SASF structure NPA resolution mechanism - Indian experience and lessons for others FICCI - IBA Conference October 5, 2005

2 Bad bank Non- governmental 2 Isolation of stressed assets to bank’s work- out group / affiliate “Self help” mechanism No special powers from Government / regulator Focus on NPA workout Isolation of stressed assets to bank’s work- out group / affiliate “Self help” mechanism No special powers from Government / regulator Focus on NPA workout High level of NPAs but no crisis Market based approach to address NPA “stock” & “flow” No direct participation by Government Conducive framework by Government & Regulator for resolution & exit High level of NPAs but no crisis Market based approach to address NPA “stock” & “flow” No direct participation by Government Conducive framework by Government & Regulator for resolution & exit Government owned Banking crisis System-wide solution Nodal ARCs to addresses NPA “stock” Fiscal support & forbearance from Government and Regulators Banking crisis System-wide solution Nodal ARCs to addresses NPA “stock” Fiscal support & forbearance from Government and Regulators Structural options for NPA clean-up ApproachApproach

3 Bad bank Non- governmental 3 Leaves NPAs with banks Risk and reward remains with the bank Limited success due to absence of debt aggregation Leaves NPAs with banks Risk and reward remains with the bank Limited success due to absence of debt aggregation Presence of willing sellers & foreign investors Risk and reward with investors Strong Regulatory inducement essential for success Presence of willing sellers & foreign investors Risk and reward with investors Strong Regulatory inducement essential for success Government owned Clean exit from NPAs to banks Resolution and consequent risks-rewards with investors Needs recapitalization of banks Clean exit from NPAs to banks Resolution and consequent risks-rewards with investors Needs recapitalization of banks OutcomeOutcome Structural options for NPA clean-up South-East Asia Taiwan, IndiaBank specific

4 Enable banks to focus on core activities Unlocking of capital in NPAs Enhancement of value by reduced time to resolution AND Redeployment of underlying assets to productive use Common theme across the models Recycling and improvement in efficiency of capital is the overarching objective Recycling and improvement in efficiency of capital is the overarching objective

5 Profile NPAs are mostly industrial assets – exposure to ‘bubble sectors’ is minimal Resolution of larger cases (80% by value) requires intense workout by way of corporate restructuring, business sale and combination NPAs in the Indian banking system Not a crisis

6 By banks themselves CDR - forum of lenders under the aegis of RBI Intermediation in resolution process Lender driven resolution Exit for selling banks on commercial basis through ARCs Inter bank/NBFCs purchase/sale of NPAs NPA resolution mechanism - options

7 Large cases (80% by value) Debt aggregation & inter- creditor issues Workout Options are complementary Small cases (20% by value) Restructuring of revivable accounts - CDR NPAs requiring complex workout - ARCs Rapid disposition Realisation from asset sale / settlement Resolution by banks themselves Exit through ARCs Inter-bank/ NBFCs purchase & sale Type of cases Resolution issuesMechanism

8 ? ? ? ? ? ? ? Infrastructure for NPA resolution is in place Effective legal framework Resolution mechanism including market based clean exit are available Issues Is the level of NPAs perceived as problem? Will there be a meaningful intermediation and market creation for NPAs? Is there a case for seller banks to continue as investors? The story so far

9 …but Gross NPA level remains high and need to be tackled Reduction by resolution / realization – key to unlock capital. Preparation for Basle II norms …but Gross NPA level remains high and need to be tackled Reduction by resolution / realization – key to unlock capital. Preparation for Basle II norms NPA level contained thru CDR restructuring... 64,017 Net NPA % Gross NPA Net NPACDR 2.00 % 4.00 % 6.00 % 8.00 % Net NPA %

10 Absence of uniform book Inadequate provisioning particularly in large accounts Impacting debt aggregation and resolution Desire to clean the books Comfort derived from net NPA levels Lack of incentive for clean-up Possible apathy of the banks’ senior management to take difficult decisions? Constraints of the sellers in taking substantial write-offs More so in inter-bank cash deals Unrealistic price expectations - considering value extraction from NPAs would be over time through operation of underlying assets Sell side constraints

11 Participation of FIIs in ARCs’ equity and SRs, key to clean exit for banks and consequential success of ARCs, yet to be permitted Limited capital with Indian banks / NBFCs operating on the buy side will limit their ability to purchase NPAs in cash Domestic market (insurance cos., MFs, pension funds etc.) not geared to participate Absence of risk appetite and policy issues Buy side constraints

12 Resolution of large NPAs with underlying industrial assets would be through intense workout Maximum value realization - over a period of time Direct sale to investors for cash would be at significant discount – requiring larger provisioning No upside available to the sellers post sale – one time exit Investment in SRs captures value at resolution stage Exit from NPAs Upside available as an investor Case for sellers to invest in SRs However, guaranteed return expectation from distressed debt investment is unrealistic However, guaranteed return expectation from distressed debt investment is unrealistic

13 Taiwan, like India, has adopted a non-governmental model for NPA clean up Approach – Sell to ARCs set up in non-governmental sector Regulatory inducements for sale of NPAs Banks to reduce their NPA ratio to 5% with penalties stipulated for non achievement Banks allowed five years to amortize losses upon transfer New money from FIIs permitted for NPA acquisition Result Banks exited from NPAs through ARCs in deals aggregating more than USD 10 billion - funded by FIIs NPA ratio of the system in December 04 < target 5% A comparison with Taiwan

14 Government / Regulators must stipulate tougher cleanup targets Delays are costly - NPAs deteriorate 20% - 30% annually if not managed timely Asset values and recovery expectations must be realistic FII investment must be permitted for cash exit to selling banks Directly (smaller cases) or through ARCs (larger cases ) Rationalization of tax and stamp duty structure with a view to minimize transaction costs Final thoughts ARCs can be only as effective as the system wants

15 Thank you