It's a recent Thursday afternoon, and in the 17th floor conference room of his office in South Mumbai's Express Towers, Rajendra Kakker and four of his colleagues are trying to make history-although, to look at it, one could never tell. After all the afternoon's exercise is more mundane than mundane. Kakker, CEO of the six-month-old Asset Reconstruction Company of India (ARCIL), and his team are busy trying to convince executives from the State Bank of India, ICICI Bank, and the IDBI to sell them their non-performing assets (NPAs), or bad loans. The bone of contention is rather predictable and pedestrian: Of the 2,500 distressed assets put on the table by the three banks and a few other financial institutions, ARCIL has cherry picked 37, and Kakker wants these at prices lower than their book value.

It's quite a radical concept for the banks to digest, because it would mean taking a huge hit on the asset value that exists on their books. Yet, the banks realise that a deal like ARCIL's may be their only hope of making their bad loans pay. A reason why at the end of a three-hour meeting, the banks, as it turned out, agreed to offload NPAs worth Rs 5,000 crore to ARCIL. For Kakker and his company, it's another small step towards building a portfolio of bad loans, but for India it's a giant leap in tackling the monumental NPA bugbear, put at a staggering Rs 100,000 crore at last count.

Ever since the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (or simply the Securitisation Bill) was introduced in November 2002, at least 10 asset reconstruction companies (ARCs) have emerged on the scene. Two of them, ARCIL-the first to kick-start operations in August last year-and Asset Care Enterprise (ACE) already have RBI licences to operate, while the others, including International Asset Reconstruction Company, promoted by former Bank of America honcho Arun Duggal and M.S. Verma, former Chairman of SBI, are awaiting the go-ahead. A vibrant asset reconstruction industry may be just what the doctor ordered for the NPA-saddled banking and financial industry. Says Rajiv Memani, Partner, Ernst & Young India: "Asset reconstruction companies will, for the first time, give the lenders a chance to put their bad loans to productive use."

An early bird, Kakker has already picked up Rs 2,000 crore worth of bad loans and is scouting for more to meet his target of Rs 10,000 crore by March 2004 Rajendra Kakker/CEO/ARCIL

How does an ARC work? Globally, there are two broad ways in which they work. One approach involves selling the asset to a willing buyer or buyers and two, turning around the asset (say, a loss-making textile mill) and then selling it for a much higher price. In India, though, we only have the ARCIL example to go by (ace is yet to acquire any distressed assets), so here's how the only active operators works: Once, say, a bank hands over a wish-list of bad assets it wants to sell, ARCIL begins the process of evaluation. Invariably, the price that ARCIL is willing to pay is much lower than the value of the assets as it sits on the bank's books. Therefore, for the deal to happen, the bank must agree to a 'haircut', being the difference in valuation. ARCIL acquired its first tranche of bad loans of Rs 2,000 crore on December 28 last year, comprising six companies: Core Healthcare, Birla VXL, Shree Rama Multitech, GSL (India), Precision Fasteners, and Kalyanpur Cements. Says Kakker: "Our goal is to acquire a substantial part of the debt from all the lenders-at least 26 per cent so that we are not elbowed out."

Fair enough, but the tricky part in this sticky loan business is of funding the ARCs. For example, ARCIL had to float special purpose vehicles (SPVs) to raise money for each of the seven assets. Who are the investors in the SPVs? The same banks or financial institutions that in the first place transferred the distressed assets to the ARC. Yes, moving money from the left pocket to the right pocket doesn't make any sense, but in the start up stage it seems inevitable because guidelines on asset securitisation (selling future revenues for upfront payment of cash) in India are still being worked out. Says Ashvin Parekh, Executive Director, Deloitte Touche: "Regulators are taking some time over working out various issues relating to guidelines and framework for qualified institutional buyers (QIBs) and formation of a registry for securitisation."

Many in the industry see that as a problem. In countries like Thailand and Malaysia, it was the central government that contributed either directly or indirectly to the capital of the ARC. Thailand, for example, pumped in 500 billion baht (Rs 58,309.5 crore) via bonds to set up a Financial Institutions Development Fund. The interest on the bonds is paid by the government out of its revenues, while the principal is paid on maturity by the country's central bank, the Bank of Thailand. In Malaysia, the government infused 1.5 billion ringgit (Rs 1,793.9 crore) into the ARC, besides giving 5 billion ringgit worth of interest free loan. Where the governments do not directly put capital into the ARC, they allow banks with bad loans to amortise their write-offs over a period of time. This way, the banks do not take a huge financial hit when they transfer the bad loans. In India, the government has allowed tax set-offs on sale of assets to ARCs, besides allowing gains from investment in government securities to be used for setting off of losses from transfer of bad loans.

ARCs in India, however, are typically non-governmental organisations. And since in India one company may have several lenders and different types of debt, ARCs end up being mere aggregators of bad loans. Even ARCIL is looking at acquiring a portfolio of bad loans (less than Rs 10 crore apiece) to companies in one geographical area. The idea: save on the cost of individual valuation. While mutual fund-type trusts have been allowed to invest in ARCs, industry watchers reckon that will take time. Says a Delhi-based industry watcher: "The delay will happen because every transaction will have to be negotiated with all the parties involved-banks, individual investors, financial institutions. It isn't easy to do that in a short time."

Others like Jack Rodman, Managing Director of E&Y's Asia Pacific Financial Institutions, who has provided due diligence to about 40,000 corporate and real estate loans in Thailand, think that once the securitisation issue is sorted out, it may be easier to fund the ARCs. Says Rodman: "The most important thing is to provide different kinds of securitised paper to take care of different types of creditors." He also points out that in most international cases, the attempt has always been to bring in a consortium of investment bankers to sell 100 per cent of the bad loans. And it is this consortium that floats different kinds of bonds on the assets and makes profits. But in India, this kind of consortium is not available.

Even in the best of economies, the experience of asset reconstruction companies has been mixed. In India, where all the pieces are still to fall into place, it's early days to say whether the 10 ARCs will make any dent on the mountain-load of Rs 100,000 crore npas. Even M. Damodaran, Chairman of UTI, admits that ARCs are no panacea. But given the other option, which tantamounts to simply wishing NPAs away, the ARCs are India's best hope. What's needed is a regulatory environment that helps them find buyers.