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ARCs: Lessons to be learnt - Views on News from Equitymaster
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  • Mar 11, 2003

    ARCs: Lessons to be learnt

    One of the most path breaking developments in the banking sector reforms process has been the passing of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest bill. This ordinance gives sweeping powers to the lenders to recover dues from defaulters. This new law also provides for the setting up of asset reconstruction companies (ARC) that can take over the assets of defaulters in order to dispose off these assets by the process of Securitisation.

    Banks with large NPAs can now set up ARCs and clean their balance sheets by disposing off assets of defaulters. The realisations from the sales of these assets will also help the banks to get something out of these assets, which would have earlier been completely written off. But the process of disposing off assets is not as simple as it seems. There are certain issues that have to be considered before an ARC becomes operational.

    The international experience of ARCs has not been too encouraging. Every instance of setting up an ARC has been preceded by massive and systemic banking collapse. For example, post the financial upheaval in the south East Asian countries in 1997, a number of ARCs were set up in countries like Thailand and Malaysia. However, these ARCs were not successful in solving the NPA problem. In Thailand and Malaysia, as well as other countries of East Asia, all ARCs had to be supported with government funds. Only two countries have had successful ARCs: the US and Scandinavia. Most others have been either abject failures or shown no sign of success.

    There are other operational issues that have to be taken care. For example, there is the issue of pricing, which becomes critical given government ownership of banks and FIs. There are two ways in which one can fix the price at which an NPA gets sold to an ARC: at book value, or at the market value. The former is beneficial for the bank, but it may generate huge losses for the ARC. Unless there is arm-twisting or some cushion by the government, no ARC will be willing to take NPAs at book value. But if the banks do transfer these assets to ARCs at market value they stand to lose a lot. The ARC is likely to buy the NPAs at a considerable discount. The experience of Malaysia shows that for the bulk of the NPAs, the average discount rate applied by Danaharta (an ARC) has been almost 48%. The sale of NPAs by some of our financial institutions to the proposed ARC at such discounts will create a hole in their balance sheet. Banks will have to bear the burden of losses on the sale of these assets.

    Another issue is that of a mature secondary market for securitisation. While the primary market for securitisation is seeing a healthy growth, the secondary market for the same is still languishing. The concept of ARCs is new in India, but the process for setting up the same has already been initiated. The country’s first asset reconstruction fund has already been set up with ICICI Bank chairman acting as its head. This ARC is being promoted by ICICI Bank, IDBI, SBI, HDFC and HDFC Bank apart from a few other banks. If ARCs have to succeed in the Indian context, the government has to learn from the experiences of other countries. What we observe is that ARCs can go a long way in cleaning up the banking system if there is a conducive environment for the development of a secondary market for securitisation, as well as a fair method of valuation of NPAs.



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