Sunday, March 5, 2017

The return of bad loans resolution debate

Arguably the biggest obstacle to India's medium term economic growth prospects is the twin-balance sheet problem. It is therefore unfortunate that it has not received the sort of attention that it deserves. 

The new deputy governor of the Reserve Bank of India, Viral Acharya, has re-ignited the debate with a comprehensive proposal involving a two-track approach. He proposes the establishment of a Private Asset Management Company (PAMC) and a National Asset Management Company (NAMC) as private and quasi-government entities to resolve assets categorized based respectively on short-run and long-run economic value realisation. 

This broad contours syncs well with the proposal laid down by Ananth and me here. See also the blogposts here, here and here. The details of the proposal is here. The only differences being that instead of direct sales to ADCs or other buyers, he suggests a PAMC route to manage resolution and sales, and he also proposes the establishment of a new NAMC instead of leveraging an existing institution like the NIIF or IIFCL. In fact, this blog's proposal goes beyond what the Deputy Governor suggests and offers two more alternatives - sale of some assets to PSUs like NTPC, and bundled auctions of certain other types of assets like steel facilities. These two are potentially easier to tackle and can be the trigger points to catalyse the process. 
This blog feels that using existing institutions may be better than the creation of new institutions. For a start, new institutions will take time. For example, the NIIF, despite its creation more than a year back is yet to have a full-fledged team and the appointment of its CEO took more than six months. Creation of another PAMC will duplicate expertise currently available with IIFCL and NIIF, both of which are themselves sorely under-utilised. 

On the private side too, existing AMCs, ARCs, PE, and private infrastructure funds can be invited to  participate in the auctions and manage these assets. This is all the more relevant since the PAMC will also end up floating several funds or special purpose entities to resolve and revive the vast portfolio of such distressed assets. Further, establishing one or more PAMCs, as fully private entities, and allocating assets to them will raise its set of problems of price discovery etc. Finally, mobilisation of skilled resolution and revival professionals for these new AMCs may take inordinately long times.  

As with all such grand plans, the devil is in the details. Some of them will doubtless emerge as thorny issues - credibility of the credit ratings, stripping and removing existing management, co-ordination problem among banks, avoiding promoters sneaking back as buyers etc. Consider the following,
Haircuts taken by banks under a feasible plan would be required by government ruling as being acceptable by the vigilance authorities. Sustainable debt would be upgraded to standard status for all involved banks. The promoters, however, would have NO choice as to what restructuring plan is accepted, and may potentially get replaced and/or diluted, as per the preference of and depending on the price at which the new managing investors come in.
This is all fine to say. Government can always lay down the process and decision criteria. The vigilance findings will generally revolve around some process details. But it is not possible to cover all contingencies. Post-facto, with the benefit of hindsight, some omission, always likely, will get packaged as part of a criminal conspiracy. And even if the vigilance authorities are kept out, PILs and Courts cannot be. And about prohibiting promoter's choice, it is always likely that they will raise some interpretation of a procedural lapse, again difficult to avoid, and litigate.

In any case, what ever be the details of the process adopted, there will be two critical challenges. 

1. The biggest challenge to the whole process will have to be in figuring out the most (likely to be) acceptable mechanism for price discovery. After all, nothing about the process will be more scrutinised and more critical to the success of the proposal than the degree of haircuts. In such cases, there are no fair valuations, howsoever objective, since judgements on such valuations are always made on post-facto considerations. A haircut arrived at through a professional approach of evaluating alternative resolution plans is no guarantee against post-facto scrutiny. Procedural lapses and process vitiations are always round the corner. Given the size of the problem, as the process proceeds, auctions are likely to generate single bids or no bids, thereby necessitating revised bids, again only to generate single bids. Further, a handful of asset managers could corner the vast proportion of the best assets and make handsome gains down the line.   

Therefore, we may need to make prudent compromises. A Committee headed by a very credible retired judge of the Supreme Court (Justice Sri Krishna?) can be given the mandate to approve the haircuts. This will both ease the vigilance fear as well as possibly limit excessive judicial trespass. 

2. Then there is the issue of recapitalisation. There is only so much that can be raised for recapitalisation through equity dilution upto 51%. Even this will run into political difficulties. Dilution below 50% is a political taboo and may not be desirable too given the distressed valuations. Therefore, the vast majority of recapitalisation will have to come from the government. It will be a few times more than the proposed Rs 70,000 Cr over the 2014-19 period. And there is also the additional capital required to meet the Basel III norms. 

In the circumstances, the banks may need at least a 0.5% of GDP annual recapitalisation for the coming 4-5 years.

Finally, apart from the Deputy Governor's caution on cherry-picking parts of the proposal and ignoring others, it would be necessary to complement this proposal with the provision of real operational autonomy so as to increase valuations and set the stage for phased divestments. 

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