Let ARCs shoulder NPAs, banks focus on credit creation

In RBI's annual publication, 'Report on Trend and Progress of Banking in India', there is a table with details about bad loans of scheduled commercial banks (SCBs) recovered through various channels. This table mentions four channels — Lok Adalat; debt recovery tribunals or DRTs; SARFAESI Act; and Insolvency and Bankruptcy Code (IBC).

In the April 2021 Newsletter of RBI, it carried an article by their own staff, titled "ARCs in India: A Study of their Business Operations and Role in NPA Resolution". On page 158 of the newsletter, it contained a table titled 'Distribution of NPAs Recovered by Banks, Various Channels'. Here the recovery percentage quoted under asset reconstruction companies (ARC) was exactly the same as classified under SARFAESI Act, in the source document, Trend and Progress of Banking In India. Since ARCs are constituted under SARFAESI Act and assignment of loans by banks to ARCs are under provisions of SARFAESI Act, presumably recovery shown under SARFAESI Act in this annual report of RBI represents the recovery from ARCs.

Now, let us view the numbers given in RBI's latest 'Report on Trend and Progress of Banking in India', which was released on December 28, 2021.

While analysing this data, one limitation to be kept in mind is that during most of FY 2020-21, fresh reference to IBC had remained suspended in respect of the Covid-19 period default.

Broadly however, as per Insolvency and Bankruptcy Board of India (IBBI) data up to September 2021, cumulatively all resolutions since inception of IBC have resulted in recovery of 35.89% to admitted claims. Pertinent to note that in respect of cases closed under IBC, 14% have yielded resolution, while 46% have headed for liquidation, the liquidation value of which is assessed less than 5% of admitted claims as per IBBI's September 2021 data. Even taking cognizance of withdrawal, appeal/settlement in respect of cases referred to IBC, etc., for which details are not available, the overall recovery has not been encouraging, and the timelines are also getting stretched.

That's the reason why many banks and financial institutions are pursuing the ARC sale for early exit. However, figures in respect of ARC acquisitions during FY 2020-21 are not available in the recent RBI report which gives an insight only into a few ARCs (Page 63 of latest report on Trend and Progress of Banking, Table IV.11: Details of Financial Assets Securitised by ARCs), possibly due to some technical glitch.

The recently constituted ARC committee has also made several recommendations to incentivise sale to ARCs by banks at a young stage to maximise value. However, there have been question marks on pricing of the assets. Pricing of an asset is a function of interplay of various operating dynamics. An asset could be valued at X, by a desktop valuation. When an ARC proposes to acquire it, it will factor the amount that can actually be realised, the time frame for realisation given long litigations, and cost of its capital. So, essentially, the price the ARC will pay, need to cover the time value of money and operational risks involved in realisation of an asset, more so, as in case of distressed debt whose value erode fast, and lot of uncertainties have to be addressed before an asset gets resolved.

The transfer of loans is done through a competitive process with the Swiss challenge method. The price of acquisition reflects the price discovered through an elaborate and well-established auction process. The section 32 of the SARFAESI Act gives immunity for acts done in good faith without malafide act or intent. "No suit, prosecution or other legal proceeding lie against the Reserve Bank or the Central Registry, or any secured creditor or any of its officers for anything done or omitted to be done in good faith under this Act."

The ARCs, the quintessential bad banks, can help the commercial banks focus on underwriting good loans. Credit creation and GDP growth have positive co-relation. Banks, free of stress, can then concentrate on extending need-based financing to help India reach a $5 trillion economy target.

(The author is a contributing columnist. Views are personal.)