Why Special Situation Funds are Necessary
India suffers from a chronic bad debt problem. To overcome this problem, banks and financial institutions were initially allowed to sell their stressed loans only to ARCs. Now they can sell to SSFs too.
- Higher bad debt requires higher provisioning, locking up more capital in the banking system. This reduces credit supply and hurts economic growth.
| Indian financial markets witnessed two crucial reforms earlier this year.
1] SSF: SEBI came out with a dedicated regulatory framework for special situation funds (SSFs). 2] Dual structure bad bank: The RBI approved the new dual-structure bad bank, NARCL-IDRCL. |
- To overcome this problem, banks and financial institutions were initially allowed to sell their stressed loans only to ARCs.
- Transfer of stressed loans would release capital locked-up in the banking system and help improve credit supply.
Understanding AIFs and SSF:
- SEBI has introduced SSFs as a distinct sub-category of Category I Alternative Investment Funds (AIFs).
- AIFs manage privately pooled funds raised from sophisticated investors with deep pockets.
- While AIFs have traditionally played a prominent role in equity markets, Regulations did not permit AIFs to participate in the secondary market for corporate loans extended by banks and NBFCs.
- The new regulations now create a special sub-category of AIFs, namely SSFs, which are allowed to participate in the secondary market for loans extended to companies that have defaulted on their debt obligations.
Why SSFs must be allowed full participation across the entire spectrum of secondary market for corporate debt:
- If lenders and bond investors could offload potentially stressed assets to SSFs before defaulting in the secondary market, they would benefit from a lesser haircut.
- Allowing SSFs to purchase investment-grade loans would also improve the liquidity in the secondary market for corporate loans.
- Secondary trading of loans is now institutionalised in international financial markets.
The RBI task force on secondary markets for corporate loans, chaired by T N Manoharan, made this suggestion in 2019. - SSFs cannot borrow funds or engage in any leverage except for temporary funding requirements. Consequently, risks associated with liquidity, credit or maturity transformation and asset-liability mismatches are unlikely to arise.
- Given their structure, SSFs are likely to acquire sufficient debt in a distressed company to acquire control or to influence its subsequent insolvency or restructuring process to maximise its value through business turnaround or sale.
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