Impact of Global Financial Crisis:

Role of Asset Reconstruction

 Contents

Impact of global financial crisis: Role of asset reconstruction

“Sub-Prime” reasons cause a prime crisis

All eyes on the governments

All thoughts on asset reconstruction

Prime issues for considerations

NPA valuation

“Standardised” sale process approved by the regulator

Flexibility in controlling structure of an ARC

Reduction and standardization of registration fee and stamp duty

Simplification of consent required for enforcement of security

Relaxation of the requirement to take consent of the borrower

Life of trust set up by ARC for asset resolution

Abbreviations used

2
Impact of global financial crisis:
Role of asset reconstruction

“Sub-Prime” reasons cause a prime crisis
The sub-prime crisis and its consequent effects on the
global economy saw some of the established financial
institutions getting consumed in the turmoil that
ensured; many others have been pushed to the brink.
The crisis itself is a manifestation of aggressive lending
with inadequate appraisals, lax regulatory supervision
and questionable credit ratings of complex instruments.
Nationalisation of institutions – a thought inconceivable
a couple years back – is turning out to be an attractive
option for institutions grappling for survival. The crisis
originating in the US has now spread across the
integrated financial world engulfing countries and
sectors that have little to do with the root causes.
The economic indicators are gloomy as the recessionary
phase sets in and market indices have reduced investors’
wealth across the globe by a whopping US$ 50 trillion.

GDP growth trend

14%

12%

USA
10%
UK
8%
Japan

6% Germany

China
4%
Australia
2%
India

0% Source: EIU Reports

-2% 2005 2006 2007 2008

Movement of stock indices

500

450

400 USA - S&P 500

350 Japan - Nikkie

300 China - Shangai A

250 India - BSE 30

200 UK - FTSE 100

150 Germany - DAX 30

100 Australia

50 Base year 2005 =100

- Source: EIU Reports

2005 2006 2007 2008

3
All eyes on the governments
The sheer magnitude and enormity of the crisis have
left no option for Governments, but to intervene. It
is realised that simultaneous increase in spending by
the Governments is the best bet to beat the crisis.
Concerted and supplementing efforts by various
Governments could be expected in the next fiscal.
Governments across the globe have announced
economic stimulus packages and have earmarked funds
to bail out financial institutions.

Stimulus packages by select countries

Country Stimulus package (US$ bn)

US 787

Japan* 38

China 586

India 14

UK# 180

Germany 693

Australia 35

*Slated to increase by US$ 320 bn.

#Rescue plan for UK banking system of US$ 692 bn
Source: EIU Reports

Various governments while extending the helping hand
to overcome the immediate challenges, are likely to
review policies and state new measures to ensure long
term stability of their respective financial markets: thus
2009 could very well turnout to be a year which would
be all about policy.
China and India have been the fastest growing
economies and are relatively better positioned to tide
over the crisis. In India, the crisis induced problems have
relatively been contained due to factors like:
•• A well capitalised and prudently regulated Indian
banking system
•• Lack of exposure to equity and asset markets for a
significant proportion of the Indian population
•• Liquidity crunch unlikely to affect agriculture and
mandatory priority sector lending
At the same time bringing the Indian GDP growth back
to the 9% trajectory, from the below 7% levels projected
for the next fiscal, is going to be a daunting task.
Going forward, asset reconstruction would be the focus
area – for all - to salvage, preserve and rejuvenate assets
of economic value.

•• Domestic demand which constitute 60% of GDP

and is likely to be only moderately affected by the
ongoing crisis

4
All thoughts on asset reconstruction Simultaneously, the legal system has been revamped
Asset reconstruction is likely to play an increasingly to enable the institutions and ARCs implement quick
important role as (a) the number of impaired assets in resolutions of impaired assets. The legal framework, has
the financial system increase and (b) learnings from the over a period of time, has become more conducive for
ongoing crisis lead to evolution of speedy systems and resolution of impaired assets with the introduction of
procedures for asset reconstruction. Lok Adalats, Debt Recovery Tribunals and SARFAESI. The
actions and recoveries across these resolution channels
In India, ARCs came into being in response to the are as under:
growing NPL levels in the financial system and the
need to have mechanisms to resolve them in a timely
manner. At the same time, there was no imminent
financial crisis to justify direct Government intervention.
As a result, and rightly so, GoI has encouraged the
asset reconstruction space to develop in a competitive
manner.

Recoveries through various channels (Amount in Rs. bn)

Resolution/recovery channel Particulars FY 2006 FY 2007 FY 2008

Lok Adalat No. of cases referred 268,090 160,368 186,535

Amount involved (a) 21.44 7.58 21.42

Amount recovered (b) 2.65 1.06 1.76

(b) as a % of (a) 12.36% 13.98% 8.22%

DRTs No. of cases referred 3,534 4,028 3,728

Amount involved (a) 62.73 91.56 58.19

Amount recovered (b) 47.35 34.63 30.20

(b) as a % of (a) 75.48% 37.82% 51.90%

SARFAESI Act No. of cases referred 41,180# 60,178# 83,942#

Amount involved (a) 85.17 90.58 72.63

Amount recovered (b) 33.63 37.49 44.29

(b) as a % of (a) 39.49% 41.39% 60.98%

#: Number of notices issued under section 13(2) of the SARFAESI Act.

Source: RBI

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The creditor friendly provisions of SARFAESI has seen
intense activity in the Indian reconstruction space that
resulted in the formation of as many as 11 ARCs in quick
succession. SARFAESI has been conceived to provide the
required “teeth” to secured creditors to pursue rapid
resolutions. Certain gaps like procedure for change of
management in a distressed company by an ARC should
be specified at the earliest so that the objective of the
Act can be operationalised. Certain other suggestions
with respect to the Act are highlighted in the sections
below.
With the deepening of the asset reconstruction space,
the number of NPL transactions is on the rise. Deloitte,
as an advisor, has been associated in many of these
transactions that have resulted in resolution of NPLs
aggregating approximately to Rs.35 bn. Deloitte
has been associated with institutions like Industrial
Investment Bank of India Ltd., Union Bank of India
and Bank of Baroda on sell side mandates and Bank of
America and Barclays Bank on buy side mandates.
The table below provides a snapshot of the resolution
activity done by ARCs in recent times.

Snapshot of resolution activities by ARC’s (Amount in Rs. bn)

Sr. No. Particulars As on 30th June, 2007 As on 30th June, 2008

1. Book value of assets acquired 285.44 414.14

2. Security receipts issued 74.36 106.58

3. Security receipts subscribed by -

a. Banks 68.94 83.19

b. SCs / RCs 4.08 16.47

c. Others (QIBs) 1.34 6.92

4. Amount of security receipts completely redeemed 6.60 12.99

Source: RBI

6
The efforts by the government to develop the asset
reconstruction space and make the legal framework
more effective, prudent regulation by RBI, concerted
efforts by banks to reduce NPA levels and the role
played by ARCs have collectively resulted in marked
improvement in the NPA levels in the banking system.

NPA movement as a % of advances of SCB’s

8%

7%

6%

5%

4%

3%

2%

1%

0%
FY 04 FY 05 FY 06 FY 07 FY 08

Gross NPA to gross advances (SCB - %)

Net NPA to net advances (SCB - %)
Source: RBI

Although the situation until the end of FY 08 has been
encouraging in the Indian context, signs of economic
distress have become visible from the second quarter
onwards of FY 09. GoI has initiated measures to contain
the impact by announcing a stimus package of
US$ 14 bn. Going forward, the focus should be retained
or else the encouraging numbers of FY 08 can get
changed in a flash. Some of the reasons which compel
us to be cautious are enlisted below:
• Fall in total foreign investments
Foreign investments in the country has seen a growing
trend during the period FY 04 to FY 08. During FY 08,
India received total foreign investment of US$ 45 bn.
This encouraging trend has been reversed as the
available data for FY 09 indicates. During the period
April – November, 2008 total foreign investment was
a mere US$ 12 bn. The ongoing liquidity crunch in
the global markets is unlikely to hold promise for the
remaining months of the current fiscal.
While RBI has announced series of reductions in the
repo rate, concerns on liquidity remain. As foreign
inflows dry up and government borrowings increase
to finance increased spendings in the backdrop of
reduction in its own revenues, pressure on interest
rates to harden could build. If interest rates were to
spike, financial viability of many projects would become
uncertain resulting in the possibility of an increase in
impaired assets.

7
• Rapid growth in the advances by SCBs
The advances by SCBs have far exceeded the growth
in GDP. During the period FY 04 to 08, while the GDP
grew at a CAGR of 11%, advances by SCBs grew at a
CAGR of 23%. During FY 08, the advances by SCBs as
a percentage of GDP reached an all time high of 58%.
Formation of NPA is a natural phenomena to lending:
higher the quantum of lending, greater the probability
of NPA formation. It will be reasonable to expect that
level of NPA could increase from current levels not
only because of the ongoing economic crisis but also
because of the sheer increase in advances by SCBs.

Advance to GDP Rs. in tn

70%
50

45
60%

40

50%
35

30
40%

25
30%
20

15 20%

10
10%
5

0 0%
FY 04 FY 05 FY 06 FY 07 FY 08

GDP at current price (base 1999-2000)

Gross advances to GDP (%)
Source: RBI

8
• Corporate results are worrisome
In the first three quarters of FY 09, the companies in
BSE 500 (excluding banks) recorded lower profits as
compared to the corresponding periods in FY 08.

PAT of BSE 500 (excluding banks) Rs. in bn

800

700

600

500

400

300

200

100

-
Q1 Q2 Q3

FY 08 FY 09
Source: Capitaline

Lending to corporates is the most remunerative earning
channel for the lending institutions. As companies
experience profit reductions, it is likely that some would
record losses and a few would become unviable. This
would lead to generation of fresh NPL accounts in the
Indian banking system. In this regard, it may be noted
that the relaxation in guidelines for NPA recognition may
not lead to immediate rise in NPA levels but during the
course of next fiscal or so, increased NPA levels are likely
to be observed.
On the balance, while India is not affected as much as
its western counterparts, there are reasons, as enlisted
above, which are worrisome. The efforts initiated by
GoI, RBI, the lending institutions and ARCs needs to
be further bolstered to ward off the stress that the
economy may experience. Having an efficient asset
reconstruction mechanism would be the key to enable
the Indian economy to sharply and swiftly recover as
the global situation improve. It is supremely important
for the above reasons that the transactions in the asset
reconstruction space get consummated in a timely
manner to preserve the economic value of assets and to
ensure faster turnaround of capital.
Deloitte, in its role as an advisor for many successful
transactions in this space, has made certain observations
which, if addressed, could result in quicker resolution,
optimal price discovery and higher number of successful
transaction closures – all of which would result in
maximisation of economic benefit. These thoughts have
been outlined in the next section.

9
Prime issues for considerations
NPA valuation
With an increase in the number of transactions in
the Indian asset reconstruction space, instances of
transactions that have fallen through at the last stages
due to irreconcilable valuation differences between the
seller and the buyer are on the rise. Valuation of NPA
has emerged as the most prevalent “deal breaker”.
While business valuation would always remain an area
where diversity of viewpoints of sellers and buyers
is certain, in case of NPA transactions, the number
of parameters where the seller and the buyer could
potentially differ is far more as the underlying asset is
non-performing to start with. Some of the key issues
that need to be addressed in this regard are discussed
below:
• Estimating the recovery period
Valuation of NPA involves estimation of recovery
periods to arrive at present value. As NPA resolution
often involves resorting to legal options, estimation of
recovery period becomes tricky as legal proceedings
could become lengthy. Resolution options like
SARFAESI, OTS, CDRs etc. have better process visibility;
resolution through these means, wherever possible, is
likely to result in better valuations by potential buyers.
Otherwise, concerns on estimating resolution period
would come in the way of attractive valuations by
potential buyers. Setting pre-specified timelines for legal
proceedings would facilitate convergence of views of
buyers and sellers as far as estimation of recovery period
is concerned.
10
• Early sale of NPAs for better valuations
A contentious issue for the sellers is that buyers rarely
offer bids that value the account on a going concern
basis even though grounds for such valuation exist. In
almost all transactions, buyers offer bids based on asset
valuation.
There is hardly any valuation in the Indian context
where valuation is carried out on a “going concern”
basis. The main reason is that the NPL accounts that
are typically offered for sale have a long history of
being non-operational which obviates the possibility
of valuation assuming business continuity. As sellers
originate transactions, it is important to expedite the
process that the sellers undertake from the point of
recognition of a NPA to its eventual transfer to an ARC.
Unless there are real opportunities to rapidly restructure
an account while ensuring its continuity, bridging the
“valuation gap” would remain a challenge for successful
transaction closure especially for accounts that have a
turnaround potential. The sellers need to make the first
move by offering such accounts for transfer in a timely
manner before significant value erosion of the account
happens.
• Account information and data collation
One of the key reasons that inhibit proper valuation by
potential buyers is the lack of adequate information
that is made available for the account offered for sale.
NPL transactions hinge critically on the quality of the
underlying data. Better the underlying data, steeper
is the valuation. Seller banks should engage in active
monitoring and follow up of the NPL accounts so that
updated information is shared during the sale process.

In consortium funded accounts, there is always the

problem of accurately determining the share of the
seller in a particular loan account offered for sale as the
outstandings for other lenders are often unavailable,
as are legal updates. In the absence of such critical
information, buyers heavily discount their bids. There
is a need to improve inter-lender communication and
coordination that would result in better exchange of
information.

It has also been observed that at times even the

available information could not be shared with bidders.
The key reason for this has been fragmented data
sources that need to be referred to when sellers launch
processes which require buyers to visit branches where
the account is based rather than making all the relevant
information available at one central data room which is
manned by professionals who understand the accounts
offered for sale and also the sale process. A fragmented
data room process also requires buyers to incur
significant upfront costs and often many buyers choose
not to participate. Centralised data room with adequate
senior level supervision is not an option but a necessity
for successful transaction closure.

11
“Standardised” sale process approved by the
regulator
Bid representing the highest value, received as a result
of a competitive bid process is often subjected to a fresh
evaluation by the seller. While the seller bank should
have a right to negotiate with the highest bidder to
explore the possibility of enhancement of the highest
bid, the disposition of the seller should be to close
the transaction when the fair market price has been
discovered.
It is necessary that all stakeholders address these
problems so that processes that are conducted in good
faith and in a transparent manner are not shelved. As
it would not be possible for the regulator to prescribe
valuation methodologies that the seller banks could
follow as the conditions associated with each asset
varies thereby making any standardisation attempt
ineffective, the next best option would be to have
sale processes prescribed by the regulator for sale
involving a single asset or a portfolio. Transparent and
competitive bid processes are already being conducted.
A formal approval by the regulator and a buy in of
the stakeholders would go a long way in instilling
confidence to sellers to close such transactions.
Flexibility in controlling structure of an ARC
Depending on the background under which ARCs
are formed in a country, we have now the following
structures that are prevalent globally:
•• ARCs that are owned / sponsored by the government
•• ARCs that are owned by the banks
•• ARCs that are in the private sector domain
12
In India, ARCs came into being in response to the
growing NPL levels in the financial system and the
imperative need to have mechanisms to resolve them
in a timely manner. At the same time, there was no
imminent financial crisis that was emerging to galvanise
direct government intervention. As a result, and rightly
so, GoI has encouraged the asset reconstruction space
to develop in a competitive manner.
The ARCs in India consequently either have a private
sector ownership or have bank based ownership.
Nevertheless, there are restrictions on controlling stake
by a single party in an ARC which in the background
of allowing competitive forces to develop the asset
reconstruction space appears to be restrictive.
A relaxation of this norm would encourage more
private sector entities, including foreign players, to have
a presence in this space bringing more depth to this
sector. There are firms who specialise in resolution of
stressed assets in specific industries and have an edge
over “generic” reconstruction companies as they bring
in superior industry specific knowledge and expertise.
Presence of such firms would expedite the resolution
process and is also likely to enhance realisation which
would eventually maximise benefit for the overall
economy. It should be possible to introduce guidelines
to check potential for misuse which a flexible ownership
structure could be prone to.
Reduction and standardisation of registration fee
and stamp duty
The registration fee and stamp duty payable at the time
of assignment to the buyer varies from state to state.
GoI should initiate the process of rationalisation of the
registration fee and the stamp duty to simplify the post
sale processes and reduce the overall transaction cost
across all states.
Simplification of consent required for enforcement
of security
SARFAESI specifies that secured lenders, in case of joint
financing, can enforce securities only if they have the
consent of 75% of lenders in value. It can be safely
concluded that in most of the complex and sticky NPL
accounts, the number of secured creditors are too many
which acts as a major deterrent in aggregation efforts.
The Act does not modify the charge to any lender group
in any manner but the consent of junior charge holder
becomes necessary nonetheless.
This provision needs to be modified to enable speedy
recovery when the assets underlying a NPL account
is still in good condition and worthy of productive
economic use.
Consequently, it would be appropriate to have consent
of only the senior and pari- passu charge holders
for security enforcement and only the loan amounts
pertaining to such senior and pari-passu charge holders
should be considered for evaluating the applicability of
75% of value requirement. The junior charge holders
do not stand to lose in the process, as they would get
compensated to the extent possible after the claim of
the senior charge holders have been settled.
Relaxation of the requirement to take consent of the
borrower
Rule 9(2) of The Security Interest (Enforcement) Rules,
2002 specifies that if for sale of an immovable property,
no bids are received at price above the reserve price,
consent of the borrower and the secured creditors
would be required to conclude the sale at a price
lower than the reserve price. The requirement to take
the consent of the borrower often results in avoidable
delays and further erosion of the underlying asset value.
It would, therefore, be helpful if the said rule is relaxed.
Life of trust set up by ARC for asset resolution
The life of the trust set up for asset reconstruction
has been specified to be a maximum of five years in
accordance with the Securitisation Companies and
Reconstruction Companies (Reserve Bank) Guidelines
and Directions, 2003.
There should be flexibility for extending the life of the
trust if resolution is ongoing or appears to be likely in
the foreseeable future.
13
In this report, we have highlighted some of the
important issues which can encourage faster transaction
closure in the asset reconstruction space which is going
to become increasingly important for the long term
stability of the financial sector. For further information
and thoughts, please feel free to contact one of the
specialist listed below.

Avinash Gupta Deepak Netto

National Leader, Financial Advisory Services Head, Reorganisation Services
Tel: +91 22 6622 0515 Tel: +91 22 6622 0506
Email: avinashgupta@deloitte.com Email: dnetto@deloitte.com

Rahul Choudhry Rajgopal Pai

Director Manager
Tel: +91 22 6622 0517 Tel: +91 22 6622 0563
Email: rachoudhry@deloitte.com Email: rpai@deloitte.com

Deloitte Touche Tohmatsu India Private Limited

Maker Towers E, 4th Floor, Cuffe Parade
Mumbai – 400 005, India
Tel: +91 22 6622 0500
Fax: +91 22 6622 0501

14
Abbreviations used
ARC: Asset Reconstruction Company
CAGR: Compounded Annual Growth Rate
CDR: Corporate Debt Restructuring
DRT: Debt Recovery Tribunal
FDI: Foreign Direct Investment
FY: Financial Year
GDP: Gross Domestic Product
GoI: Government of India
NPA: Non Performing Asset
NPL: Non Performing Loans
OTS: One Time Settlement
RBI: Reserve Bank of India
SARFAESI Act: Securitisation and Reconstruction of Financial Asset and
Enforcement of Security Interest Act
SC / RC: Securitisation Company / Reconstruction Company
SCB: Schedule Commercial Bank
QIB: Qualified Institutional Buyers
15
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