The study to be released at an ASSOCHAM programme in Mumbai tomorrow, suggests asset reconstruction with the help of a revamped Asset Reconstruction (ARCs) sector for achieving a sustainable level of bank debts, going down the non-performing assets (NPAs).
Since in the current cycle most of the stress is driven by stretched balance sheet, viability assessment needs to be looked at on a going concern basis. However, a mix of measures such as recognition of sustainable debt, ability to bring third-party investors in Security Receipts (SR) could set the ball rolling for the revival of distressed companies.
It suggested encouraging third-party capital to replace banks' investment in SRs. The current model of banks investing in SRs backed by their own distressed debt has its own limitations. The current model could still be useful for cases of liquidation where further capital commitment is not called for. The benefit of the prevailing model was that it allowed banks to capture the contingent upside and also in some cases harmonise the required provisioning by investing in SRs.
However, this model has had a number of issues such as misalignment of interest between banks and ARCs, the existence of an unsustainable level of debt delaying the restructuring of companies and banks having to subsist with the problem in their investment books. This problem can be solved if banks are allowed to transact at realistic haircuts with the benefit to amortise the loss on sale as long as third-party investors are ready to fully step into their positions".
Asset reconstruction companies need re-positioning; the issue of bad debt amounting to Rs 6 trillion would need ARCs to re-orient themselves, if they are to facilitate the resolution process. With the 15 per cent mandatory investment rule and the capital constraint, ARCs would need to be supported with third-party capital for any meaningful movement on the bad debt issue.
The study argues that the current capital position of ARCs can at most take care of 10 per cent of the bad debt in the Indian banking system. Also, a debt-led strategy for investing in SRs that result in the leverage of more than 2x equity could create liquidity issues for ARCs and may not be coherent with the long gestation period for recovery in India.
It said the adoption of the Insolvency and Bankruptcy Code is likely to streamline debt resolution. However, it is important that the impact of the new regime is reflected in better recoveries or lower loss given default over a period of time.
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Currently, India is classified as a Group D country by Fitch with recoveries expected in the range of 30-50 per cent given the level of creditor-friendliness of its insolvency regime. An improved recovery in at least the 50-70 per cent range will be the real achievement of the effective implementation of the code. In developed countries such as the United States, continued operation as going concern after emergence from bankruptcy as reorganised company or via sales of the whole company as a going concern is a much more common outcome than liquidation.
While releasing the paper Mr.Sunil Kannoria, President ASSOCHAM said, the number of ARCs has been inadequate vis-vis the need. These ARCs typically have low capital base and their methodology towards addressing needs of troubled companies has an overt financial focus. The average recovery rate for ARCs in India has been around 30 per cent of the principal and the average time taken has been anything between 4 to 5 years.
However, that scenario is about to change. In the Union Budget 2016-17, 100 per cent foreign direct investment (FDI) has been allowed for ARCs which is expected to substantially improve their capital base. Moreover, the introduction of the Bankruptcy Code has now positioned ARCs as a very important intermediary between lenders and borrowers, adds its chief.
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