MARKET-BASED SECURITISATION OF STRESSED ASSETS - ECONOMY
NEWS: The RBI has proposed to allow securitisation of stressed assets through a market-based mechanism, not just through Asset Reconstruction Companies (ARCs) as is currently done.
WHAT’S IN THE NEWS?
Asset Reconstruction Companies (ARCs)
1. What Are ARCs?
• Asset Reconstruction Companies are specialized financial institutions set up to buy bad loans (stressed assets) from banks and recover money through restructuring or asset sales.
• In India, ARCs were introduced under the SARFAESI Act, 2002 (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act).
• Their goal is to relieve banks of non-performing assets (NPAs) so that banks can focus on fresh lending.
2. How ARCs Work:
• Banks sell their stressed loans to ARCs at a discounted price.
• ARCs try to recover the money from the borrower by:
• Restructuring the loan,
• Taking legal action,
• Selling the borrower’s collateral.
Limitations of the ARC-Driven Model
1. Limited Number of Players:
• The number of ARCs operating in India is small.
• This restricts competition and innovation in debt resolution methods.
2. Low Recovery Rates:
• Many ARCs struggle to recover a significant portion of the bad loans they acquire.
• The recovery process can be slow and complicated, often involving legal hurdles and poor borrower cooperation.
3. Market Concentration:
• A few large ARCs (like Edelweiss ARC and Asset Care & Reconstruction Enterprise) dominate the sector.
• This creates entry barriers for smaller or newer players and limits the diversity of strategies in resolving bad loans.
Shift Toward a Market-Based Securitisation Approach
1. New RBI Proposal:
• The Reserve Bank of India (RBI) plans to open up the market for distressed assets, rather than keeping it restricted to ARCs alone.
• This would allow broader participation by non-ARC entities.
2. Expected Benefits:
a) More Market Participants:
• Entities like mutual funds, private equity firms, and institutional investors can now invest in stressed assets.
• This diversifies risk and improves resource mobilization for recovery.
b) Secondary Market for Stressed Debt:
• Creating a tradable market for distressed loans helps in price discovery, making the valuation of stressed assets more transparent and efficient.
• Investors can buy and sell distressed debt, just like stocks or bonds.
c) Alignment with Global Best Practices:
• Advanced economies like the United States and United Kingdom already have robust distressed asset markets.
• India's move towards a similar model promotes financial system maturity and resilience.
What Are Stressed Assets?
1. Definition:
• Stressed assets are loans that show signs of repayment trouble or are unlikely to be recovered in full.
2. Types of Stressed Assets:
a) Non-Performing Assets (NPAs):
• Loans that are overdue for more than 90 days.
• The bank stops receiving interest or principal repayments on these loans.
b) Restructured Loans:
• Loans where the repayment terms have been modified to help the borrower due to financial stress.
• Though not in default, these loans carry higher risk and often end up becoming NPAs later.
c) Written-Off Assets:
• Loans that the bank has deemed uncollectible and removed from its balance sheet.
• These are shown as a loss but recovery efforts may still continue.
3. Impact on Banks:
• Stressed assets weaken a bank’s financial health.
• They block capital that could be used for fresh, productive lending.
• High levels of stressed assets lead to reduced investor confidence in the banking sector.
What is Securitisation?
1. Definition:
• Securitisation is a process where banks convert their loan assets into tradable securities, which are then sold to investors.
• It helps banks transfer the risk associated with loans and free up capital.
2. How It Works:
• Banks pool together similar loans (like housing loans or stressed corporate loans).
• These loans are packaged into a financial product (called a security or pass-through certificate).
• The securities are sold to investors, who receive returns based on the loan repayments from borrowers.
Benefits of Securitisation
1. Frees Up Bank Capital:
• Selling loan assets allows banks to recover money upfront, which can be used for new lending.
• It improves the bank’s capital adequacy and balance sheet health.
2. Distributes Credit Risk:
• The risk of default is spread across multiple investors, instead of being concentrated with a single bank.
• This promotes financial stability in case of defaults.
3. Speeds Up Balance Sheet Clean-Up:
• Banks can clean up their balance sheets without waiting for slow, legal recovery processes.
• This leads to faster resolution and a healthier banking sector.
Risks of Securitisation
1. Complex and Opaque Instruments:
• The securities created through securitisation can become complicated and difficult to evaluate, especially when they include many low-quality loans.
• Poor transparency was a major factor in the 2008 global financial crisis.
2. Inadequate Risk Assessment:
• If banks or investors do not carefully assess the quality of loans in the securitised pool, it can lead to massive defaults and losses.
• Over-reliance on credit ratings or faulty models can mislead investors.
Source: https://economictimes.indiatimes.com/news/economy/policy/rbi-issues-draft-norms-on-securitisation-of-stressed-assets/articleshow/120131799.cms?from=mdr