1. FAIR III – Session V Developing the Asian Markets for Non- Performing Assets – India’s Experience November 11, 2003 Presented By: Mr. S. Khasnobis

2. FAIR III – Session V NPAs in the Indian Banking System Agenda

3. FAIR III – Session V NPAs in the Indian Banking System  Indian banking system witnessed gradual increase in levels of NPAs in the post-liberalisation period Shake-up in real sector  However NPA levels did not threaten to undermine the banking system Tightening of prudential and capital adequacy norms by the regulator Selective recapitalisation support and mergers of weaker institutions

4. FAIR III – Session V While the problem is not as intense… * Including exposure to bubble sectors

5. FAIR III – Session V …NPA “stock” merits a systemic response Gross NPA levels on the rise NPA holding cost = 25% of the net profit of the banking system

6. FAIR III – Session V Agenda

7. FAIR III – Session V  ARCs in India are set up as a non-government vehicle Minimal government participation in the ARC resolution process Market forces to consolidate and attractively package lender interests Create investors’ interest Support from the banking system – an essential requirement ARC – Indian model

8. FAIR III – Session V  Fiscal Incentives to banking system Tax set-offs on sale of asset to ARCs Gains from buy-back of high yield government bonds to be used for set-off of losses from asset transfer to ARCs  Provision for operation of multiple ARCs ARC – Indian model

9. FAIR III – Session V Rapid Disposition Agency Debt Resolution Agency Risk & Rewards transferred to the investor Immediate sell down of debt to third party investors Risk & Rewards retained by the banking system Focus on Asset Management & Resolution The business model – Indian context ARCs - Generic business models

10. FAIR III – Session V Indian ARCs – a Debt Resolution Agency (DRA)  Expeditious resolution of NPA “stock”- a priority  Indian NPA profile suggests Recoveries from NPAs would be over a longer time-frame as against rapid realisation Predominantly in industrial sector (Low exposure to “bubble” sectors – Real estate/ Capital Markets)  Banking landscape necessitates debt-aggregation One borrower, many lenders (inter-creditor issues) Different security classes and structures Moral hazards related issues

11. FAIR III – Session V  Markets for NPAs – Non-existent Absence of market makers (limited participation of foreign lenders in Indian credit market) No pricing bench marks Debt aggregation and resolution approach is likely to succeed Focus on recoveries from NPAs Improved leverage over debtor through aggregation Eliminates moral hazards Regulatory empowerment Indian ARCs –Debt Resolution Agency (DRA)

12. FAIR III – Session V Banks/FIsARCILInvestor Sell asset SRs Sell debt Proceeds Company Restructuring Debt servicing Time line t = 0 t = 1 t = 5 Management & Resolution Sell Down Acquisition Structured along the DRA model Value capturing at resolution stage becomes critical for final exit

13. FAIR III – Session V ARCs – Legal Framework Agenda

14. FAIR III – Session V  Proactive response of government and Central Bank – aimed at NPA resolution Setting-up of Corporate Debt Restructuring (CDR) forum Enactment of “Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002” Proposed formation of National Company Law Appellate Tribunal Addressing the NPA levels

15. FAIR III – Session V Regulator Central Bank Restructuring Asset Sale Addressing “stock” and “flow” problem Agencies CDR ARC Debt Aggregation Regulation Special Court Tribunal Self empowered body Resolution strategies Access to legal mechanisms Regulatory Empowerment

16. FAIR III – Session V Legal Framework (1/2)  Act introduced two important new initiatives to bring about structural reforms to the Indian credit market Setting up of Asset Reconstruction Company Enforcement of securities without the intervention of the court  ARCs requirements Registered with Central Bank 15% capital adequacy Arcil is the first ARC which has been granted license by the Central Bank

17. FAIR III – Session V Legal Framework (2/2)  ARCs empowered to take following measures for the purpose of asset reconstruction:- Take possession of secured assets Sell or lease a part or whole of the business of the borrower Change or take over of the management of the business of the borrower Rescheduling the payment of debt payable by the borrower Settlement of dues payable by the borrower

18. FAIR III – Session V Non Performing Asset 60 day notice 75 % secured creditors’ consent Enforcement of Security Interest…

19. FAIR III – Session V …without court intervention No intervention of court Overcoming cumbersome procedural delays Expeditious recovery

20. FAIR III – Session V India’s Premier ARC - Arcil Agenda

21. FAIR III – Session V Arcil brings together the complementary strengths of the three largest players in the Indian financial sector 100.0%Total 26.5%Other private sponsor banks 24.5%ICICI Bank 24.5%IDBI 24.5%State Bank of India ShareholdingEquity participation Sponsors hold 40 % of NPAs of the system Private sector character- 51% shareholding with private banks/ institutions Sponsors hold 40 % of NPAs of the system Private sector character- 51% shareholding with private banks/ institutions

22. FAIR III – Session V Building Blocks Structure Resolution Approach Investor

23. FAIR III – Session V Resolution strategy framework  Loan management strategy Restructuring of loan based on transparent policy Maximise overall recovery value Fair treatment to all stakeholder Settlement  Asset management strategy – Asset restructuring Sale of business/collateral Preservation and enhancement of value of business/collateral Orderly disposition through transparent process

24. FAIR III – Session V Participation from Indian banking system at initial stage – key to value retention T=0T=1Time NPAImplementation of resolution A performing asset Return Expectations Rerating as normal debt Rerating Banks can capture value by staying invested in the assets till the resolution stage 25% 15%

25. FAIR III – Session V Management quality Industry viabilityLowHigh Low High Settlement with Existing promoters Restructuring Strip sale of Assets Sale of business/ Induction of JV partner Resolution strategy framework

26. FAIR III – Session V Building Blocks Structure Resolution Approach Investor

27. FAIR III – Session V Borrower Reconstruction thru’ Restructuring / Asset sale / M&A Cash realization Redemption of SRs SRs Payment for Subscription to SRs QIBs (Banks/FIs) Purchase Consideration Scheme Borrower wise Banks/ FIs ARCs/ Trusts Sale of loan assets Transaction structure - Asset Specific Trust

28. FAIR III – Session V Redemption of Original SRs Payment for subscription to fresh SRs SRs Investors Master Trust / Scheme Pooling of SRs QIBs (Banks/FIs) QIBs (Banks/FIs) Scheme Borrower A Scheme Borrower B Borrowers A,B Cash realization Redemption of SRs Pooling and sale/ Securitisation at Subsequent Stage – Exit for original investors

29. FAIR III – Session V Building Blocks Structure Resolution Approach Investor

30. FAIR III – Session V Distressed debt investment opportunity Distressed Company Direct from Bank / ARC Asset Pool Large Portfolio INVESTORS CORPORATES Securitization Fund level Partner with ARC Restructuring fund/private equity option MULTIPLE OPTIONS AVAILABLE Direct investor Ideally suited for all classes of investors

31. FAIR III – Session V Geared to unlock value  Indian economy buoyant and future outlook is positive Right time to tackle NPA problem Maximize value and distribute it back to the system Re-energize the financial sector Unlock under utilized productive assets  A ‘Win-Win’ model - provides a medium-term structural banking sector solution

32. FAIR III – Session V Thank You