FAIR III – Session V

Developing the Asian Markets for Non-Performing Assets – India’s Experience

November 11, 2003

Presented By: Mr. S. Khasnobis

FAIR III – Session V

ARCs – Indian ContextARCs – Indian Context ARCs – Indian ContextARCs – Indian Context

India’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - Arcil

ARCs – Legal FrameworkARCs – Legal Framework ARCs – Legal FrameworkARCs – Legal Framework

NPAs in the Indian Banking System NPAs in the Indian Banking System

Agenda

FAIR III – Session V

NPAs in the Indian Banking System

Indian banking system witnessed gradual increase in levels of NPAs in the post-liberalisation period Shake-up in real sector

However NPA levels did not threaten to undermine the banking system Tightening of prudential and capital adequacy norms by the

regulator Selective recapitalisation support and mergers of weaker

institutions

FAIR III – Session V

While the problem is not as intense…

Factors Korea Thailand Malaysia Indonesia J apan IndiaRapid deregulationRegulatory failureDeteriorating macroeconomicsAggressive lending practices *Peak level NPAs 30% 40% 25% 50% 20% 15% High Meduim low/ Non-existent

* Including exposure to bubble sectors

FAIR III – Session V

…NPA “stock” merits a systemic response

-

20,000

40,000

60,000

80,000

100,000

120,000

1999 2000 2001 2002

Rs

in c

rore

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

GrossNPA

Net NPA(%)

•Gross NPA levels on the rise•NPA holding cost = 25% of the net profit of the banking system

FAIR III – Session V

ARCs – Indian Context ARCs – Indian Context

India’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - Arcil

ARCs – Legal FrameworkARCs – Legal Framework ARCs – Legal FrameworkARCs – Legal Framework

NPAs in the Indian Banking SystemNPAs in the Indian Banking System NPAs in the Indian Banking SystemNPAs in the Indian Banking System

Agenda

FAIR III – Session V

ARCs in India are set up as a non-government vehicle Minimal government participation in the ARC

resolution process Market forces to consolidate and attractively

package lender interests Create investors’ interest

Support from the banking system – an essential requirement

ARC – Indian model

FAIR III – Session V

Fiscal Incentives to banking system Tax set-offs on sale of asset to ARCs Gains from buy-back of high yield

government bonds to be used for set-off of losses from asset transfer to ARCs

Provision for operation of multiple ARCs

ARC – Indian model

FAIR III – Session V

RapidDisposition

Agency

DebtResolution

Agency

Risk & Rewardstransferred tothe investor

Immediate selldown of debt to

third party investors

Risk & Rewardsretained by the banking system

Focus on Asset

Management & Resolution

The business model – Indian context

ARCs - Generic business models

FAIR III – Session V

Indian ARCs – a Debt Resolution Agency (DRA)

Expeditious resolution of NPA “stock”- a priority Indian NPA profile suggests

Recoveries from NPAs would be over a longer time-frame as against rapid realisation

Predominantly in industrial sector (Low exposure to “bubble” sectors – Real estate/ Capital Markets)

Banking landscape necessitates debt-aggregation One borrower, many lenders (inter-creditor issues) Different security classes and structures Moral hazards related issues

FAIR III – Session V

Markets for NPAs – Non-existent Absence of market makers (limited

participation of foreign lenders in Indian credit market)

No pricing bench marks

Debt aggregation and resolution approach is likely to succeed Focus on recoveries from NPAs Improved leverage over debtor through

aggregation Eliminates moral hazards Regulatory empowerment

Indian ARCs –Debt Resolution Agency (DRA)

FAIR III – Session V

Banks/FIs

ARCIL Investor

Sell asset

SRs

Sell debt

Proceeds

Company

Rest

ruct

uri

ng

Debt

serv

icin

g

Time line

t = 0 t = 1 t = 5

Management &

Resolution

Sell Down Acquisition

Structured along the DRA model

Value capturing at resolution stage becomes critical

for final exit

FAIR III – Session V

ARCs – Indian ContextARCs – Indian Context ARCs – Indian ContextARCs – Indian Context

India’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - ArcilIndia’s Premier ARC - Arcil

NPAs in the Indian Banking SystemNPAs in the Indian Banking System NPAs in the Indian Banking SystemNPAs in the Indian Banking System

ARCs – Legal Framework ARCs – Legal Framework

Agenda

FAIR III – Session V

Proactive response of government and Central Bank – aimed at NPA resolution Setting-up of Corporate Debt

Restructuring (CDR) forum Enactment of “Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002”

Proposed formation of National Company Law Appellate Tribunal

Addressing the NPA levels

FAIR III – Session V

Regulator Central Bank

Restructuring Asset Sale

Addressing “stock” and “flow” problem

Agencies CDR ARCDebt

Aggregation

Regulation Special Court Tribunal

Self Self empowered empowered

bodybody

Resolution strategies

Access to legal mechanismsAccess to legal mechanisms

Regulatory Empowerment

FAIR III – Session V

Legal Framework (1/2)

Act introduced two important new initiatives to bring about structural reforms to the Indian credit market Setting up of Asset Reconstruction Company Enforcement of securities without the

intervention of the court ARCs requirements

Registered with Central Bank 15% capital adequacy Arcil is the first ARC which has been granted

license by the Central Bank

FAIR III – Session V

Legal Framework (2/2)

ARCs empowered to take following measures for the purpose of asset reconstruction:- Take possession of secured assets Sell or lease a part or whole of the

business of the borrower Change or take over of the management

of the business of the borrower Rescheduling the payment of debt

payable by the borrower Settlement of dues payable by the

borrower

FAIR III – Session V

Non Perf

ormin

g Ass

et

60 day

notic

e

75 % s

ecure

d cre

ditors

’ conse

nt

Enforcement of Security Interest…

FAIR III – Session V

…without court intervention

No intervention of court

Overcoming cumbersome procedural delays

Expeditious recovery

FAIR III – Session V

ARCs – Indian ContextARCs – Indian Context ARCs – Indian ContextARCs – Indian Context

ARCs – Legal FrameworkARCs – Legal FrameworkARCs – Legal FrameworkARCs – Legal Framework

NPAs in the Indian Banking SystemNPAs in the Indian Banking System NPAs in the Indian Banking SystemNPAs in the Indian Banking System

India’s Premier ARC - ArcilIndia’s Premier ARC - Arcil

Agenda

FAIR III – Session V

Arcil brings together the complementary strengths of the three largest players in the Indian financial sector

100.0%Total26.5%Other private sponsor banks

24.5%ICICI Bank24.5%IDBI24.5%State Bank of India

ShareholdingEquity participation

Sponsors hold 40 % of NPAs of the system Private sector character- 51% shareholding

with private banks/ institutions

Sponsors hold 40 % of NPAs of the system Private sector character- 51% shareholding

with private banks/ institutions

FAIR III – Session V

Building Blocks StructureStructure

ResolutionResolution

Approach

InvestorInvestor

FAIR III – Session V

Resolution strategy framework

Loan management strategy Restructuring of loan based on transparent

policy Maximise overall recovery value Fair treatment to all stakeholder

Settlement Asset management strategy – Asset restructuring

Sale of business/collateral Preservation and enhancement of value of

business/collateral Orderly disposition through transparent

process

FAIR III – Session V

Participation from Indian banking system at initial stage – key to value retention

T=0 T=1 Time

NPA Implementationof resolution

A performing asset

Return Expectations Rerating as normal

debtRerating

Banks can capture value by staying invested in the assets till the resolution stage

25%

15%

FAIR III – Session V

Man

ag

em

en

t q

uality

Industry viabilityLow High

Low

High Settlement with

Existing promotersRestructuring

Strip sale of

Assets

Sale of business/

Induction of JV partner

Resolution strategy framework

FAIR III – Session V

Building Blocks StructureStructure

ResolutionResolution

Approach

InvestorInvestor

FAIR III – Session V

BorrowerReconstruction thru’ Restructuring / Asset sale / M&A

Cash realization

Redemption of SRs

SRs

Payment for Subscription to SRs

QIBs(Banks/FIs)

PurchaseConsiderati

on

SchemeBorrower wise

Banks/ FIs

ARCs/ Trusts

Sale of loan assets

Transaction structure - Asset Specific Trust

FAIR III – Session V

Redemption of

Original SRs

Payment for

subscription to

fresh SRs

SRs

Investors

Master Trust / Scheme

Pooling of SRs

QIBs(Banks/FIs)

QIBs(Banks/FIs)

SchemeBorrower A

SchemeBorrower B

Borrowers A,B

Cash realization

Redemption of SRs

Pooling and sale/ Securitisation at Subsequent Stage – Exit for original investors

FAIR III – Session V

Building Blocks StructureStructure

ResolutionResolution

Approach

InvestorInvestor

FAIR III – Session V

Distressed debt investment opportunity

Distressed Company

Direct from Bank / ARC

Asset Pool

Large Portfolio

INVESTORSCORPORATES

Securitization

Fund level

Partner with ARC

Restructuring fund/private equity option

MU

LT

IPL

E O

PT

ION

S

AV

AIL

AB

LE

Direct investor

Ideally suited for all classes of investors

FAIR III – Session V

Geared to unlock value

Indian economy buoyant and future outlook is positive Right time to tackle NPA problem Maximize value and distribute it back to the

system Re-energize the financial sector Unlock under utilized productive assets

A ‘Win-Win’ model - provides a medium-term structural banking sector solution

FAIR III – Session V

Thank You