in the bill currently in the House.
The govt. has also decided to transfer power pertaining to reduction of share capital to the NCLT. At present, companies have to seek clearance of the high court u/s 100-103 of the Companies Act, 1956, to reduce its share capital after being authorised by a special resolution of its shareholders.
RBI puts cap on Loans to Directors
In a move to obviate conflict of interest in lending operations of financial institutions, the RBI has directed them `not to grant' loans or advances on the security of its own shares or enter into any commitment on behalf of their directors in which they may have interests.
FIs or its subsidiary should not grant loans to a director who holds substantial interests to an individual, who is a partner or a guarantor of the concerned director, the central bank said on 21.12.2002.
To address the issue of reciprocal arrangements among FIs and banks for extending credit and non-funded facilities, awarding contracts to each others directors or their kin, RBI said FIs should not grant loans of Rs.25 lakhs and above to any director who `holds substantial interest or is interested as one or as a guarantor'.
On extending guarantees and establishing letters of credit on behalf of its directors, RBI has said in the event of default by the principal debtor, the FI will have to honour its obligations and the relationship between the FI and the director can become one of a creditor and a debtor. The FI will not be called upon to grant any loan or advance to meet the liability consequent upon the invocation of guarantee or devolvement of letter of credit and no liability will devolve on the FI. With reference to loans and advances to relatives of the FI directors or them such loans should not be granted except to the extent permitted in the guidelines.
Banks instructed to give reasons for refusing a loan.
The RBI has made it clear that banks and financial institutions armed with the new security enforcement law must also honour their part of the deal. In the Fair Practices Code on Lenders Liability issued today, the central bank has said that lenders should ensure `timely disbursement' of loan sanctions and specify reasons for rejection of loans.
The guidelines, which are aimed at customer protection, also require that lenders should keep the borrowers informed about the state of their accounts from time to time and inform them of any change in the terms and conditions, including interest rates and service charges. They should also release securities on receiving payment of loan or realisation of loan. Some of the norms prescribed for lenders are :
A high level meeting in the Planning Commission on 10.12.2002 on the flow of credit to the small scale sector decided to work on various proposals that would remove the current hurdles in such units seeking institutional finance. Among the proposals under consideration are those on hiking the loan limit at prime lending rates and on collateral security alongwith legislations for delayed payments and factoring services.
The Dy. Chairman of the Planning Commission, Shri K.C. Pant, said the RBI had been asked to look into the issues including reduction in lending rates to SSIs at prime lending rate and to come up with concrete suggestions by January, 2003.
ShriVepa Kamesam, Deputy Governor, RBI said refusal of loans to small units should be referred to higher authorities in the bank and the unit had to be informed about the reason why the loan applications had been rejected.
Shri Pant added that a Delayed Payment Act was under considration in view of the large number of cases where large units had delayed payments due to SSI units, which in turn had resulted in the default in payment of bank loans by the smaller companies. Overall, there were 73 lakh defaulters of which a bulk 63 lakh were from the small scale sector. In value terms, 19 percent of the defaults of bank loans were from the small sector.
The Secretary in the Deptt. of SSI, Shri Ashok Pradhan, said the proposed Delayed Payment Act was under consideration of the Finance Ministry and certain contentious issues needed to be sorted out. The proposed Act would seek to disallow MODVAT credit on goods purchased from the small units if payment was not made within a stipulated time. The legislation might also make provisions to disallow deduction of expenses to the extent of dues outstanding to SSI for the purpose of calculation of income-tax rebate.
The proposed Factoring Service Act would enable banks to take over the assets of large units with outstanding dues to SSIs and pay 80 percent of the dues amount upfront. The Government was also planning to streamline micro-finance in the SSI sector.
RBI drive in West Bengal
The RBI on December 10, 2002 assured the West Bengal govt. that a special drive to increase bank loans for the state's SSIs, agriculture sectors and self-employment schemes would be taken up next month in the face of complaints of low CDR in commercial banks. This was stated by West Bengal finance minister, Shri Asim Das Gupta who attended a meeting with RBI Governor, Shri Bimal Jalan alongwith Chief Minister Shri Buddhadev Bhattacharjee. Shri Das Gupta said that while the commercial banks raised Rs.77,000 crore in deposits from West Bengal, it advanced only 45 percent of the amount as loans in the state, against 62 percent given in other states.
Revision of interest rate structure under Refinance Scheme
SIDBI vide its Circular No.3888/Ref.(50)/4753 dated December 12, 2002 has decided to revise the rates of interest on refinance against term loans sanctioned to the units in small scale sector. The modified interest rate structure is as under : -
Rate Structure under Refinance Scheme of SIDBI Effective from Dec. 12,
However, cases where refinance on term loans have been partly disbursed before December 12, 2002, will continue to carry the pre-revised applicable rates of interest.
The PLIs may continue to ensure to charge interest rate, for loans upto Rs.50,000 and above Rs.50,000 and upto Rs.2 lakh, with a maximum spread of 3% over and above the applicable refinance rates, which are presently revised to 8.75% p.a., and 9.25% p.a. respectively, and for loans above Rs.2 lakh and upto Rs.25 lakh and above Rs.25 lakh depending upon the risk perception in each proposal. It may however, be ensured that the interest rate to the ultimate borrower in the latter category is reasonable in relation to the cost of funds and risk perception.
SIDBI may hive off Micro Credit Arm
SIDBI has proposed to hive off its micro credit arm, SIDBI Foundation for Micro Credit (SFMC), as a separate entity, according to Shri P.B. Nimbalkar, Chairman, SIDBI.
SFMC was launched during 1999 with an initial seed capital of Rs.100 crore as a proactive step to facilitate accelerated and orderly growth of the micro finance sector in India. The initiative has emerged as an apex wholesaler for micro finance providing a complete range of financial and non-financial services. These services include : providing term loan to micro finance institutions (MFIs), short term loans for liquidity management, extending equity to eligible corporate MFIs, providing support activities such as training, MIS, rating etc.
SFMC has an ongoing collaboration with Deptt. for International Development and International Fund for Agricultural Development (IFAD). As on March, 2002, the institution reported a cumulative assistance under micro credit to the tune of Rs.122.75 crore and supported 179 NGOs/MFIs benefiting about 7.28 lakh rural poor.
The institution has plans to develop and build a network of about 100 MFIs, 10 to 15 technical and management institutions offering specialised micro finance programmes.
Fall in sanctions, disbursements by FIs
During 2001-02 - for the first time in the last four years - financial assistance sanctioned as well as disbursed by financial institutions including ICICI Ltd. (now ICICI Bank) declined by 36.9 percent and 20.6 percent, respectively to Rs.72,878 crore and Rs.56,985 crore. This can be attributed to economic slow-down in general and deceleration in the growth of the industrial sector in particular.
Concomitantly, the share of fresh deployments of funds in the total uses of funds by FIs also declined. The institutions seemed to have taken advantage of the softer interest rate environment and increased the share of external sources in the total sources of funds. Simultaneously, the share of repayment of past borrowings in total use of funds also increased.
Aggregate financial assets of banks and FIs as on March 31, 2002 at Rs.17,58,032 crore were up by 9.2 percent over the same period last year, and lowest in the last ten years. There was also a sharp decline in the growth of financial assets of FIs by 12.5 percent as at end March 2002 consequent to the merger of ICICI Ltd. with ICICI Bank. Accordingly, the share of FIs in the aggregate financial assets of banks and FIs as at end March 2002 declined compared to the previous year.
Banks agree to roll over IFCI and IDBI dues
Top bankers on November 26, 2003 have agreed to roll over loans due to them from IFCI Ltd. and IDBI as part of their respective restructuring packages.
A core group drawn from State Bank of India, LIC, Bank of Baroda, Punjab National Bank and Oriental Bank of Commerce as well as the two financial institutions has been set up to work out the new rates of interest.
The government has already agreed to guarantee the rollover of the Rs.2,900 crore SLR securities components of IFCI's debt through bonds at the existing rate. Banks also agreed to work out a "relationship" with IDBI to enable it to transform it into a universal bank.
Amnesty scheme for NPAs up to Rs.10 cr
The finance ministry is set to come out with a new one-time settlement plan for sticky loans of upto Rs.10 crore. The RBI is in the process of working out the guidelines for the settlement at the instance of the ministry.
"The government is following a carrot-and-stick policy. The new settlement formula will offer another opportunity to chronic defaulters to come to the negotiating table. If they do not respond, banks and financial institutions will seize and sell their securities, armed with the new NPAs law".
The bulk of the NPAs come under the category of loans of upto Rs.10 crore. The OTS scheme will help the banks to clean up their books. Last time, the settlement scheme covered sticky loans of upto Rs.5 crore which was a success.
The previous scheme covered accounts of upto Rs.5 crore in all sectors, including the small-scale sector, but excluded cases of wilful default, fraud or malfesance. The scheme closed in March, 2002.
IFCI pares loss 41% in Q2
IFCI Ltd. today reported a 41.45 % decrease in net loss to Rs.242.19 crore during the second quarter of the current financial year against Rs.413.69 crore in the corresponding period last year on account of lower provisioning for sticky loans.
While the financial institutions had provided Rs.225.95 crore during the three months ended September 2002 against 50.83 crore during July-September this year. A provision of Rs.100 crore has been made in the accounts as provisions for loans and advances and diminution in the value of investments in terms of RBI guidelines is made at the end of the year. IFCI has, however, recognised income from certain accounts based on expected performance.
According to the audited accounts cleared by the board today, for the six months ended September 30, IFCI's net loss was 16.55 percent higher at Rs.514.58 crore against Rs.441.49 crore in the corresponding period last year. Operating losses, however, registered a much steep rise to touch Rs.413.17 crore during April-September this year as against Rs.189.52 crore in the corresponding period last. year.
The company's income fell over 25 percent to Rs.804.26 crore during the first half of the year, against Rs.1074.20 crore in the corresponding period last year.
Expenditure, however, remained nearly the same at Rs.1,239.11 crore during the first half of the year as against Rs.1,266.64 crore in the corresponding period last year.
The reason why worry kills more people than work is that more people worry than work. - Robert Frost