Gross NPAs are expected to rise from Rs 8 lakh crore in March 2017 to Rs 9.5 lakh crore by March 2018, which is about 10.5 percent of total advances, while stressed assets are expected to be at Rs 11.5 lakh crore, according to a joint study by ASSOCHAM and Crisil.

“High level of stressed assets in the banking system provides enormous opportunity size for asset reconstruction companies (ARCs) which are an important stakeholder in the NPA resolution process,” said the joint report ‘ARCs headed for a structural shift’.

It, however, said that owing to capital constraints, growth of ARCs is expected to come down significantly. “While growth is expected to fall to around 12 percent until June 2019, however the AUM (assets under management) are expected to reach Rs one lakh crore and that is fairly sizeable.”

The study added that with banks expected to make higher provisioning over and above the provisions made for stressed assets, they may sell the assets at lower discounts, thus increasing the capital requirement.

The report stated that as existing capital base of ARCs will not support in absorbing stressed assets available in the market, they are expected to be a part of the multi-platform business model with co-investors/large funds to bring in capital and stay relevant.

Expecting recovery prospects to improve with these structural changes, the ASSOCHAM-Crisil report said, “The recovery rate, which is a good indicator of the effectiveness of ARCs is expected to rise from 38 percent earlier to about 44-48 percent.”
“An improvement in the recovery rate and reduction in timeline for resolution will increase investor confidence in the Indian bond market,” it added.

It noted that quicker debt aggregation, acquisition of assets with low vintage, and support from promoters have driven improvement in recovery.

Noting that ARCs have been active in acquiring companies in metal and construction sectors which constitute a small portion of overall tapped NPAs in the system, the ASSOCHAM-Crisil study suggested that to tap opportunities, ARCs are required to look at large assets that require large capital commitments in sectors such as power.

Power, metal and construction sectors contribute the bulk of stressed assets. According to an analysis of 50 stressed assets, sectors like metal, construction and power form nearly 30 per cent, 25 percent and 15 percent respectively, while other sectors together form the remaining 30 percent.

The study also said that effective implementation of the Insolvency and Bankruptcy Code (IBC) would be a remedy to the challenge of prolonged litigation and it can help improve the recovery rate of stressed assets’ industry further.
“A strong bankruptcy code can strengthen the creditor rights and can lead to a deeper bond market.”

The report stated that 2018 would see a structural shift in the stressed assets' space as increased stringency in banks’ provisioning norms for investments in security receipts is likely to result in more cash purchases.

“Fiscal 2018 marks beginning of third phase of ARCs which promises to change the landscape as new regulations and other changes kick-in.”

While the first phase between fiscals 2003-2014 saw setting up of many ARCs along with a rise in their AUM owing to surging NPAs and low levels of required investment, the second phase between fiscals 2014 and 2017 saw key regulatory change in terms of increase in minimum investment required by ARCs for asset acquisition which increased the capital requirement.