A fair playing field for ARCs to rival our new bad bank

News: ARCs should be treated equally with National Asset Reconstruction Company Ltd (NARCL).

In many countries, the national bad banks, set up to help clean the balance sheets of banks, make losses. This is because they buy non-performing assets (NPAs) from banks at inflated value, and sell them at market value after efforts to revive the underlying businesses. So, they require government support to thrive.

However, India can change this trend with the help of Asset Reconstruction Companies (ARCs).

A level playing field to ARCs will improve the asset recovery and allow ARC industry to participate in the process of price discovery in competition with the national bad bank. This can reduce the burden on taxpayers.

How the ARCs have performed till now?

The performance of ARCs has been poor till now. For example, during the period from 2003-04 to 2012-13, banks and other investors were only able to recover about 14.29% of the amount owed by borrowers.

What are the factors affecting the performance of ARCs?

Constraints imposed by the regulations: Adequate infusion of capital, a pre-condition for successful recovery, was limited by regulations that constrain an ARC’s ability to take control of a distressed company. For instance, the current proposal allows the NARCL to buy NPAs with a 15-85 split between cash and securities, with the value of these securities guaranteed by the government.

Whereas, Private ARCs will be allowed to place counter-bids, but ARCs must pay 100% cash. This does not create a fair playing field. This gives a distinct advantage to NARCL.

NARCL is backed by the government and 15-85 split between cash and securities criteria allows it to infuse more money, whereas ARCs are constrained by capital.

What are the steps taken to improve the functioning of ARCs?

The panel set up by the RBI had recommended that ARCs should be allowed to set up alternate investment funds for the purpose of bringing in capital and competencies for reconstruction.

What needs to be done?

First, it is essential to create a fair playing field between private ARCs and the National Asset Reconstruction Company Ltd (NARCL). The pre-condition of cash requirement needs to be addressed.

– An economic model developed by Yogesh Mathur reveals that the maximum amount any ARC (NARCL included) would be willing to bid rises steeply, as the cash proportion of the deal falls.

Second, setting reserve prices conservatively and adopting a multi-round auction format will result in NPAs moving off the books of banks at fair price.

Source: This post is based on the article “A fair playing field for ARCs to rival our new bad bank ” published in Livemint on 22^nd Dec 2021.