Balance SSF worries with a pass-through

India now has a policy environment enabling big money from overseas to tackle its bad loan problem. Sebi has set up the regulatory framework to operationalise special situation funds (SSFs), which invest in distressed assets. This aligns with RBI’s move to let regulated entities buy and sell bad loans. Placed in a sub-category within the top tier of alternative investment funds (AIFs), SSFs have also been allowed to invest in bankruptcy resolution, security receipts issued by asset reconstruction companies and securities of companies in distress.

So far, efforts to drain bad loans from India’s banking system have faced headwinds, the latest being a recovery moratorium induced by the pandemic. The median recovery rate in an RBI study of 60 corporate debtors resolved in September 2019-September 2021 through the Insolvency and Bankruptcy Code (IBC) was 24.7%. This was far higher than the recovery rate under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (Sarfaesi) Act, and banks have been shrinking the share of stressed asset sales to asset reconstruction companies as the realisable value dips. RBI’s latest Financial Stability Report sees banks’ bad loans climbing from 6.9% of total advances in September 2021 to 8.1% by September 2022 under a baseline scenario, and to 9.5% under severe stress.

Expectations of billions flowing in though SSFs may, however, have to be tempered by the tax treatment of these funds. Business income earned by the category of AIFs SSFs find themselves in is taxed at the fund level at an effective rate of 42.7%, including surcharge and cess. To interest foreign investors in these funds, GoI may have to consider allowing a pass-through of business income.


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