Untitled Document
  
 

Asset reconstruction companies have a long history throughout the world. The Federal Deposit Insurance Corporation was established by the US government in 1933, to counter the devastating effects of the Great Depression on banks and financial institutions. Thereafter in 1980s, the US faced crisis in real estate market since a change in the regulatory framework allowed large number of banks with high risk policies to enter the real estate which, destabilised the capital market. In pursuant to this, the US formed the Resolution Trust Corporation in 1989.

Japan also faced insolvency in its banking sector following indiscriminate lending during the 1990s. This led the Japanese government setting up the Resolution and Collection Corporation in 1999. The main purpose of the institution was to manage, collect and dispose off assets transferred from 7 Jusen companies i.e. housing loan companies and failed financial institutions, to enhance their capital adequacy and to purchase assets from sound financial institutions. In 2004, Japan set up The Second Bridge Bank whose function was to assume the bank’s operations till it finds its takeover candidate and if no takeover of the bank is found within a stipulated period then the recipient bank was placed for liquidation.

The table below shows a global view of the ARC models used.

Source: Barents Group, International Monetary Fund, and World Bank.

Case 1 - United States of America

Asset liability mismatches and other economic issues led to a major banking crisis in the mid 1980s in the US.. From the period ranging from 1980 through 1991, a total of 1,400 banks in the US failed or sought government assistance. During the same period, 1,100 savings and loan associations or thrifts (as they are referred to in the US) also failed.

This financial downturn led to the insolvency of the Federal Savings and Loan Insurance Corporation (FSLIC) which used to provide government insurance guarantee over thrift retail deposits. The Federal Deposit Insurance Corporation (FDIC) which used to provide a similar insurance cover over retail bank deposits underwent a similar crisis. The Bank Insurance Fund (BIF) administered by the FDIC carried a deficit balance of USD 7 bn at the end of 1991.

To stabilise its economy and financial sector, the US government passed legislation for setting up of the Resolution Trust Corporation (RTC) in 1989, to resolve the issue of NPLs in the US. The directive given to RTC was to take over the NPA of failed thrifts and actively manage these assets to maximise value. The RTC had a daunting task of resolving assets totalling approximately USD 1 trillion. The RTC was able to resolve all these assets successfully, and it ceased operations in 1996.

Case 2 - Mexico

During the 1995 economic crisis, Mexican banks suffered failures on account of huge NPA. To revive the banking sector, the government received financial assistance from the US, the World Bank, and the Inter-American Development Bank. This allowed the Mexican government to provide support to the failing banks through the Bank Fund for Savings - Fondo Bancario de Protección al Ahorro or “Banking Fund for the Protection of Savings” (FOBAPROA). The rationale behind the creation of FOBAPROA was that it would acquire the NPA of the Mexican banks and would provide capital to them if they faced liquidity problems in the event of economic crises. The FOBAPROA took over debt of approximately USD 552 bn which was equivalent to 40% of GDP of Mexico in 1997.

In January 1995 the Mexican government started PROCAPTE (Programa de Capitalización Temporal or “Temporary capitalization program”), while the FOBAPROA was acquiring outstanding debt of banks. The PROCAPTE allowed faster access to a higher volume of foreign capital and the solvency of banks. FOBAPROA acquired the debt of the insolvent FIs with a condition that the stockholders of these financial institutions would re-invest their capital in the market.

In 1996 the UCABE (Unidad Coordinadora para el Acuerdo Bancario Empresarial or “Coordinating unit for the Bank-Entrepreneur Agreement”) was created to restructure debt. A total of 54 companies took advantage of the UCABE to re-structure USD 9.7 bn.

FOBAPROA is different from the Asian AMCs, as it is essentially a recapitalisation exercise. FOBAPROA is a trust established by Banco de Mexico to provide ‘preventive support’ to problem banks.

Case 3 - Korea

During the 1997-1998 Asian financial crisis, thousands of Korean companies went bankrupt, leaving banks with huge portfolios of nonperforming loans. The Korean government moved aggressively to deal with the problem; among other steps,

It also started the Korean Asset Management Corporation (KAMCO) to acquire and dispose of the banks’ NPLs. Korea’s NPL market peaked in 2000 and a few large-volume NPL sales to investors were closed in 2001. While banks were reducing their portfolios of corporate NPLs, their consumer NPLs began to increase as overextended consumers defaulted on their credit card debt. In 2002, banks began to dispose of their consumer NPLs, and when Korea’s credit bubble burst in early 2003, they shifted their focus from corporate loans to write-offs and sales of portfolios of consumer NPLs. The change in NPL pools from corporate to predominantly consumer loans also led to changes in the makeup of NPL buyers, with domestic investors such as savings and loans, mid-sized corporate restructuring companies (CRCs), and collection agents forming investment groups to acquire consumer NPLs. Foreign investment banks and private equity funds that had been buying corporate NPLs generally shunned consumer NPLs, choosing instead to target M&A deals and a diminishing number of corporate NPL opportunities. With the continuing disposition of their NPL portfolios, financial institutions have managed to improve their asset quality, which has resulted in a more stable banking system. In 2005, Korean banks posted record earnings and a record low NPL ratio.

KAMCO adopted a number of techniques to dispose of the NPA it acquired from problem banks. These include traditional methods such as competitive auctions, collection of rescheduled repayments and recourse to the original seller, and other innovative techniques which included bulk (pooled) sales, individual sales, issuance of asset backed securities (ABS) and joint venture partnerships.

The choice of a particular method depended on the nature and size of NPA. Bulk or pooled sales included issuing ABS and international bidding with an aim for early resolution of NPA and quick cash flows. Individual sales focused on discovering the market value of each individual asset and include public auction of collateral, foreclosure auction, and sales of individual loans. Joint venture partnerships were used as a tool for promoting cooperation with foreign and domestic investment companies who are specialists in asset management and corporate restructuring.

Case 4 - Malaysia

Net non-performing loan (NPL) ratio in the banking system since the Asian financial crisis has gradually been on a decline from a high of 13.6% (3-month classification) in December 1998 to 5.5% in June 2006.

Danaharta, the national AMC, was set up in 1998 to tackle the NPL problem that arose during the Asian financial crisis with the objective of removing the NPLs from the financial institutions and subsequently to extract maximum recovery from the NPL.

The legislation called the Pengurusan Danaharta Nasional Berhad Act 1998 (Danaharta Act), was critical in allowing Danaharta to acquire NPLs from financial institutions through statutory vesting. It also conferred extensive powers to the national AMC to aid in speedy recovery of NPL.

Danaharta ceased operations on December 31, 2005 after being in existence for seven and a half years. The total residual recovery assets of Danaharta at that point stood at close to RM 3 bn. Upon Danaharta’s closure of operations, control of these assets reverted to Danaharta’s shareholder, Minister of Finance Incorporated (MOF Inc). MOF Inc has appointed a wholly owned subsidiary, Prokhas Sdn Bhd, to act as a collection agent for the residual recovery assets.

Case 5 - Thailand

The Thai Government formulated the Thai Asset Management Corporation (TAMC) policy in February 2001 with a view to boost the stability of the financial sector and to promote efficient management of non-performing assets and minimise economic losses. The TAMC Decree came into force on June 9, 2001 with the creation of a national asset management corporation, the Thai Asset Management Corporation (TAMC) to resolve the high level of NPA in state-controlled and private financial institutions in Thailand. The TAMC is managed by a Board of Directors appointed by the Minister of Finance with due approvals from the Council of Ministers.

The TAMC is a government agency with 100% share of the Financial Institutions Development Fund (FIDF). To acquire and resolve the high incidence of NPA in the Thai financial sector, the TAMC issued Baht 170 bn (approximately USD 3.7 bn) 10-year notes guaranteed by the FIDF to financial institutions.

TAMC’s main aim is to accept the transfer and management of sub-quality assets in the Thai banking sector. TAMC has unprecedented powers to ensure this. Additionally it has been empowered to establish limited companies, guarantee credit for debtors, and lend money to debtors. TAMC after four years has largely succeeded in NPL resolution. As of Q2, 2005, TAMC has resolved Baht 772.4 bn (USD 8.8 bn) of NPL from a total NPL of Baht 778 bn (USD 9 bn). 74% of the NPL were resolved through debt restructuring or rehabilitation in the Central Bankruptcy Court.

Case 6 - China

The Chinese government set up four state-owned asset management corporations (AMCs) in 1999 to address the problem of NPLs on the bank balance sheets. The objective of these AMCs was to buy bad debts of the four major state-owned commercial banks and resolve them over 10 years. As the big four banks hold almost 65% of the Chinese banking sector’s loan portfolio, they were the main focus of any bank restructuring efforts.

The Chinese government adopted the model of separate and decentralised NPL management as followed by the Swedish authorities. Each of the four AMCs pairs up with one of the big four banks.

The Ministry of Finance (MoF) provides each AMC with an initial equity capital of RMB 10 bn (USD 1.2 bn). China’s AMCs have done well in meeting their recovery targets. For example, as of year-end 2005, China Cinda AMC (Cinda) reported collecting RMB 62.84 bn (USD 7.8 bn) of cash from RMB 201.21 bn (USD 24.9 bn) of face value. In addition, NPL sales by the AMC are accelerating, with Huarong selling RMB 36.4 bn (USD 4.5 bn) of Category 5 NPL to Silver Grant, a Hong Kong listed asset management and investment company.

Huarong also sold RMB 14.5 bn (USD 1.8 bn) of assets to an Equity Joint Venture (EJV) with Deutsche Bank/AIG. Huarong and Deutsche Bank/AIG will jointly manage the entity. Huarong is the majority shareholder and has a majority of the seats on the board. The EJV has a 15-year life and will function as an operating platform for a variety of investments. The EJV structure is a pioneering effort to help the AMC transform themselves into independent commercial investment companies (subject to the approval of regulators).

Case 7 - Indonesia

Since Indonesia’s 1998 financial crisis, rehabilitation of its banking industry has been a long-term process. The Indonesian Bank Restructuring Agency (IBRA), a special purpose institution established by the government in 1998, was liquidated in February 2004 after completing the mandate to restructure and rehabilitate the banking industry. IBRA was comprised of Asset Management Credit (AMC) and Asset Management Investment (AMI). AMC was responsible for handling NPLs of the closed or taken-over banks by the government, while AMI was responsible for taking care of the pledged or given-up assets related to the NPLs. During these years, IBRA recovered an estimated 28% of its approximately IDR 600 trillion (USD 61 bn) non-performing loan portfolio. During 2002-2004, foreign investors also participated in this rehabilitation process by acquiring controlling stakes in certain major private banks such as Bank Danamon, Bank Niaga, and Bank International Indonesia (BII). These foreign banks are seen as better-equipped strategic investors, who can meet any additional capital requirements, competitive pressures, and the need for international banking experience, including risk management practices. To prepare the state banks as anchor banks and to privatise them, the government publicly listed Bank Mandiri in 2002 and Bank Rakyat Indonesia in 2003 on the Jakarta Stock Exchange.

After IBRA was liquidated, its remaining unsold assets were transferred to the state asset management company, Perusahaan Pengelola Asset (PPA), which was established under the control of the Ministry of Finance. Under PPA, further divestments to foreign investors were to continue.

Comparison of ARCs in East Asian Countries

Structure used and the reasons for setting up of ARC

The infamous currency crisis of 1997 left the economies in East Asia in tatters. It was a period of financial crisis that gripped much of Asia. The crisis had significant macro level effects. There was a sharp decline in the values of almost all assets including currency, stock prices and on businesses. All this resulted in very high levels of non-performing loans in these economies. During 1997, the financial crisis in Indonesia was at its peak, 70% of the loans were estimated to be under-performing. Similarly in Thailand, Malaysia and Korea the under performing loans were in the range of 30-50%. There was a prudent need for a mechanism for the revival of these NPAs.

The table below shows the comparison for these counties and the model followed

AMC
APT
BBAM
CBAM
DBP
FRA/TAMC
IBRA
KAMCO
PNB

Asset Management Corporation
Asset Privatisation Trust
Bank Based Asset Management Company
Central Bank Asset Management
Development Bank of the Philippines
Financial Sector Restructuring Authority
Indonesian Bank Restructuring Agency
Korea Asset Management Corporation
Philippine National Bank

Case 8 - India

The idea of asset reconstruction in India dates back to the Narsimham Committee in 1991 suggesting the setting up of an asset reconstruction fund. The idea behind this was to recapitalise the banks that wrote off their NPA and thereby lost capital. However, due to budgetary constraints this idea never gained ground.

By the late nineties, the burgeoning figures of NPA sounded the alarm bells for the government. As a result two committees in quick succession were set up and reports submitted. Narsimhan Committee II (banking sector reforms) in April 1998 suggested two alternatives to the growing NPA problems in the Indian economy.

India did not have to experience the levels of financial degradation as other South East Asian economies did in the 1990s. However, the government of India took a proactive measure way back in 1993 by introducing Debt Recovery Tribunals and Debt Appellate Tribunals under the Recovery of Debts Due to Banks and Financial Institutions Act. Thereafter in 2003, the SARFAESI Act was enacted by the Indian government to further moderate the problem of recovery of NPAs. The SARFAESI Act provide ample power to ARCs for resolving the problem of NPA by giving them access to all options which were already available to banks and FIs. Some additional empowerments to the ARCs include step-in rights and change in management, sale or lease of business. As a result, ARCs today are in a much better position to implement timely resolution strategies which enable them to increase the value received from recoveries of NPA. The act thus provided impetus to the formation of Asset Reconstruction Companies in India.

Summary of the Regulatory/Legal Framework: