Om Kumar Goswami
The idea of Asset Reconstruction Companies (ARCs) has had its moments of glory ever since the Narasimham Committee report was released in December 1991. Of late, debates on bad loans of banks and financial institutions (FIs) are veering to the necessity of forming such companies - with the M.S. Verma Committee Report on Weak Banks (September 1999) being the most recent proponent. ARCs have an elegant policy feel. But can they be made to work in India?
ARCs are nothing but external `bad banks'. In theory, banks with a large proportion of bad debts or non-performing assets (NPAs) can sell these to a legally separate ARC, which then recovers whatever it can through attachment, foreclosure or liquidation. The Bank enjoys the benefits of a relatively `clean' asset book; and if the transfer prices of the NPAs are low enough, the ARC also ends up making a profit. Looks like a `win-win' situation, doesn't it? Except that ARCs are like communism : so easy to speak of, so difficult to achieve.
First, a look at the international experience. Barring a very recent case of Xinda asset Management Corporation in China - which has barely begun its operations - every instance of setting up an ARC has been preceded by massive and systemic banking collapse. This was true of the Resolution Test Corporation (RTC) in the US, which came into being in 1989 after the failure of the savings-and-loan industry; of four ARCs in Scandinavia in the early 1990's; of Danaharta in Malaysia in 1998; of the Financial Restructuring Authority in Thailand in 1997; of Korea Asset Management Corporation; and of FOBAPROA after the December 1994 peso crisis in Mexico, `Although the financial system in India suffers from a large burden of NPAs, there has been no systemic banking crisis that automatically warrants an ARC-type bailout. Moreover, only two countries have had successful ARCs : the US and Scandinavia. Most others have been either abject failures or shown no sign of success.
Second, all ARCs suffer from `moral hazard'. It is simply this : If I know that my bad debts will be taken off the books, then I have no incentive to focus on good loan appraisal and prompt recovery. In effect, ARCs insure banks from the market driven downside of poor performance. This moral hazard gets exacerbated for government-controlled public sector banks and FIs. In a milieu where neither is performance rewarded nor non-performance punished, an ARC is like candy to diabetics. This is particularly true for the three weak banks; Indian Bank, United Bank of India and UCO Bank. For them, an ARC will create spuriously clean finances and a false picture of health while the organisational cancer continues to spread.
Third, there is the vexed issue of pricing, which becomes critical given government ownership of banks and FIs. There are only two ways in which one can fix the price at which an NPA gets sold to an ARC: at book value, or according to what the market can bear. The former is great for the bank, but a sure-shot recipe for generating huge losses for the ARC. Given our relatively gentle provisioning criteria, no ARC worth the name will be willing to take on bad debts at book value - unless of course it is arm-twisted to doing so by the government. Book value transfers only shift losses from the banks to the ARCs, with taxpayers continuing to take the hit. So, what about transferring at realistic market prices which are discounts to book value? Great idea. But can anyone in India say with any certainty that such transactions will not be questioned by the CBI, CAG and the CVC? That being so, why should a much harassed and short-tenured Chairman of a public sector bank take the risk?
Fourth, what is the realisable value of the underlying asset that is being transferred? This is particularly important in the case of banks, especially the three weak ones for which ARCs are to be panaceas. Banks usually lend working capital against inventories and work-in-progress. Portfolios that are expected to be transferred to an ARC are loans that have been NPAs for several years, where the companies concerned are bankrupt with current liabilities vastly in excess of current assets. To give an example : on March 31, 1998, for 347 private sector listed companies, current liabilities exceeded current assets by Rs.5,392 crore. Their short-term bank borrowing was Rs.3,531 crore. In effect, there is no positive price for selling these NPAs because there is no collateral worth recovering. Here, the FIs are somewhat better off: they have first charge on plant, machinery and fixed assets, which erode less than inventories. Their NPAs might command better valuation.
Fifth, ARCs mean precious little given the state of bankruptcy and recovery procedures in India. It takes BIFR four years to decide on a case. Defaulters get permanent stays from creditors'claims under Section 22 of SICA. Recovery processes are fraught with delays. Debt Recovery Tribunals are overloaded with cases. Judges with little or no commercial competence grant adjournments as a matter of course. Liquidation takes atleast 10 years - and that too with great luck. In India, the transfer price of NPAs will be determined by the payoffs from `out-of-court' settlements. Those payoffs aren't very attractive.
So, how can ARCs work in India? For one, we first need to radically alter bankruptcy and recovery laws and procedures which include SICA/BIFR, debt recovery, foreclosure and liquidation. No country with poor bankruptcy processes has had successful ARCs. For another, ARCs might work for the better-off banks and FIs, provided that the NPAs are transferred at an early stage of default when there are still securities worth recovering. Even so, an ARC needs to be structured very carefully like a professional, private sector run mutual fund. Moreover, it is important to state very clearly that cleaning books through ARCs will only be allowed as a prelude to privatisation of selected banks and FIs. Unfortunately, privatising banks is anathema to politicians and trade unions. Finally, we need to understand that ARCs cannot work for the three weak banks. Their solution lies elsewhere.