Asset Reconstruction Ordinance: Will it help? - Views on News from Equitymaster

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Asset Reconstruction Ordinance: Will it help?

Nov 23, 2002

One of the main economic concerns of the government has been the high level of NPAs (non performing assets) in the Indian banking system. Estimates suggest that net NPAs surmount to Rs 300 bn in the banking sector. Reforms to reduce such high levels have been mooted since the time the first round of economic reforms was initiated in 1991. Numerous deliberations and two Narasimham Committee reports later, the government has finally passed the Securitisation and Reconstruction of Financial Assets and Enforcement Security Interest Ordinance, 2002.

So has the government done its part and is it all now left to the banks and the financial institutions? The ordinance gives sweeping powers to banks and financial institutions (lenders). According to the provisions of the ordinance, secured creditors can take over management control of a borrower company upon default and sell assets without the intervention of courts in cases where 75% of secured creditors decide to do so. This new law circumvents the judicial process to a certain extent, thus shortening the loan recovery process considerably. Another feature of this ordinance is that it gives the lender more teeth against the borrower friendly board of industrial and financial restructuring (BIFR).

The new law has gone a step further as far as the promoters are concerned. The lender can now attach and sell the assets of the promoter if they have given personal guarantees for these loans. It also defines a timeframe for this whole process. Within sixty days of default the lender can notify the borrower of action that can be taken against him due to default. Post this time period the lender can go ahead and seize the assets of the company.

Though the new laws give power to the lenders, it raises a few questions. First of all, the lenders have been given sweeping powers to cease management control but to what end? Do the lenders have access to management to run/turnaround these companies?

Under such circumstances, banks are likely to dispose off these ceased assets for the recoverable value. The ordinance provides for the setting up of asset reconstruction companies (ARC) to tackle to issue of disposing these assets and recover part/whole of the loan amount. As per the proposed plan in the ordinance, core NPAs of banks over a certain size will be taken over in exchange of NPA swap bonds representing the realizable value of the assets transferred. These bonds will in effect convert a part of the NPAs into assets. The non-realizable value of assets will have to be written off.

So till these loans are recovered the NPAs will be transferred to books of the ARC. This provision results in the commercial risk of banks being passed on to the ARC. In the past, lenders, due to the lack of adequate skills, have not been able to run sick companies. The ARCs that are set up are expected to have the necessary skills to become successful where the banks have failed in the past. But another concern is that even if these assets are sold the realizable value of the assets may be well below the value of loans that were given out by the lenders to the ARC.

For the ARCs to perform in the intended way, the bankruptcy and foreclosure laws should be workable. The legal framework is critically linked to the success of ARCs. It will be harsh to say that the government had not done enough in the past with respect to regulations to tackle the issue of NPAs. The existing laws could have been adequate but we reckon the laxity was in implementation of the same. Moreover, political interference did not permit enforcement of these laws in the past. So what is the guarantee that they will allow smooth functioning this time around?

The issue of disposal of assets could also be answered by way of setting up a central pool of professionals that have the necessary skills to turnaround a sick company. In this way banks will not have to bother running the company and will be able to sell off the assets when the company turns profitable again. Thereby recovering a larger percentage/entire loan in question.

Growing NPAs are a common concern in developing countries and now also in countries like U.S (Enron, WorldCom etc.). There never can be a foolproof regulation/system, as the system is run by society at large. If society at large lacks integrity no regulation/system designed in good faith -- can work.

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