The Reserve Bank of India (RBI) on 1 September 2016 issued Guidelines on Sale of Stressed Assets by banks
. The Guidelines are an attempt to improve the framework for sale of stressed accounts by banks. The essence of the Guidelines is urging banks to create mechanism for timely identification of stressed accounts and take appropriate actions to ensure there is low vintage and better price realisation for banks.
The guidelines view the world with rose-tinted glasses. Currently the non-performing asset (NPA) levels in the financial system are extremely high and are causing sleepless nights to the Boards of banks and financial institutions. In such times where there is a dire need for quick resolution, the Guidelines are optimistic about finding takers for bad assets and creating dynamic market for the same outside of ARCs as well. While this is the core area for ARCs and special situation funds (which the guidelines do not make a mention of at all), there may be very little or no motivation for other non-banking financial companies (NBFCs) or banks to acquire bad loans.
The Guidelines also seem to suggest that the sale of junk should be undertaken by an open auction process, which will result in price discovery. The existing Framework for Revitalising Distressed Assets in the Economy
as applicable to banks and issued on 26 February 2014 mentioned that there were practically challenges in sale of assets through auction process. The bidding process is quite costly and the due diligence takes long. The framework urged for creating transparency in the auction process and required prescription of sufficient disclosures for seamless auction process. Unfortunately, none of these issues from the 2014 Framework are addressed in the new Guidelines. We highlight the prescriptions of the recently issued Guidelines in this article.
Process of identification of stressed assets
The Guidelines mandate the banks to do the following:
1. Early identify stressed assets and special mention accounts and make them available for sale.
2. Identify and list internally, once a year (preferably at the beginning of the year), specific financial assets available for sale to other institutions.
3. Doubtful assets above a threshold should be identified and reviewed by the board or its committee to make them available for sale.
4. The sale should be undertaken through e-auction process, so as to attract wide variety of buyers and enable larger participation from prospective buyers.
5. At the time of sale, specifications should be provided for acceptance of internal or external valuations. In case of exposure beyond Rs50 crores, take 2 external valuation reports.
6. Banks should provide adequate time for due diligence with a floor of 2 weeks’ time.
7. Cost of valuation to be borne by banks
Eligible buyers of banks’ junk
Banks can sell the stressed assets to:
a. Asset reconstruction companies;
b. Other banks;
c. Non-banking financial companies;
d. Financial institutions.
Preference will be given to asset reconstruction companies as buyers.
Swiss Challenge Method
This is the prime focus of the Guidelines. As in case of government tenders and bidding, Swiss Challenge Method is envisaged to be introduced for sale of stressed assets as well. The mechanism is as follows:
1. Prospective buyer gives a bid to the bank for acquisition of assets;
2. Where a prospective buyer offers more than the minimum percentage specified in the bank’s policy in the form of cash, the bank shall be required to publicly call for counter bids from other prospective buyers, on comparable terms;
3. Once bids are received, the bank shall first invite the securitisation companies (SCs) and reconstruction companies (RCs), if any, which has already acquired highest significant stake to match the highest bid. Asset Reconstruction Companies (ARCs) acquiring majority stake and bidding highest will be given a right of first refusal for acquiring the assets
4. The order of preference to sell the asset shall be as follows:
a. The SC or RC, which has already acquired highest significant stake;
b. The original bidder and
c. The highest bidder during the counter bidding process.
5. In any event, preference will be given to asset reconstruction companies to acquire the assets
6. Bank may sell to the winning bidder otherwise make provision which would be higher of the two:
a. The discount on the book value quoted by the highest bidder; and
b. The provisioning required as per extant asset classification and provisioning norms
Investment in security receipts (SRs)
Banks typically sell the stressed assets to the ARCs and then hold them in the form of security receipts. This is a way of creating a façade whereby the banks continuing to hold the bad assets as investment. The guidelines state that where banks continue to hold 50% or more of security receipts with the underlying of the assets it sold to the ARCs, then higher of the below mentioned provisioning norms shall apply
a. Provisioning rate required in terms of net asset value declared by ARCs
b. Provisioning rates as applicable to banks
The above provisions will become applicable from 1 April 2017. The threshold of 50% investment in SRs will be reduced to 10% from 1 April 2018.
In addition, banks will be required to do disclosure of SRs acquired and the disclosure goes 8 years backward.
Buy-back of refurbished junk
The Guidelines state that the Banks should have a board approved policy to buy-back financial assets from asset reconstruction companies once the asset has become standard after successful implementation of the restructuring program by the ARCs and after satisfactory performance of the asset during the specified period.
However, banks cannot buy-back the assets they sold to the ARCs. This means banks can buy someone else’s refurbished junk but cannot buy-back its own.
Banks to formulate policies
In light of the Guidelines issued, banks will be required make changes in their policies dealing with stressed assets. The following are the changes or policies required:
1. Banks to lay down board approved policies and guidelines for sale of stressed assets, which would include
a. Types of financial assets to be sold
b. Norms and procedures for sale
c. Valuation procedure to be adopted and policy for valuation either to be taken internally or externally.
d. Delegation of powers for undertaking the sale of financial assets
e. Discount rates used for valuations will be provided for in the policy
f. Minimum percentage/ floor of cash expected in case of sale
2. Banks will require a board approved policy for buy-back of financial assets. The policy should provide for facets such as type of assets that may be taken over, due diligence requirements, viability criteria, performance requirement of asset, etc.
3. The existing NPA policies should be reviewed and revised in lines with the Guidelines.
Selling of bad loans is not a thriving business where price discovery is the primary agenda, neither is broadbasing investors in junk the agenda. However, the Guidelines do focus on sensitising the banks by saying a stitch in time will save nine.
is executive vice president at Vinod Kothari Consultants Pvt Ltd)