Private sector banks (PvSBs) are evincing keen interest in selling loans exhibiting signs of incipient stress (also known as special mention accounts/SMAs) to Asset Reconstruction Companies (ARCs) to correct skewed credit-deposit (C-D) ratio and present a better picture on bad loans to investors.

Non-banking finance companies (NBFCs) too are going down that road to unlock liquidity as RBI increased risk weight on bank credit to these companies in November 2023, making borrowing from banks costly.

The special mention accounts (SMAs) are sub-classified into three categories – SMA-0 (where principal or interest payment is not overdue for more than 30 days but the account is showing signs of incipient stress), SMA-1 (principal or interest payment overdue between 31-60 days), and SMA-2 (principal or interest overdue between 61-90 days).

“Market savvy banks and NBFCs factor in the premium paid by market for reduced NPA and healthy balance sheet. From the ARC perspective, the “catch them (NPAs) young” approach increases the chances of turnaround and value maximization. Going forward, the proportion of SMAs in NPA sales will improve as markets mature,” said Hari Hara Mishra, CEO, Association of ARCs in India.

However, this needs to be supplemented by requisite legislative changes for enforcement of underlying security in respect of SMAs. This will be more of a deterrence than use, as in these cases restructuring will be the preferred option, Mishra added.

Under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002, the security can be enforced only in case of a non-performing asset (NPA). In the case of SMA, the powers of SARFAESI cannot be invoked.

SMA sales can help correct C-D ratio.

In the current context of credit growth outpacing deposit growth, RBI wants banks to have a healthy C-D ratio of 75-80 per cent thereabouts, said a senior executive of a public sector bank (PSB).

So, banks having C-D ratio beyond this threshold either have to pare credit growth or bump up deposit growth. So, if SMAs are sold to ARCs, the numerator (credit) in the C-D ratio will come down.

Among Banks, SMAs are sold mainly by PvSBs. Public sector banks usually exhaust all other options before selling assets to an ARC due to Central Vigilance Commission and other guidelines.

The PSB official observed that one of the reasons private sector banks command a premium over public sector banks is because they keep their NPAs low by selling even assets showing signs of incipient stress.

Given that most of the PvSBs are listed and every quarter they have to disclose to investors and analysts their financial ratios, they ensure that their NPA ratios are as low as possible in order to get a better premium in the market.

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