A Strategic Note on Stressed Assets in India

The Insolvency & Bankruptcy Code was landmark piece of legislation passed in 2016.

The Act harmonized the various laws applicable to corporate affairs in India; especially with respect to their obligations towards the Banking industry and the treatment of Non Performing Assets. The NPA phenomenon is well documented in India, causing one to note the inherent deficiencies of the regulatory framework of the country.

While it is clear that while legislative pathways are more clearly defined as compared to the past – the bureaucratic burden, amongst other hurdles, prevents the country from offering investors access to a market worth USD 150 Billion.

However, since the passing of the ISB the Gross Non-Performing Assets ratio of Scheduled Commercial Banks has dropped to the lowest point since 2015.

Regulatory Environment

The IBC wasn’t the first Act to be passed with the goals of governing and managing the sale of non performing assets.

This initiative was started by the Sick Industrial Companies (Special Provisions) Act, 1985.

India, which has a diverse library of laws via which to approach the question of stressed assets, however has failed to address the root causes of such failures, i.e. these failures are systematic. Law firms within India, such as the notorious Shardul Amarchand Mangaldas released position papers heralding a new era of asset reconstruction in India; even going so far as to call it a "game changer".

However, the reality is that the game is still the same. Of the 2000 or so cases involving distressed assets, more than 1280 cases had crossed the resolution time limit of 270 days . Investors who would like to invest in these assets face issues not limited to litigation and recalcitrant debtors.

While the gross amount of Non Performing Assets submitted for resolutions are lower than pre-pandemic levels, the core issues which prevent fresh capital being injected into fundamentally sound assets still persist.

These delays do not just penalize the investor, but more importantly place a heavy burden on the original lender (such as banks) – who in many instances has been forced to accept haircuts of up to 70% . In 2017, a CRISIL report illustrated how the banks have no choice but to accept INR 2.4 Lakh Crore [approximately USD 20 Billion] on assets cumulatively worth INR 4.3 Lakh Crore 6 [approximately USD 30 Billion].

Securitization

Even before the onset of the Coronavirus pandemic and its associated global economic slowdown, securitisation was the obvious answer to the woes of the Indian financial ecosystem.

The support for securitisation of bad loans also gained further support when it was revealed that Non-Banking Financial Entities, much like their brethren in banking, were also sitting on INR 1.8 Lakh Crore [approximately USD 15 Billion] of NPAs.

While a committee was established to investigate a mechanism through which a secondary market could be created for NPAs in 2019, it was only earlier this year in 2023 that the Reserve Bank of India released a discussion paper on Special Purpose Entities having the power to securitize the non performing assets that it may acquire.

One of the signs that the IBC achieved its goals was that all sets of stakeholders (promoters, investors and creditors) were all equally upset at the resolutions reached under the NCLT. Globally, the Asset Reconstruction Company was packaged as a magical solution to the plague of bad debt. The narrative of effective management with industry expertise worked wonders for ARCs investing in energy, manufacturing and pharmaceutical sectors.

In recent times, this has slowed down significantly because of the aforementioned issues involving lengthy delays in the resolution process . To add to this, questions remained on the fundamental quality of the assets underlying these loans.

This is concerning for the Reserve Bank of India as in FY22, foreign institutional investors pumped in INR 14,482 Crore [approximately USD 1.7 Billion] as compared to the previous year when INR 10,156 Crore [approximately USD 1.2 Billion] was injected into Asset Reconstruction Companies.

Secured Notes: India & Abroad

The discussion paper published by the Reserve Bank of India hypothesizes a framework within Banks would be able to offload their bad debts to a SPE, as mentioned previously. What is unique in that the Special Purpose Entity would not only be able to raise debt via secured assets in order to purchase the asset; but also be able to appoint a servicing entity which would manage the stressed asset. A common sense approach, powered by thinking that is not yet bullet-proof, but is well on the way to being so.

The House View on this upcoming regulatory change is positive.

Theoretically, this could unlock an entire section of the Indian economy which has suffered as a result of unclear legislation, bad faith actors and lengthy red-tape. Verticals such as construction, housing, gold and jewelry, as well as the previously mentioned usual suspects such as Manufacturing and Pharmaceuticals still retain incredible value.

Investors, both inside the subcontinent as well as abroad should study this new framework for access to opportunities via Secured Notes.

Sources

Insolvency & Bankruptcy Act.
Data | Bad loans share at a decadal low in Indian banks
Shardul Amarchand Mangaldas – Distressed Assets Opportunities in India
IBC Resolutions on the Road to Nowhere – Hindu Business Line
NCLT Report – Bizz Buzz
CRISIL Research
NBFC GNPA - CRISIL
Economic Times – RBI seeks views on Securitisation of NPA
Bloomberg – Bad Debt Reconstruction Firms
Regulation Asia – Proposal of New Securitisation Framework