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INDIA
BUSINESS WORLD -
NOVEMBER 2005
THE MONTH THAT WAS
FOREIGNERS ALLOWED TO BUY BAD LOANS
Foreign investors
will be allowed to buy bad loans lying in the books of Indian
banks and FIs. Such deals in sticky assets, which have flourished
in Malaysia, Korea, Taiwan and China, will now be cut in India,
albeit in a smaller way. The government today permitted 49%
FDI in the equity capital of asset reconstruction companies
through the non-automatic route. This means they will have
to be routed through FIPB.
An ARC acquires
bad loans, better known as NPAs, at a steep discount from
banks. If an ARC controls 75% of the bad debt of defaulting
firm, it can use the security enforcement law to take management
control of the company-something which banks can't.
The Dutch financial services group, ING, private equity player
Actis and the British banking group StanChart are some of
the foreign players who had shown interest in participating
in an ARC. If more players join, it could help to clean up
the balance-sheets of ARCs.
The government,
however, will not allow FIIs to pick up stakes in ARCs. Ashwani
Puri, executive director, PricewaterhouseCoopers said, this
may not create difficulties as the ARCs are not listed entities.
The government has also specified that applications for holding
more than 10% stake in the total equity of any ARC by a foreign
investor would have to comply with the provisions of Sarfaesi
Act, 2002, which specifies the norms for such bids.
Significantly,
the decision is possibly the first step towards the development
of a junk bond market. How? ARCs issue security receipts (SRs)
to banks they buy the bad loans from. SRs, which show up in
the books of banks as investment, are similar to units of
mutual funds, where the value depends on the pricing of bad
loans.
The transaction
between an ARC and bank is cashless. Banks receive cash only
after SRs are redeemed, and this depends on how successful
an ARC is recovering money from the borrower. At present,
SRs are unlisted, and there is no trading. But in the next
step if the government allows listing of SRs in stock exchanges,
then the SRs would be junk bonds. Puri said with NPAs of over
Rs 1 lakh crore, the market for such bonds in the country
could touch about Rs 8,000 crore in another two years.
Currently, Arcil
is the only functional ARC is the country in which SBI, ICICI
Bank and IDBI are the principal sponsors.
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