SASF structure

1. SASF structure NPA resolution mechanism - Indian experience and lessons for others FICCI - IBA Conference October 5, 2005

2. Structural options for NPA clean-up Non-governmental Government owned Bad bank • High level of NPAs but no crisis • Market based approach to address NPA “stock” & “flow” • No direct participation by Government • Conducive framework by Government & Regulator for resolution & exit • Banking crisis • System-wide solution • Nodal ARCs • to addresses NPA “stock” • Fiscal support & forbearance from Government and Regulators • Isolation of stressed assets to bank’s work- out group / affiliate • “Self help” mechanism • No special powers from Government / regulator • Focus on NPA workout Approach 2

3. Structural options for NPA clean-up Bad bank Government owned Non-governmental • Clean exit from NPAs to banks • Resolution and consequent risks-rewards with investors • Needs recapitalization of banks • Presence of willing sellers & foreign investors • Risk and reward with investors • Strong Regulatory inducement essential for success • Leaves NPAs with banks • Risk and reward remains with the bank • Limited success due to absence of debt aggregation Outcome 3 Taiwan, India Bank specific South-East Asia

4. Common theme across the models • Enable banks to focus on core activities • Unlocking of capital in NPAs • Enhancement of value by reduced time to resolution AND • Redeployment of underlying assets to productive use Recycling and improvement in efficiency of capital is the overarching objective

5. NPAs in the Indian banking system • Profile • NPAs are mostly industrial assets – exposure to ‘bubble sectors’ is minimal • Resolution of larger cases (80% by value) requires intense workout by way of corporate restructuring, business sale and combination Not a crisis

6. NPA resolution mechanism - options Lender driven resolution Intermediation in resolution process • By banks themselves • CDR - forum of lenders under the aegis of RBI • Exit for selling banks on commercial basis through • ARCs • Inter bank/NBFCs purchase/sale of NPAs

7. Options are complementary Resolution issues Mechanism Type of cases Large cases (80% by value) • Debt aggregation & • inter- creditor issues • Workout • Restructuring of revivable • accounts - CDR • NPAs requiring complex • workout - ARCs • Resolutionbybanks • themselves • Exit through • ARCs • Inter-bank/ NBFCs • purchase & sale Small cases (20% by value) • Realisation from • asset sale / settlement • Rapid disposition

8. The story so far ? ? • Infrastructure for NPA resolution is in place • Effective legal framework • Resolution mechanism including market based clean exit are available • Issues • Is the level of NPAs perceived as problem? • Will there be a meaningful intermediation and market creation for NPAs? • Is there a case for seller banks to continue as investors? ? ? ? ? ?

9. NPA level contained thru CDR restructuring... 8.00 % 64,017 6.00 % Net NPA % 4.00 % 2.00 % Net NPA % Gross NPA Net NPA CDR • …but Gross NPA level remains high and need to be tackled • Reduction by resolution / realization – key to unlock capital. • Preparation for Basle II norms

10. Absence of uniform book Inadequate provisioning particularly in large accounts Impacting debt aggregation and resolution Desire to clean the books Comfort derived from net NPA levels Lack of incentive for clean-up Possible apathy of the banks’ senior management to take difficult decisions? Constraints of the sellers in taking substantial write-offs More so in inter-bank cash deals Unrealistic price expectations - considering value extraction from NPAs would be over time through operation of underlying assets Sell side constraints

11. Buy side constraints • Participation of FIIs in ARCs’ equity and SRs, key to clean exit for banks and consequential success of ARCs, yet to be permitted • Limited capital with Indian banks / NBFCs operating on the buy side will limit their ability to purchase NPAs in cash • Domestic market (insurance cos., MFs, pension funds etc.) not geared to participate • Absence of risk appetite and policy issues

12. Case for sellers to invest in SRs • Resolution of large NPAs with underlying industrial assets would be through intense workout • Maximum value realization - over a period of time • Direct sale to investors for cash would be at significant discount – requiring larger provisioning • No upside available to the sellers post sale – one time exit • Investment in SRs captures value at resolution stage • Exit from NPAs • Upside available as an investor However, guaranteed return expectation from distressed debt investment is unrealistic

13. A comparison with Taiwan • Taiwan, like India, has adopted a non-governmental model for NPA clean up • Approach – Sell to ARCs set up in non-governmental sector • Regulatory inducements for sale of NPAs • Banks to reduce their NPA ratio to 5% with penalties stipulated for non achievement • Banks allowed five years to amortize losses upon transfer • New money from FIIs permitted for NPA acquisition • Result • Banks exited from NPAs through ARCs in deals aggregating more than USD 10 billion - funded by FIIs • NPA ratio of the system in December 04 < target 5%

14. Final thoughts ARCs canbe only as effective as the system wants

15. Thank you