August 21, 2014 12:00 am JST

Modi first has to fix India's bad-loan problem

RYAN MAXIM RODRIGUES, Contributing writer

MUMBAI -- High on Prime Minister Narendra Modi's reform agenda is modernizing India's creaking infrastructure and making chronic power shortages a thing of the past. But financing those ambitions first requires digging the country's lenders out from under a mountain of bad debt.

Cleaning up the mess

A recent spike in nonperforming loans is partly the result of debt-ridden infrastructure and energy projects. G.S. Sandhu, the financial services secretary, in July proposed a new breed of state-funded asset reconstruction companies, or ARCs, that could take these soured energy and infrastructure loans off the banks' books. Supporters of the plan say this could help revive stalled projects and free up much-needed bank capital for fresh loans.

     According to the Reserve Bank of India, around 85% of nonperforming assets are held by state-controlled banks. As India's economic growth slowed in the last two years, nonperforming assets at India's public-sector banks ballooned, reaching $36 billion for the year through March 2014, up 39% over the previous year.

     There are 14 private ARCs in India. Arcil, which commenced business in 2003, is the oldest and has $1.6 billion in assets under management.

    The ARCs have yet to make much of a dent in the amount of bad debt carried by banks.

     Between April and July, nearly $5 billion of assets were put up for sale by Indian banks, said Puthukulangara Rudran, Arcil's managing director and CEO. He said around half of these assets failed to find buyers.

     Private ARCs are too small to take on big infrastructure loans, and they often fail to agree on pricing for loans with public-sector banks.

Fixing the flaws

In a typical transaction, an ARC pays cash for 5% of an asset's face value, while the bank keeps the remaining 95%. The ARC then takes over management of the entire project for a fee of around 2% a year, which is recovered from the asset.

     Details about the government's plan to set up state-controlled ARCs are sparse, but CEOs of private ARCs say they expect such entities to take full ownership of the bad assets they purchase from banks and be in charge of turning around the attached projects. Sandhu has said the idea is to bring in specialist companies with the relevant expertise to run infrastructure or power projects. The banks, by taking equity stakes in the new ARCs, will continue to have a stake in the projects they had approved loans for.

Slowly but surely

Meanwhile, the central bank has been studying ways to inject more life into private ARCs and recently removed a limit on foreign investment in them. It will now allow ARCs to buy and sell debt from each other and require banks to sell their bad debt through transparent public auctions.

     On Aug. 6, the central bank issued new guidelines that require ARCs to purchase at least 15% of an asset. Banks with assets to offload are now required to give ARCs no less than two weeks to conduct due diligence.

     Another positive development is that banks are more willing to group together their shares in a problematic loan for sale in a single transaction. In early July, investment bank JM Financial's ARC unit bought soured loans totaling 38.8 billion rupees ($638 million) owed by the troubled Hotel Leelaventure hospitality group.