NPA problem: Economic Survey stresses centralised AMC approach
Vinod Kothari  and  Abhirup Ghosh 01 February 2017
The Economic Survey 2016-17 has brought up what may actually lie at the root of India’s humongous non-performing asset (NPA) problem: the way India has tried to tackle the problem with asset reconstruction companies (ARCs). While comparing the case of India with the East Asian economies, the Survey candidly makes a case for revisiting the existing policy and makes a strong case for centralised asset management companies (AMCs) in India.
India’s burgeoning NPA problem
The Indian banking system has been struggling with NPA issues since long, but things became worse when, at the end of the third quarter of 2015-16, public sector banks (PSBs) started reporting a huge surge in their NPA levels. The news came as a shock, as many thought it would be difficult for the system to recover. This almost forced the finance minister to come up with a bailout package for banks.
Figure 1: Gross NPA Rate in India (FY04 - H1FY17) as per Economic Survey
The trend of rising NPAs continued thereafter and, as at the end of the first half of the FY 2016-17, the gross NPA reported by the banking sector stood at 9.1% of gross advances. Almost 80% of the NPAs were reported by public sector banks, with NPA levels of 12%. Figure 1 shows the  NPA levels of banks.
According to World Bank data, as on 31 December 2016, total NPAs across the world stood at 3.913%. In comparison, the level of NPAs reported by Indian banks is alarming. Further, in comparison to its fellow countries in G20, India ranks second, after Russia, in the level of NPAs.
Figure 2 shows the NPA levels reported by G20 nations.
The failure of the measures: SDR, SSSS-A & ARCs
In the past few years, the Reserve Bank of India (RBI) has come up with several steps to check the increasing stress in the economy, be it through regulatory changes or by granting more licenses for asset reconstruction businesses. However, all of them have failed miserably which is quite evident from the increasing level of NPAs.
The regulatory rejig started with the introduction of the Framework for revitalizing distressed assets in the economy, in February 2014. The failure of the corporate debt restructuring (CDR) mechanism, which was earlier set up, induced the apex body to come up with this Framework. The Framework mainly provided for early recognition of stress in an account and ways of forming joint lenders’ forum to structure possible solutions to resolve the stress in the assets. However, several changes have been made to the Framework from time to time, based on the need of the hour. One such change marked the introduction of Strategic Debt Restructuring (SDR) in 2015.
SDR gave massive powers to the lenders, allowing them to, at first, take over the management of the borrower, and then identify new promoters and transfer control to the new promoters. Though, as soon it was introduced, several big ticket lenders expressed interest in availing of SDR, at the end of December 2016 only two such deals materialised. 
Apart from SDR, one more arrangement, introduced by RBI, had drawn a lot of eyeballs. This is the Scheme for Sustainable Structuring of Stressed Assets (S4A). Under this scheme, introduced in June 2016, the sustainable portion of the total debt was to be identified and retained in the books, while the rest was to be converted into equity, or optionally convertible cumulative preference shares. Although banks were enthusiastic about this scheme, by December 2016 end only one deal had fructified. 
Not only have the regulations changed, but also ARCs, which play an important role in keeping a check on stressed assets worldwide, have also not been able to contribute significantly in India. As on end of August 2016, there were around 19 ARCs in the market. However, only a miniscule portion of NPAs were passed on to them compared to the humongous total. This is mainly because ARCs in India are only willing to purchase loans at lower prices, which has de-motivated the banks to transact with them. Over FY2014-15 and FY2015-16, only 5% of the total NPAs were sold to ARCs. 
Indian approach versus East Asia
There are two ways of modelling asset management companies (AMC) or asset reconstruction companies: a) centralised model, and b) decentralised model. While the former is followed by countries which have floated AMCs with government support and provided them with special legal powers, India opted for the latter, resulting in the current situation. 
The difference between the two models was brought out in the book, Securitisation, Asset Reconstruction and Enforcement of Security Interests, by Vinod Kothari, thus:
“The approach in India is one of several AMCs – the Act enables anyone satisfying the requisite criteria to float asset reconstruction companies. If too many ARCs in course of time, an ARC might just be a bank look-alike. Worse still, since the price at which the bad loans will be sold is only a paper price (represented by a bond or debenture), the ARCs will start competing on the price they offer for the bad loans, leading to artificially inflated value of bad loans. The problem with too many ARCS could well mean at least some of them will become as bad as the loans they buy.”
In the East, it is a common practice to rely on the centralised AMC model. Countries like Korea and Malaysia have successfully been able to resolve their NPA problems through centralised AMCs. While in Korea, it was the Korean Asset Management Co (KAMCO), in Malaysia it was the Dinharta that successfully tackled the bad loans problems.
The Indian Ministry of Finance, in its Economic Survey, 2016-17, has also expressed the need for a public sector entity for asset reconstruction in the country to combat the rising level of NPAs. 
Need for centralised AMC in India
As mentioned earlier, a case has been made for a public sector centralised AMC in India in the Economic Survey, 2016-17. Seven reasons that have been put forward to justify the case:
1. Earlier, the focus was on identifying proper channels to make funds available to public sector banks and not on securing the assets. This has proved disastrous for the industry. There is an urgent need for a change in focus.
2. Apart from diversion of funds, economic problems also play a huge role in default of debt repayments. 
3. Concentration of stressed debt in large companies makes it difficult to resolve the problem.
4. There have been cases where, in order to restore the viability of the project, debt reduction of more than 50% was needed. This has led to the only alternative available to lenders, i.e., conversion of the debt into equity, taking over the company and selling off the shares at a loss. 
5. Though several resolution mechanisms were introduced, they hardly worked. This is because of issues like coordination problems, political challenges in taking over large companies etc. 
6. The habit of banks to refinance existing bad loans, instead of resolving the cases, has affected the government badly, through rising bad debts, increasing the ultimate recapitalisation bill for the government and the associated political difficulties.
7. Failure of the private sector ARCs to resolve debts.
The Finance Ministry, going by international success stories of centralised professionally run AMCs with government backing, has now provided for the introduction of the Public Sector Asset Rehabilitation Agency (PARA).
Though being government-owned would mean it would have its own problems to deal with, such an initiative has the potential to tackle the huge NPA problem.
(Vinod Kothari is a chartered accountant, trainer and author. Mr Kothari, through his firm, Vinod Kothari and Company, is also engaged in the practice of corporate law for over 25 years. Abhirup Ghosh is a senior manager at Vinod Kothari & Company) 
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