Securitisation & Functioning of Asset Reconstruction Companies

Asset Reconstruction Companies

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SECURITISATION & FUNCTIONING OF ASSET RECONSTRUCTION COMPANIES

SUBMITED BYVikrant YadavPRN: 11020441334Finance-Marketing (D-53)2011-13

Under the Guidance ofMr. Aneesh Day

SYMBIOSIS INSTITUTE OF MANAGEMENT STUDIES (SIMS)(CONSTIUENT OF SYMBIOSIS INTERNATIONAL UNIVERSITY)

February 2013

Certificate

Acknowledgement

I would like to express my gratitude to all those who have gave me the possibility to complete this project. I want to thank to our Internal Faculty Guide Prof. Aneesh Day for showing us the path to commence this project in the first instance. He looked closely at the final version of the project for correction and offered suggestions for improvement.

Thank You,Vikrant Yadav

Date:Place:

Table of Contents1.Executive Summary62.Introduction73.Need for Securitisation companies/ Asset Reconstruction Companies94.Global Scenario95.Indian History16Narasimham committee I (1991) - ARF16Narasimham committee II (1998) ARC16SARFAESI 2002186.Working of the SCs/RCs19Securitisation19Asset Reconstruction197.Flow of Securitisation218.Benefits of Securitisation22Benefits to the Originators, especially FIs22Benefits to the Investors239.Recommendations241.Permission for HNI investors to buy Security Receipts issued by the Trust set up by the Securitization Companies/Reconstruction Companies.242.Individual FII investment limit to be increased243.Double Stamp Duty to be abolished254.Reserve price for NPA sale265.Restructuring Support Finance2710.References28

Executive Summary

Asset Reconstruction Companies are special entities which use market forces to consolidate and attractively package lender interests and arrange funding for asset reconstruction. The requirement of Asset reconstruction arises in India from the bad loans emerging out of a systemic banking crisis.

Asset Reconstruction Companies more popularly known as Asset Management Companies in other countries were established by the SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST BILL(SARFAESI), 2002.

ARCs are established to assists banks and financial institutions to manage the problems of liquidity, asset liability mismatch and recovery of NPAs by taking possession of the NPAs from the banks and financial institutions. ARCs in India adopt a trust structure, through which they issue pass through securities or pay through securities. A standard business model of a typical ARC is to buy distressed assets from a Bank/Financial Institutions; and then choose between directly securitizing them or first reconstructing the asset and then securitizing it before sale to investors. Another prospect to invest in the reconstruction exercise lies in partnering the ARC in reconstructing debt. This opportunity is unavailable to retail investors & only Qualified Institutional Buyers can participate in it.

Any instrument issued by an Asset Reconstruction Company needs to possess certain features before it becomes palatable to the investors. These include credibility, marketability of the issuer & credit enhancer, transparency, wide distribution, homogeneity & the presence of an SPV (special purpose vehicle).

1. Introduction

Asset reconstruction refers to the acquisition of asset from the Banks/FIs by any securitization or reconstruction company for the purpose of realizing the asset.Asset reconstruction originated from the recommendation of setting up an Asset Reconstruction Fund by the Narsimham Committee Report 1991. The money for setting up the fund was supposed to be contributed by the Central government which was to be used for bailing out the banks from the bad loans in their portfolio. However faced with difficulties and an increase of debt burden on the Central government this idea was scrapped and the Narsimham Committee Report 1998 recommended formation of asset reconstruction companies(ARCs), the likes of which had already been doing well in Malaysia, Korea and several other nations in the world.

Objectives of the Study:

1. To analyze the need and impact of securitization in restoration of liquidity in financial system.

2. To provide recommendations for amendments in SARFAESI Act to facilitate concerned entities.

2. Literature Review

Over the years, a lot of attempts have been made by the researchers to evaluate the various aspects of securitized instruments and examine the justifiability of its introduction in the financial markets.

Ketkar and Ratha (2001) suggested that developing countries cannot obtain low-cost, long-term loans during financial crises. Thus, securitization of future flow receivables can help investment-grade public and private sector entities in these countries obtain credit ratings higher than those of their governments and raise funds in international capital markets.

Kothari and Gupta (2004) studied the development of MBS market in India and examined the relevance of securitization, both agency-backed securitization (i.e. MBSs issued by government sponsored agencies which promote mortgage secondary markets) and private label securitization (i.e. mortgage backed issues securitized by non-agency financial institutions) over the development of housing refinance market in India.

3. Need for Securitization companies/ Asset Reconstruction Companies

SCs/RCs were required to clean the balance sheets of the banks/ Financial Institutions by removing the bad loans' from the books of banks/ Financial Institutions. This enables banks/Financial Institutions to

1. Release funds tied up in bad loans for lending to productive manufacturing sector.2. Increase the availability of liquidity in the market for lending.3. Shore up their balance sheets.

4. Global Scenario

In recent times many countries have experienced banking problems requiring a major and expensive overhaul of their banking system. As cross country evidence suggests, stock solutions tend to be necessary where banking distress is systematic and often include liquidation of unviable banks, dumping and management of impaired assets and restructuring of viable banks. For the management and disposal of bad debt, governments have made widespread use of publically owned Asset Management Companies (AMC) that either dispose off assets hived from bank balance sheets or restructure debt. AMCs have become very popular including in Asian Financial crisis.

Some of the measures adopted by the countries worldwide are:

A. United States of AmericaAsset liability mismatches and other economic issues led to a major banking crisis in the mid 1980s in the US. From the period ranging from 1980 through 1991, a total of 1,400 banks in the US failed or sought government assistance. During the same period, 1,100 savings and loan associations or thrifts (as they are referred to in the US) also failed.This financial slump led to the insolvency of the Federal Savings and Loan Insurance Corporation (FSLIC) which used to provide government insurance guarantee over thrift retail deposits. The FDIC (Federal Deposit Insurance Corporation) which used to provide a similar insurance cover over retail bank deposits underwent a similar crisis. The Bank Insurance Fund (BIF) administered by the FDIC carried a deficit balance of USD 7 bn at the end of 1991.To stabilise its economy and financial sector, the US government passed legislation for setting up of the Resolution Trust Corporation (RTC) in 1989, to resolve the issue of NPLs in the US. The directive given to RTC was to take over the NPA of failed thrifts and actively manage these assets to maximize value. The RTC had a daunting task of resolving assets adding together approximately USD 1 trillion. The RTC was able to resolve all these assets successfully, and it ceased operations in 1996.

B. MexicoDuring the 1995 economic crisis, Mexican banks suffered failures on account of huge NPA. To revive the banking sector, the government received financial assistance from the US, the World Bank, and the Inter-American Development Bank. This allowed the Mexican government to provide support to the failing banks through the Bank Fund for Savings - Fondo Bancario de Proteccin al Ahorro or Banking Fund for the Protection of Savings (FOBAPROA). The justification behind the creation of FOBAPROA was that it would acquire the NPA of the Mexican banks and would provide capital to them if they faced liquidity problems in the event of economic crises. The FOBAPROA took over debt of approximately USD 552 bn which was equivalent to 40% of GDP of Mexico in 1997.In January 1995 the Mexican government started PROCAPTE (Programa de Capitalizacin Temporal or Temporary capitalization program), while FOBAPROA was acquiring outstanding debt of banks. The PROCAPTE allowed faster access to a higher volume of foreign capital and the solvency of banks. FOBAPROA acquired the debt of the insolvent FIs with a condition that the stockholders of these financial institutions would re-invest their capital in the market.In 1996 the UCABE (Unidad Coordinadora para el Acuerdo Bancario Empresarial or Coordinating unit for the Bank-Entrepreneur Agreement) was created to restructure debt. A total of 54 companies took advantage of the UCABE to re-structure USD 9.7 bn.FOBAPROA is different from the Asian AMCs, as it is essentially a recapitalisation exercise. FOBAPROA is a trust established by Banco de Mexico to provide preventive support to problem banks.

C. KoreaDuring the 1997-1998 Asian financial crisis, thousands of Korean companies went bankrupt, leaving banks with huge portfolios of nonperforming loans. The Korean government moved aggressively to deal with the problem; among other steps, It closed, merged, or sold scores of banks and financial institutions Mandated banks to raise their capital adequacy ratios Strengthened asset classification standards for banks Required banks to make adequate provisions for nonperforming loans. Instituted reforms to increase corporate accountability and transparency.It also started the Korean Asset Management Corporation (KAMCO) to acquire and dispose of the banks Non Performing Loans. Koreas NPL market peaked in 2000 and a few large-volume NPL sales to investors were closed in 2001. While banks were reducing their portfolios of corporate NPLs, their consumer NPLs began to increase as overextended consumers defaulted on their credit card debt. In 2002, banks began to dispose off their consumer NPLs, and when Koreas credit bubble burst in early 2003, they shifted their focus from corporate loans to write-offs and sales of portfolios of consumer NPLs. The change in NPL pools from corporate to predominantly consumer loans also led to changes in the makeup of NPL buyers, with domestic investors such as savings and loans, mid-sized corporate restructuring companies (CRCs), and collection agents forming investment groups to acquire consumer NPLs. Foreign investment banks and private equity funds that had been buying corporate NPLs generally shunned consumer NPLs, choosing instead to target M&A deals and a diminishing number of corporate NPL opportunities. With the continuing disposition of their NPL portfolios, financial institutions have managed to improve their asset quality, which has resulted in a more stable banking system. In 2005, Korean banks posted record earnings and a record low NPL ratio.KAMCO adopted a number of techniques to dispose of the NPA it acquired from problem banks. These include traditional methods such as collection of rescheduled repayments, competitive auctions and recourse to the original seller, and other innovative techniques which included bulk (pooled) sales, individual sales, issuance of asset backed securities (ABS) and joint venture partnerships.The choice of a particular method depended on the type and size of NPA. Bulk or pooled sales included issuing Asset Backed Securities and international bidding with an aim for early resolution of NPA and quick cash flows. Individual sales focused on discovering the market value of each individual asset and include foreclosure auction, public auction of collateral, and sales of individual loans. Joint venture partnerships were used as a tool for promoting cooperation with foreign and domestic investment companies who are specialists in asset management and corporate restructuring.

D. MalaysiaNet non-performing loan (NPL) ratio in the banking system since the Asian financial crisis has gradually been on a decline from a high of 13.6% (3-month classification) in December 1998 to 5.5% in June 2006.Danaharta, the national AMC, was set up in 1998 to tackle the NPL problem that arose during the Asian financial crisis with the objective of removing the NPLs from the financial institutions and subsequently to extract maximum recovery from the NPL.The legislation called the Pengurusan Danaharta Nasional Berhad Act 1998 (Danaharta Act), was critical in allowing Danaharta to acquire NPLs from financial institutions through statutory vesting. It also conferred extensive powers to the national AMC to aid in speedy recovery of NPL.Danaharta ceased operations on December 31, 2005 after being in existence for seven and a half years. The total residual recovery assets of Danaharta at that point stood at close to RM 3 bn. Upon Danahartas closure of operations, control of these assets reverted to Danahartas shareholder, Minister of Finance Incorporated (MOF Inc). MOF Inc appointed a wholly owned subsidiary, Prokhas Sdn Bhd, to act as a collection agent for the residual recovery assets.

E. ThailandThe Thai Government formulated the Thai Asset Management Corporation (TAMC) policy in February 2001 with a view to boost the stability of the financial sector and to promote efficient management of non-performing assets and minimize economic losses. The TAMC Decree came into force on June 9, 2001 with the creation of a national asset management corporation, the Thai Asset Management Corporation (TAMC) to resolve the high level of NPA in state-controlled and private financial institutions in Thailand. The TAMC is managed by a Board of Directors appointed by the Minister of Finance with due approvals from the Council of Ministers.The TAMC is a government agency with 100% share of the Financial Institutions Development Fund (FIDF). To acquire and resolve the high incidence of NPA in the Thai financial sector, the TAMC issued Baht 170 bn (approximately USD 3.7 bn) 10-year notes guaranteed by the FIDF to financial institutions.TAMCs main aim is to accept the transfer and management of sub-quality assets in the Thai banking sector. TAMC has unprecedented powers to ensure this. Additionally it has been empowered to establish limited companies, guarantee credit for debtors, and lend money to debtors. TAMC after four years has largely succeeded in NPL resolution. As of Q2, 2005, TAMC has resolved Baht 772.4 bn (USD 8.8 bn) of NPL from a total NPL of Baht 778 bn (USD 9 bn). 74% of the NPL were resolved through debt restructuring or rehabilitation in the Central Bankruptcy Court.

F. ChinaThe Chinese government set up four state-owned asset management corporations (AMCs) in 1999 to address the problem of NPLs on the bank balance sheets. The objective of these AMCs was to buy bad debts of the four major state-owned commercial banks and resolve them over 10 years. As the big four banks hold almost 65% of the Chinese banking sectors loan portfolio, they were the main focus of any bank restructuring efforts.The Chinese government adopted the model of separate and decentralised NPL management as followed by the Swedish authorities. Each of the four AMCs pairs up with one of the big four banks.

The Ministry of Finance (MoF) provides each AMC with an initial equity capital of RMB 10 bn (USD 1.2 bn). Chinas AMCs have done well in meeting their recovery targets. For example, as of year-end 2005, China Cinda AMC (Cinda) reported collecting RMB 62.84 bn (USD 7.8 bn) of cash from RMB 201.21 bn (USD 24.9 bn) of face value. In addition, NPL sales by the AMC are accelerating, with Huarong selling RMB 36.4 bn (USD 4.5 bn) of Category 5 NPL to Silver Grant, a Hong Kong listed asset management and investment company.Huarong also sold RMB 14.5 bn (USD 1.8 bn) of assets to an Equity Joint Venture (EJV) with Deutsche Bank/AIG. Huarong and Deutsche Bank/AIG will jointly manage the entity. Huarong is the majority shareholder and has a majority of the seats on the board. The EJV has a 15-year

life and will function as an operating platform for a variety of investments. The EJV structure is a pioneering effort to help the AMC transform themselves into independent commercial investment companies (subject to the approval of regulators).

G. IndonesiaSince Indonesias 1998 financial crisis, rehabilitation of its banking industry has been a long-term process. The Indonesian Bank Restructuring Agency (IBRA), a special purpose institution established by the government in 1998, was liquidated in February 2004 after completing the mandate to restructure and rehabilitate the banking industry. IBRA was comprised of Asset Management Credit (AMC) and Asset Management Investment (AMI). AMC was responsible for handling NPLs of the closed or taken-over banks by the government, while AMI was responsible for taking care of the pledged or given-up assets related to the NPLs. During these years, IBRA recovered an estimated 28% of its approximately IDR 600 trillion (USD 61 bn) non-performing loan portfolio. During 2002-2004, foreign investors also participated in this rehabilitation process by acquiring controlling stakes in certain major private banks such as Bank Danamon, Bank Niaga, and Bank International Indonesia (BII). These foreign banks are seen as better-equipped strategic investors, who can meet any additional capital requirements, competitive pressures, and the need for international banking experience, including risk management practices. To prepare the state banks as anchor banks and to privatise them, the government publicly listed Bank Mandiri in 2002 and Bank Rakyat Indonesia in 2003 on the Jakarta Stock Exchange.After IBRA was liquidated, its remaining unsold assets were transferred to the state asset management company, Perusahaan Pengelola Asset (PPA), which was established under the control of the Ministry of Finance. Under PPA, further divestments to foreign investors were to continue.

Comparison of ARCs in East Asian CountriesStructure used and the reasons for setting up of ARCThe infamous currency crisis of 1997 left the economies in East Asia in shreds. It was a period of financial crisis that gripped much of Asia. The crisis had considerable macro level effects. There was a pointed decline in the values of almost all assets including stock prices, currency and on businesses. All this resulted in extraordinarily high levels of non-performing loans in these economies. In 1997, the financial crisis in Indonesia was at its peak, 70% of the loans were estimated to be under-performing. Similarly in Malaysia, Thailand and Korea the under performing loans were in the range of 30-50%. There was a prudent need for a mechanism for the revival of these NPAs.The following table shows the comparison of these counties and the model followed

AMC APTBBAM CBAM DBP FRA/TAMCIBRA KAMCOPNB Asset Management CorporationAsset Privatization TrustBank Based Asset Management CompanyCentral Bank Asset ManagementDevelopment Bank of the PhilippinesFinancial Sector Restructuring AuthorityIndonesian Bank Restructuring AgencyKorea Asset Management CorporationPhilippine National Bank

5. Indian History

Narasimham committee I (1991) - ARF

With the proportion of bad debts and Non performing assets (NPA) high prior to 1991 the Narsimham Committee report 1991 proposed the creation of an Asset Reconstruction Fund. This proposed fund would take over the bad debts and doubtful debts from the banks and financial institutes which would help the banks to improve their liquidity position as well as their profitability.

However, it was felt that centralised all India fund may not be effective in securing recoveries due to Lack of widespread geographical outreach as enjoyed by the banks.

Banks may slacken their efforts in monitoring the other accounts due to which even the healthy accounts may turn ' bad' over period of time.

The large fiscal deficit.

Narasimham committee II (1998) ARC

Narasimham committee report II, 1998 recommended two alternatives for tackling the NPA problem, 1. All loan assets in the doubtful and loss categories which represent the bulk of the hard core NPAs in most banks should be identified and their realizable value determined. These doubtful assets could be transferred to an Asset Reconstruction Company (ARC) which would issue to the bank NPA Swap bonds representing the realizable value of the assets transferred. The ARC could be set up by one bank or a set of banks or even in the private

sector. Funding of such an ARC could be facilitated by treating it on par with venture capital for purpose of tax incentives. Banks may also fund such assets in effect by securitizing them.

2. Another approach suggested was to enable banks in difficulty to issue bonds which could form part of Tier II capital. This approach will help the banks to strengthen capital adequacy which has been eroded because of the provisioning requirements for NPAs. As the banks in trouble may find it difficult to attract subscribers for bonds, Government will be required to guarantee these instruments which would then make them eligible for SLR investments by banks and approve instruments by GIC, LIC and Provident Funds.

Following the Narasimham committee report II, 1998 the need for helping the banks/ FIs to recover their sticky dues expeditiously was recognized. Hence it was proposed in the Union Budget for the year 2002-03 to set up a Pilot Asset Reconstruction Company in India. Accordingly an ordinance was promulgated on June 21, 2002, empowering Reserve Bank of India to determine policy and issue directions in matters relating to regulation of Securitisation Companies/ Asset Reconstruction Companies to be set up under the provisions of the ordinance. The main purpose of issuing the ordinance was to enable the banks and Financial Institutions to improve recovery by exercising powers to take possession of the underlying securities of the bad loans, sell them and reduce non performing assets by adopting measures for recovery or reconstruction of these non performing loans.The ordinance was replaced with the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002) in December 2002.

SARFAESI 2002

Following the Narasimham Committee recommendations The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act was passed in the year 2002. This Act was enacted to regulate securitization and reconstruction of financial assets and enforcement of security interest and for the matters connected thereto. This Act enabled the banks and financial institutions to realize long-term assets, manage liquidity problems, asset liability mis-match and improve recovery by exercising powers to take possession of securities, sell them and diminish non-performing assets by adopting measures for recovery or reconstruction. The Act further provided for setting up of asset reconstruction companies which are empowered to take possession of secured assets of the borrower including the right to transfer by way of lease, assignment or sale & realize the secured assets and take over the management of the business of the borrower.RBI further issued guidelines in the year 2003 which provided the regulatory framework for several critical aspects of securitization.

6. Working of the SCs/RCs

The Act provides different alternatives for recovery of Non Performing Assets, namely: Securitisation Asset Reconstruction

SecuritisationIt means issue of security by raising of receipts or funds by ARCs/SCs. A reconstruction company or securitisation company may raise funds from the QIBs by forming schemes for acquiring financial assets. The ARC/SC shall keep and maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired, out of investments made by a QIB and make sure that realisations of such financial asset is held and applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme.

Securitisation is:-1. Acquisition of financial asset by the SC/RC 2. Repackaging these assets into new financial assets in the shape of security receipt.3. Issue security receipts to the QIBs.4. Collecting the balance amount due from the borrowers.5. Using the same to redeem the SRs subscribed by the QIBs as per underlying agreement for issue of such SRs.

Asset ReconstructionThe ARCs/SCs for the purpose of asset reconstruction should provide for any one or more of the following measures:1. The proper management of the business of the borrower, by change in, or takeover of, the management of the business of the borrower2. The sale or lease of a part or whole of the business of the borrower3. Rescheduling of payment of debts payable by the borrower

4. Enforcement of security interest in accordance with the provisions of this Act5. Settlement of dues payable by the borrower6. Taking possession of secured assets in accordance with the provisions of this Act.

Thus it is clear that the process of securitization of acquired assets involves acquisition of assets by a SC/RC, transfer of these assets to trust and issue of Security Receipts by the SC/RC in the capacity of trustee of the trust, to the Qualified Institutional Buyers. The asset reconstruction, on the other hands, involves evolving of resolution strategy for the acquired assets by employing any of the methods given in Section 9 of the (SARFAESI) Act, 2002

The SC/ARC registered with the RBI, works as an agent for any bank or FI for the purpose of recovering their dues from the borrower on payment of such fees or charges act as a manager amid the parties, with no financial liability for itself; acts as receiver if selected by any court or tribunal.Apart from above functions any SC/RC cannot commence or carryout other business without the prior approval of RBI.

7. Flow of Securitisation

Banks / FIs

Redemption of SRsPayment for Subscription to SRsARC as Asset ManagerTrusts of ARCsBorrowerScheme Borrower wise

Sale of Loan Assets

Purchase Consideration

Reconstruction

Cash Realization

SRs

Investors

8. Benefits of Securitization

Globalization, deregulation of financial markets and growing cross border business transactions has reset the ambience among financial institutions, increasing diverse opportunities for financial engineering. Securitization increases the capacity of lending of an FI without having to find additional capital or deposits. Securitization facilitates specialization and is gaining wide acceptance as the most innovative form of asset financing. A noteworthy impact of securitization is the profiling and placement of different risks and rights of an asset with the most efficient owners. Securitization provides capital relief, expands opportunities for risk sharing and risk pooling, improves market allocation efficiency, enhances liquidity, improves the financial ratios of FIs and banks, creates numerous streams of cash flows for the investors, is customized to the risk profile of a number of customers and facilitates asset-liability management(ALM). The requirements of capital adequacy in recent years have also motivated financial institutions and banks to perform securitization. On the demand side, investors are motivated to buy these securities as they view these as having risk characteristics and compatible with the profile.

Benefits to the Originators, especially FIsFor Financial Institutions, securitization is an opportunity offered in the form of capital relief, capital allocation efficiency, and improvements in financial ratios. Lower cost of borrowing: Securitization reduces the total cost of financing as assets are transferred to a separate bankruptcy-resistant entity. To that degree FIs need not maintain capital to maintain their capital adequacy norms. Also, cos./institutions with a riskier credit profile can benefit from lowered borrowing costs. A source of liquidity: FIs could face a liquidity crunch either due to their risky credit profile or delayed receivables. The liquidity provided from securitization acts as a very potent tool, that FIs could use to adjust the asset mix quickly and effectively. Also, the risks associated with an asset portfolio can be identified and apportioned to arrive at an effective asset mix. Improved financial indicators: Securitization leads to capital relief that improves the companys leverage and in turn the Return on Equity (ROE). The repercussions of securitization on the balance sheet of a company can vary depending on the strategy for its capital structure and its appetite for increasing or decreasing leverage.

Asset-Liability Management: Securitization offers the flexibility in structuring and timing cash flows to each n every security tranche. Securitization provides a means whereby customised securities can be created which helps in matching the tenure of the liabilities and assets. Diversified fund sources: With securitizing its receivables, the instrument of which could be sold to global investors, the originator has an opportunity to diversify its funding source. Positive signals to the Capital Markets: Lenders are at times trapped in a situation where they cannot rollover their debt due to downgrading of their credit ratings, possibly due to economic changes. Within these circumstances, securitization enables lenders like FIs to increase the rating of debt much higher than that of the issuer through the intrinsic credit value of the asset. This enables the Financial Institutions to obtain funding. Avenue for divestiture: Securitization provides an optimal exit route for entities that wish to exit a business comprising of financial assets without going through the mergers and acquisition route.

Benefits to the Investors Portfolio Diversification: As investments in the SRs are uncorrelated to the other investments made by QIBs it offers an opportunity to them to diversify their portfolio. High Returns: Many securitized products offer relatively attractive yields. These high profits don't come for free though; compared to many other types of bonds/investments, the timing of the cash flows from securitized products is relatively uncertain. This uncertainty is the reason, why investors demand higher returns.

9. Recommendations

1. Permission for HNI investors to buy Security Receipts issued by the Trust set up by the Securitization Companies/Reconstruction Companies.

Current Scenario

According to Sec 7 of SARFASEI Act every securitization company or Reconstruction Company shall issue the security receipts through the trust set up exclusively for the purpose. The trusteeship of such trust shall vest with the Securitization Company or Reconstruction Company. The trust shall issue security only to qualified institutional buyers and such security receipts shall be transferable/ assignable only in favour of other qualified institutional buyers.

Problem

With only Qualified Institutional buyers being allowed to buy the SRs issued by the trust set up by the SCs/RCs the depth in this market is limited. Also the true price will not be easily found with only QIB buyers.

Solution

To tackle this problem on an initial stage HNI buyers should be allowed to buy the SRs issued by the SC/RCs as this will increase the depth of the market, help in price discovery and also lead to further growth of this sector in terms of marketability and liquidity.

2. Individual FII investment limit to be increased

Current ScenarioAccording to the SARFASEI Act FDI investments in the equity capital of an ARC can be up to 49%. Also the FII investment limit is 49% in the SRs issued by ARCs with sub-cap of 10% for the participation by individual FIIs.

ProblemWith a 10% cap on individual FII investment the liquidity in the buyers of SRs segment gets affected. With the sector growing more and more FII inflow is expected and thus this cap is a road block in their investment strategy.SolutionThis sub-cap should be removed, however the overall cap of 49% should remain the same. This will increase interest of FII buyers in this sector and will also increase the liquidity in the market. It will also help the new ARCs to raise funds easily for the trust set up by them.

3. Double Stamp Duty to be abolished

Current ScenarioThe stamp duty payable on Assignment Agreement for acquisition of financial assets by ARC varies from state to state. Some states have issued notification restricting the maximum stamp duty payable on Assignment Agreement to one lakh rupees; such a notification is yet to be issued by all states.ProblemIn India, stamp duty is payable on any instrument which seeks to transfer rights or receivables. Hence, the process of transfer of the receivables from the originator to the SPV involves an outlay on account of stamp duty, which can render securitization commercially unviable in states that still have a heavy stamp duty. Some states have reduced their stamp duty rates, though a few still maintain quite high rates ranging from 5-12 per cent. Also Acquisition of assets by ARCs has multi-Sate effect. For example ARC is located in State A the Bank whose assets are to acquired is in State B and the location of the assets may be in State C. In terms of the present stamp duty laws if rates of duty are different the difference has to be paid in each State.This hampers the growth of this sector in the states with high stamp duty as ARC are reluctant to purchase NPAs which are from these states or from banks which are from these states.

SolutionThere should be a uniform stamp duty all over India. This should be low as growth in this sector is required and measures should be taken to make the NPAs commercially viable for the ARCs to purchase.

4. Reserve price for NPA sale

Current Scenario

Currently Seller banks adopt competitive bidding process for sale of their NPAs. These processes are defined by the banks themselves and they are free to reject offers after the ARCs have submitted their bids.

Problem

Despite adopting a process as defined by the banks themselves, transactions are aborted/ not closed even after running the defined process and receipt of multiple bids on the pretext that bids are lower than their expected price. This is genuine reason is some cases, however many banks use this in order to gain a reserve price which is the best offer by the ARC to negotiate with the clients. ARCs spend considerable time and resources in conducting due diligence of the assets on sale. This not acceptance of bids by the banks is a problem which needs to be addressed.

Solution

It should be made mandatory for Banks to disclose a reserve price before an auction process is carried out. This will ensure that ARCs who feel reserve price is high will not participate in the process and will not waste their resources. It will also to lead to transaction going through as ARCs will submit a bid higher than the reserve price which the Banks will have to accept.

5. Restructuring Support Finance

Current Scenario

Funds can be infused in an NPA bought by an ARC that is transferred to a trust by the ARC only. Funds are required for making the NPA good. These funds can be required for managing the immediate cash flow of the NPA so that in can continue its operations and make good the loan it has taken.

Problems

Infusion of funds by the ARC only limits the funds that can be infused to make a NPA good. An ARC holding around 5% share in the scheme of which the NPA is the collateral will be sometimes reluctant to infuse funds as the percentage holding would be less compared to the cash requirement the borrower has. Investors holding the remaining 95% are not allowed to infuse funds. Their funds are utilized only for acquisition of financial assets.

Solution

Funds mobilized from the investors may be allowed for additional funding required to make the NPA good as a part of restructuring strategy. This should be done by passing a special resolution where at least 75% of the investors agree to deploy these additional funds for restructuring.

10. References

Reserve Bank of India, Guidelines to Securitisation Companies and Reconstruction Companies, Banks and Financial Institutions.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

Setting up & working of asset reconstruction companies in India- A Ketkar, Suhas and Ratha, Dilip, (2001), Securitization of Future Flow Receivables: A Useful Tool for Developing Countries, Finance & Development

Kothari, Vinod and Gupta, Abhishek, (2004), Development of RMBS markets in India: Issues and Concerns, Project work at the Indian Institute of Management, Bangalore

Its time to clear the asset recast logjam article, Rajiv Ranjan http://www.topcafirms.com/index.php/white-paper/72-asset-reconstruction-companies-an-overview

http://kalyan-city.blogspot.in/2010/09/narasimham-committee-report-1991-1998.html

http://www.dnb.co.in/Arcil2008/Reconstruction.asp

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