Tuesday, July 19, 2011

Published on 19th July 2011 in EconomicsTimes (Editorial)

The Reserve Bank of India's (RBI) inspection report on Arcil, the earliest asset reconstruction company set up to buy distressed loans of banks and other financial institutions, is a wake-up call for the banking sector regulator. It points to a number of deficiencies in the asset-reconstruction business and in Arcil's functioning in particular. First, there is the issue of poor corporate governance that enabled major shareholders to collude in offloading their bad loans to Arcil.

State Bank of India , IDBI Bank and ICICI Bank together own more than 50% of Arcil's equity and they apparently used this clout to enter into questionable deals that furthered their own interests at the cost of Arcil. Second, is the technical issue of Arcil's business model for acquiring and subsequently realising non-performing loans (NPLs).

Typically, NPLs are acquired by Arcil under a trust structure and security receipts representing interest in underlying assets issued to Qualified Institutional Buyers, with Arcil acting as the trustee. The proceeds from these receipts are then utilised to pay sellers of NPLs.

Since the sellers are also banks or financial institutions the model is akin to a cosy deal between banks and the asset reconstruction company, reminiscent of the incestuous relationship between financial players that was a hallmark of the 2008 financial crisis. In effect, banks get NPLs off their books by selling to a trust while the latter in turn is funded by the banks.

So instead of impaired loans they now hold security receipts representing the same impaired assets. The third, critical deficiency that the RBI report suggests, if not in so many words, that Arcil seems no better equipped to recover the NPLs than the banks themselves.

The Securitisation Act 2002, was expected to strengthen the hands of banks, financial institutions and other specialised agencies like Arcil by providing a legal framework for securitisation and for enforcement of security. But a quick resolution is still nowhere on the cards. That is what we need to address, both to ensure wilful defaulters don't hold the system to ransom and to turn around locked-in capital in a capital scarce economy.



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