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The NPA problem: Lessons from South Korea

LiveMint logoLiveMint 15-08-2017 Harsh Vora

In the aftermath of the global financial crisis, many Indian banks pursued an aggressive lending strategy, wagering on a miraculous revival of the economy. As much of this lending was done without conducting adequate credit appraisal or post-disbursal monitoring, their asset quality quickly deteriorated. Growth slowdown in heavily indebted sectors such as infrastructure, metals, telecom, and textiles only exacerbated the problem.

Nine years on, the worse is not yet over. Reserve Bank of India’s (RBI) Financial Stability Report released in June warned that the banking system’s gross bad loan ratio could rise to as high as 10.2% of the total loan book by March 2018 from 9.6% in March 2017. This should be especially alarming for an economy whose corporate bond markets are shallow and underdeveloped and therefore incapable of sharing the banking system’s burden of lending.

Unfortunately, the numerous solutions that have been attempted over the past decade, such as the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, Corporate Debt Restructuring Mechanism, Strategic Debt Restructuring Scheme, Scheme for Sustainable Structuring of Stressed Assets or S4A and others have hardly helped ameliorate the bad loan situation. To be sure, this is not because these schemes are poor, but because the regulatory environment has not been conducive. The promulgation of the new, consolidated bankruptcy law, though imperfect, is a step in the right direction.

Further structural changes proposed by many experts involve bank consolidation, significant divestment, or even privatization. Though these seem like ideal solutions, political expediency would most likely trump economic exigency. A more pragmatic approach would involve creating a national asset management company (NAMC) along the lines of South Korea’s Kamco (Korea Asset Management Corp.) or Malaysia’s Danaharta. This idea was first proposed by RBI’s deputy governor Viral Acharya at a conference in Mumbai early this year.

Following the Asian financial crisis, both Kamco and Danaharta played a crucial role in reducing the stressed assets of ailing banks within specified time frames. Their major contribution entailed reducing imperfections in the market for stressed assets, thereby creating liquidity and fostering competition.

Besides being highly illiquid, the market for stressed assets is also characterized by large information asymmetries—sellers possess more information about soured assets than the buyers. This increases the bid-ask spread and damages the chances of market clearance. The illiquidity in the market also comes with a first-mover disadvantage. Owing to the absence of information on comparables, the buyers end up paying higher prices for the assets.

This is where Kamco, for example, aided price discovery in the illiquid market by stepping in as the first-mover. A 2004 IMF report ( stated that up until mid-1999, Kamco appeared to pay higher prices than average for buying bad loans. Soon after, however, prices became more realistic, drawing interest from private players in the market for distressed loans. Kamco facilitated the building of a market where none existed earlier. India has a similar opportunity today.

An NAMC would take over the NPAs corresponding to projects that are unviable in the short and medium term but may become viable in the longer term. It would then help discover the right price of those assets by being the first-mover in the market. The government’s role in it would be that of a facilitator. It would hold a minority stake, but could guarantee the debt raised by the company for its financing needs.

This is unlike Kamco, which at one point was beset by political interference. In the aftermath of Daewoo’s collapse, it was forced to purchase Daewoo bonds from the investment trust companies (ITC), which held those bonds at the time. In doing so, the government wanted to ensure the ITCs’ stability. The government, of course, wielded such disproportionate influence over Kamco’s governance because of its majority holding. NAMC, on the other hand, would have fewer incentives to succumb to political considerations because the government would only be a minority holder.

Another way NAMC could reduce market imperfections would be through leveraging the benefits of structured finance. By pooling different non-performing assets (NPAs), dividing them into tranches according to their risk profiles, and then selling them to interested investors, NAMC could help generate liquidity in the market. This is because investors would be able to participate according to their risk preferences.

John Fell, Maciej Grodzicki, Reiner Martin, and Edward O’Brien of the European Central Bank also suggest setting up an NPA transaction platform that would act as a central repository of data on stressed assets from participating banks ( This would further enhance liquidity by making transaction data standardized and transparent, allowing investors to take informed decisions.

Most importantly, the creation of an NAMC should come with a “sunset clause”. After a predefined period, when the company’s operations are no longer deemed necessary, it should be wound up or the government’s stake sold to private parties. This would ensure that the company does not fall prey to the same disincentives that plagued the US’ Fannie Mae and Freddie Mac—that is, degenerate into a bad bank that engages in impetuous lending.

One of the major factors that facilitated Kamco’s success was the existence of political will backed by a strong public interest in ensuring the right usage of public funds. India’s government too has demonstrated its political will for resolving the NPA crisis by putting in place a bankruptcy law. It must now follow up with reforms that address the imperfections in the market for distressed assets.

Harsh Vora is an entrepreneur, investor and trader.

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