After tripling between fiscals 2015 and 2018, the Indian banking system’s gross NPAs are showing signs of easing. Bank NPAs are expected to shrink 350 basis points (bps) to ~8% by March 2020, compared with the peak of 11.5% in March 2018 and 9.3% in March 2019.

The decline will be driven by a slowdown in NPA accretion and stepped-up recoveries from existing NPA accounts. Resolution of large NPA accounts, especially under the IBC, will help, assuming the bulk of the cases pending with the National Company Law Tribunal (NCLT) will be resolved. A pick-up in credit growth will be a booster, too.

That said, there is significant potential opportunity for stressed-assets investors, given around Rs 9.4 lakh crore NPAs in the banking system as on March 31, 2019. Of this, the corporate segment, which has seen active interest from most investors, is estimated to account for ~70%. Large stressed borrowers have debt aggregating to Rs 5.4 lakh crore, which is a huge playing field in itself for investors.

Additionally, an enabling regulatory framework has paved the way for attracting investors in the stressed-assets space. Indeed, regulations introduced in recent years – including RBI’s revised resolution framework (issued in June 2019), and the IBC, with its recent amendments (passed in Lok Sabha in August 2019) – augur well for resolution of stressed assets.

The recovery rates and resolution timelines have improved. However, some of the expectations set during the IBC’s introduction still need to be met.

Notably, regulatory changes in recent years have been aimed at putting ARCs’ skin in the game and diversifying the potential investor base for stressed assets. In August 2014, the minimum investment requirement by ARCs for the acquired assets was increased to 15% from 5%. The norms for investments in ARCs and security receipts (SRs) – including for foreign investors – were eased subsequently.

But the real push came when the provisioning norms for the selling banks were changed, wherein their investments in SRs over 50% (effective April 1, 2017) led to higher provisioning requirement by banks. This limit is now at 10%, effective April 1, 2018.

Given this, the business model of ARCs has become more capital-intensive, with a need to either put in their own funds or bring in other investors.

Fiscal 2019 saw a structural shift, with a substantial jump in the cash share of the acquisition cost, resulting in sizeable investments by investor groups, apart from the selling institutions and ARCs.

That said, ARCs have been able to rope in external investors to subscribe to the SRs. In fact, in fiscal 2019, foreign banks, stressed-assets funds and global pension funds subscribed to ~60% of total SRs issued by CRISIL-rated ARCs.

Given the higher capital requirement, the partnership model will be the way forward for ARCs. It could be via various routes, ranging from investment in ARCs, investments in SRs to direct investments in stressed assets.

To summarise, there is a sizable opportunity in the stressed-assets space for investors, with IBC being a game changer. The IBC ecosystem is developing at a fast pace, but adherence to the timelines remains a challenge. According to a poll conducted by CRISIL, 89% of the respondents believe ARCs will remain relevant in the post-IBC era. With a higher cash share becoming a norm, ARCs will need to focus more on resolutions and attracting co-investors.