DARP—Creating Distressed

Assets Markets
LESSONS LEARNED SINCE THE GLOBAL FINANCIAL CRISIS AND
OPPORTUNITIES FOR INVESTORS IN EMERGING MARKETS TODAY
Chapter 3, Public Asset Management Companies, was previously published by the Financial Sector Advisory Center of the
World Bank Group’s Finance, Competitiveness & Innovation Global Practice. Please see: Cerruti, Caroline. 2018. “Public Asset
Management Companies: International Experience.” Policy Brief, World Bank, Washington, DC.

About IFC
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delivered more than $23 billion in long-term financing for developing countries, leveraging the power of the private sector to end
extreme poverty and boost shared prosperity. For more information, visit www.ifc.org.

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DARP—Creating Distressed
Assets Markets
LESSONS LEARNED SINCE THE GLOBAL FINANCIAL CRISIS AND
OPPORTUNITIES FOR INVESTORS IN EMERGING MARKETS TODAY
ABOUT THE AUTHORS
CAROLINE CERRUTI, CFA, is a Senior Financial Sector Specialist in the World Bank. She works primarily on financial
sector restructuring issues (asset quality reviews, asset management companies, bank resolution) and long-term
finance. She has been involved in various financial sector assessments (FSAP) jointly with the IMF. Caroline spent
three years working with a client on how to set up an asset management company and develop a comprehensive
non-performing loan resolution strategy. This work led her to co-author the toolkit on Public Asset Management
Companies, which was presented in several international conferences. She was also involved in the resolution of
various distressed financial institutions (Chapter 3).
ERIC D. CRUIKSHANK is a former IFC Manager covering financial markets and jeopardy-investment workouts. He also
represented IFC on the supervisory boards of 11 IFC investee financial institutions. Prior to joining IFC, he was a Senior
Economist and Deputy Resident Representative for the World Bank in Nepal and Brazil. He is the author of two books,
including Distressed Financial Markets: Navigating the Shoals of Liquidity Risk (2008). Currently, he is a consultant with
IFC within the Distressed Asset Recovery Program (DARP)—Financial Institutions Group (Chapters 1, 4, introduction to
Chapter 3).
JOSEP M. JULIÀ was the Chief Investment Officer and Global Lead of IFC´s Distressed Asset Recovery Program (DARP)
until June 2019. He managed IFC’s business of acquisition and resolution of distressed assets and special situations,
with deals totaling more than $7.3 billion across regions. Josep led the DARP global team in sourcing and structuring
distressed assets transactions, as well as active portfolio monitoring (Chapters 1, 4).
ANDRÉS F. MARTÍNEZ is a Senior Financial Sector Specialist for the World Bank Group’s Finance, Competitiveness,
and Innovation Global Practice. Andrés is an insolvency lawyer since the year 2000 and, since 2011, has been advising
several countries on debt-resolution reform, including on insolvency systems and debt recovery in Eastern Europe
and Central Asia, Latin America, and the Middle East. In his current position, he leads the dialogue with several
governments on technical issues related to debt resolution and insolvency (Chapter 2).
MARTA SÁNCHEZ SACHÉ is an Investment Officer in IFC’s DARP team currently based in Washington, DC. She
manages IFC’s investments in the distressed assets space in Brazil and India, and IFC’s global platform for distressed
investing across emerging markets. Prior to her position in DARP, she was based in Brazil, where she managed debt
and equity investments in banks and non-bank financial institutions (Chapters 1, 4).

CONTENT ADVISORS
Economics and Private Sector Development | Neil Gregory, Thomas Rehermann
Legal | Konrad Braunoehler
Financial Institutions Group | Paulo de Bolle, Nathalie Louat, Josep M. Julià, José Luis García Lascurain Almeida,
Marta Sánchez Saché
Partnerships, Communications and Outreach | Tom Kerr, Philip McNally, Nadine Shamounki Ghannam, Henry Pulizzi

ACKNOWLEDGMENTS
The authors wish to acknowledge the following World Bank Group colleagues for their helpful comments, suggestions
and advice: Emiliano Agopian (IFC), Jeffrey David Anderson (IFC), Camilo Amezquita (IFC), Sriram Balasubramanian
(IFC), John Barham (IFC), Mohit Bhatia (IFC), Monika Blaszkiewicz (IFC), Aimilios Chatzinikolaou (IFC), Bruno Choi (IFC),
Fernando Dancausa (IFC), Sameer Goyal (World Bank), Gunjan Gulati (IFC), Elisabeth Hyun Kim (IFC), Michele Isidori
(IFC), Kyung Kyun Park (World Bank), Jean Pierre Lacombe (IFC), Zuberoa Mainz (IFC), Antonia Menezes (World Bank),
Iuliia Mironova (IFC), Ronen Nehmad (IFC), Lara Pillonca (IFC), James Reed (IFC), Andreas Rimkus (IFC), Tatiana Urasaki
(IFC), Marcos Vaena (IFC), Alexei Volkov (IFC), Jonathan Wheatley (IFC)

PROJECT AND CONTENT TEAM

Project Manager | Thomas Rehermann
Editors | David Lawrence, Susan Caroline Schroeder
Research Assistants | Sulayman Cham, Jung Ryun Byun
Composition and Design | Rikki Campbell Ogden
CONTENTS

6 | FOREWORD

8 | INTRODUCTION

10 | EXECUTIVE SUMMARY

13 | CHAPTER 1
DARP: Creating Markets to Promote Development
and Financial Stability

28 | CHAPTER 2
The Legal Framework Behind a Distressed Assets Market:
Insolvency, Enforcement, and Workouts

34 | CHAPTER 3
Public Asset Management Companies

46 | CHAPTER 4
Attractive Markets for Investing in Distressed Assets

69 | CONCLUSION

70 | REFERENCES

72 | FURTHER READING
Figures, Tables, and Boxes
FIGURE 1.1 High Levels of NPLs Led to Reduced Lending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
FIGURE 1.2 DARP’s Global Network of Partners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
FIGURE 1.3 DARP’s Investments: Building Resolution Capacity and Mobilizing and Deploying Capital. . . . . . . 17
FIGURE 1.4 DARP in Colombia: Timeline. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
FIGURE 1.5 Bridging the Pricing Gap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
FIGURE 1.6 How DARP Can Create and Deepen Local Capital Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
FIGURE 1.7 DARP Key Milestones, 2007-19. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
FIGURE 1.8 Selected DARP Results. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
FIGURE 2.1 Recovery Rate Based on Time to Resolve Insolvency and Outcome. . . . . . . . . . . . . . . . . . . . . . . . . . . 32
FIGURE 3.1 Two Types of Public AMCs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
FIGURE 3.2 Comprehensive NPL Management Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
FIGURE 3.3 State Aid in the Transfer of Impaired Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
FIGURE 3.4 Real Economic Value from Previous Cases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
FIGURE 4.1 Brazil—Total Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
FIGURE 4.2 Brazil—E-H Rated Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
FIGURE 4.3 China—Total Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
FIGURE 4.4 China—NPLs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
FIGURE 4.5 Greece—Total Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
FIGURE 4.6 Greece—NPLs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
FIGURE 4.7 India—Total Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
FIGURE 4.8 India—NPLs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
FIGURE 4.9 Turkey—Total Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
FIGURE 4.10 Turkey—NPLs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
FIGURE 4.11 Ukraine—Total Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
FIGURE 4.12 Ukraine—NPLs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

TABLE 3.1 Examples of Public AMCs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

TABLE 4.1 Legal and Regulatory Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
TABLE 4.2 Greece: Summary of NPL Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

BOX 1.1 Benefits of a Distressed Assets Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

BOX 1.2 DARP, Innovation Across Distressed Assets Markets—Part 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
BOX 1.3 DARP, Innovation Across Distressed Assets Markets—Part 2. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
BOX 2.1 The London Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
BOX 2.2 Regulatory and Tax Impediments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
BOX 3.1 AMCs of Vietnam and China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
BOX 4.1 DARP Involvement in Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
BOX 4.2 DARP Involvement in China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
BOX 4.3 DARP Involvement in Greece. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
BOX 4.4 Insolvency, Bankruptcy, and NPL Resolution Progress in India. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
BOX 4.5 DARP Involvement in India. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
BOX 4.6 DARP Involvement in Turkey. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
BOX 4.7 DARP Involvement in Ukraine. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Abbreviations and Acronyms

AMC Asset Management Company KPI Key Performance Indicators

AMCON Asset Management Corporation of LMC Loan Management Company
Nigeria MENA Middle East & North Africa
ARC Asset Reconstruction Company MSME Micro, Small, and Medium-Sized
BAMC/DUTB Bank Asset Management Company Enterprise
BCR Banca Comercială Română NAMA National Asset Management Agency
BRSA Banking Regulation and Supervision NBFC Non-Bank Financial Company
Agency NBFI Non-Bank Financial Institution
CAGR Compound Annual Growth Rate NCLT National Company Law Tribunal
CBIRC China Banking and Insurance NPL Non-Performing Loan
Regulatory Commission
OCW Out-of-Court Workout
CCBC China Construction Bank Corporation
RBI Reserve Bank of India
CISA Central de Inversiones S.A.
REO Real Estate Owned Assets
DARP Distressed Asset Recovery Program
REV Real Economic Value
DCF Discounted Cash Flow
RTC Resolution Trust Corporation
DIP Debtor-in-Possession
SAREB Sociedad de Gestión de Activos
E&S Environmental and Social procedentes de la Reestructuración
EBL Enterprise Bankruptcy Law Bancaria
ECA Eastern Europe and Central Asia SDIF Savings Deposit Insurance Fund
EMS Emerging Markets SME Small and Medium-Sized Enterprise
EU European Union SML Special Mention Loan
FCI GP Finance, Competitiveness & SOE State-Owned Enterprise
Innovation Global Practice SSA Sub-Saharan Africa
FOGAFIN Fondo de Garantias de Instituciones UNCITRAL United Nations Commission on
Financieras International Trade Law
FY Fiscal Year
GOI Government of India Note: All dollar amounts are U.S. dollars unless otherwise indicated

GDP Gross Domestic Product

IBBI Insolvency and Bankruptcy Board of
India
IBC Insolvency and Bankruptcy Code
IBRA Indonesian Bank Restructuring
Agency
ICA Inter Creditor Agreement
ICBC Industrial and Commercial Bank in
China
IFC International Finance Corporation
IMF International Monetary Fund
IPO Initial Public Offering
IRP Insolvency Resolution Professional
KAMCO Korea Asset Management
Corporation
FOREWORD

The flow of credit is essential to economic growth, development, and vibrant financial
markets. And while all economies experience periods of financial instability, many emerging
economies lack the tools to adjust, leaving them more vulnerable to boom and bust cycles,
with negative consequences for households and businesses. Non-performing loans are a
natural consequence of expanded credit, but without the means to effectively resolve them,
economies will falter.

This is why we at the International Finance credit environment by improving the insolvency and
Corporation place such a high value on our Distressed bankruptcy code, as well as a range of distressed assets
Asset Recovery Program, or DARP. If we are to fulfill solutions, including the first dedicated platform to
our mission of developing new and stronger financial target mid-to-large distressed companies.
markets for private sector solutions in emerging Similarly, in Colombia, in certain countries across
economies, we must deploy effective tools and solutions the Caribbean, as well as in other countries in
to ensure financial stability and maintain the flow of Eastern Europe, DARP has significantly contributed
credit across the markets in which we work. to the creation of new, vibrant markets for non-
DARP fits the bill. IFC’s mandate for creating markets, performing loans. In other countries such as Brazil,
as formulated in our IFC 3.0 strategy, means both the Philippines, and Mexico, where NPL markets were
helping to initiate them as well as intervening when more developed but fell out of favor with investors
necessary to maintain their stability and capacity after the crisis of 2008, DARP helped re-activate
to recover.1 In collaboration with the World Bank, dormant markets for distressed assets.
DARP offers the ability to systematically intervene These approaches have allowed DARP to play a critical
in financial markets to address the problem of rising role in providing stability to financial systems across
levels of distressed assets. This aligns it perfectly with emerging economies. Over the last decade, DARP and
IFC’s cascade approach of implementing reforms its partners have committed more than $7.3 billion
to address market failures and other constraints to to the acquisition and resolution of distressed assets.
private sector investment. This has enabled financial institutions to remove
As such, DARP leverages the upstream work done over $30 billion of problem loans from their balance
by the World Bank’s Finance, Competitiveness & sheets, facilitating new lending into these economies;
Innovation Global Practice to support the development it is helping more than 18 million small and medium
of robust regulatory regimes for distressed assets enterprises and households become debt free so that
resolution, and combines it with pioneering, market- they regain access to finance; and it has introduced best
based interventions that mobilize capital and expertise resolution practices. This report examines insights and
from leading private sector distressed assets investors. lessons learned since DARP was launched in 2008.
For example, in India, where a large stock of non- I invite you to engage with us on this critical topic.
performing loans—currently the equivalent of
approximately $134 billion—created a negative PAULO DE BOLLE
feedback loop that slowed credit expansion and Senior Director
reduced financial inclusion and economic growth, Financial Institutions Group, IFC

DARP worked closely with the World Bank to develop

a dynamic market for distressed assets resolution.
This included technical assistance to strengthen the

6
INTRODUCTION

Every financial system has faced or will face a crisis at some point. But even in the absence of a
crisis, the extraordinary growth in credit over the last two decades has resulted in an increase
of non-performing loans (NPLs), which are an unavoidable by-product of lending. This can put
economies at risk. When not addressed, distressed assets can grow to reach critical thresholds
that can slow down, or even prevent, economic recovery and increase unemployment,
creating a vicious circle that is difficult to break. Well-developed distressed assets markets
can interrupt this loop, allowing for a return to economic growth and financial stability.
However, this requires that all stakeholders—each inevitably with different motivations—are
prepared to reach compromises. Similarly, the magnitude of the NPL problem is so severe in
many economies that collaboration between the private and public sectors is also crucial. In
response to these challenges, the International Finance Corporation (IFC) is taking the lead in
supporting the development of strong distressed assets markets across emerging economies
through its Distressed Asset Recovery Program (DARP) and capitalizing on the attractive
investment opportunities deriving from these challenges.

The problem is clear and severe: high NPL volumes across emerging markets (EMs) may face challenges at
are a major problem facing emerging economies. a systemic level. To alleviate this risk, an efficient and
Considering the NPLs on the balance sheets of banks effective distressed assets resolution system is critical
alone, there is an estimated $1 trillion of distressed to: (a) allow banks to dispose of their non-productive
assets representing capital that could be put to more assets and free up capital to resume lending, (b) help
productive use. However, when restructured and individuals, SMEs and corporates regain access to the
written-off loans are taken into account, as well as financial system while keeping their most valuable
other assets categorized as special mention or similar assets such as their homes or their key productive assets,
loans, the total stock of banks’ distressed assets is much and (c) restructure and refinance potentially viable
larger. First, large stocks of NPLs limit credit expansion companies to preserve existing jobs and create new ones.
and financial inclusion, as they adversely impact banks’
Many stakeholders, from both the private and public
capital and profitability, and therefore their ability to
sectors, need to be involved to create sound distressed
supply credit to fuel economic growth. Second, defaulted
borrowers gradually lose access to financing and are at assets markets. Given the magnitude of the NPL
risk of losing their assets. Third, the absence of adequate problem, as well as the need for significant capital and
credit availability defers planned investments and keeps expertise, private sector participation is crucial. The
many high-potential small and medium enterprises ecosystem of a well-developed distressed assets market
(SMEs) and corporates from recovering from financial includes the following elements:
distress, causing significant production and job losses. • Regulators are key, since a legal framework that
Fourth, the large overhang of NPLs may require capital enables the efficient transfer of these NPLs and
injections from the banks’ shareholders to take capital allows for their proper resolution is a precondition
adequacy to acceptable levels, while it can also impose for distressed assets markets to develop. In the
a major fiscal burden on governments that may need to absence of a clear, sound, and efficient legal,
recapitalize systemic banks. regulatory, and judicial process, market participants
If no action is taken, however, and the volume of NPLs lack the certainty required to pursue the sale and
continues to rise, there is a risk that banking systems acquisition of NPLs.

8
• Sellers needing to offload their NPL portfolios This report is structured in four chapters. Chapter 1
must recognize the benefits of disposing of them. provides an overview of DARP, how DARP addresses
These include strengthening of their balance sheets, market inefficiencies today, and what DARP will focus
providing liquidity, reducing the cost of managing on going forward. Chapter 2 examines the importance
these non-core assets, freeing up management to of having a robust legal framework that enables the
focus on their core business, and avoiding potential development of distressed assets markets, while Chapter
contamination of their performing loan portfolios. 3 explores how the establishment of public asset
management companies (AMCs) can complement the
• Buyers must acknowledge that, in addition to
crucial private sector involvement. Finally, Chapter 4 looks
maximizing their return, the use of best practices
more closely at several markets where most preconditions
in their resolution process is key to the sustainable
for large-scale distressed assets resolution are being put
development of a distressed assets market—not only
in place. These warrant a closer look by investors seeking
because dealing with debtors in an appropriate and
opportunities in distressed assets markets.
ethical way maximizes the chances of an actual
recovery, but also because sellers are very concerned As a leader in this ecosystem, IFC, through DARP, has
with their reputation. An investment in best practices had a significant impact over the last decade, building
in the short term helps promote a healthy market the infrastructure needed for the resolution of distressed
where buyers can achieve long-term positive returns. assets globally and serving as a catalyst for the creation
of vibrant secondary markets around the world.
• Servicers should look at debtors as clients and
However, this would not have been possible without
build long-term relationships based on trust to
the active participation and valuable contribution of
optimize recoveries. They also need to understand
the relevant distressed assets stakeholders. Thanks
the importance of aligning their interests with
to the partnerships established over the years, DARP
investors and not just focus on maximizing their
has committed over $7.3 billion, allowing financial
revenues in the short term. Of equal importance is
institutions to offload NPLs of more than $30 billion
for servicers to be up to date on new technologies
in face value, thereby improving their liquidity levels
that are fundamentally changing the way collections
and freeing up capital for new loans. At the same time,
are performed.
DARP platforms are helping normalize the obligations
• Advisors, both on the sell side and on the buy side, of more than 18 million households and businesses. This
play a key role in matchmaking. To be effective, unique DARP global network enables IFC to continue
they need to look after the interests of both ends of playing its active role in developing local distressed
the trade, rather than just trying to maximize short- assets markets across emerging economies as well as
term returns for their clients. mobilizing private sector capital and expertise. n

NATHALIE LOUAT ARIANE DE IORIO JOSEP M. JULIÀ

Senior Manager Chief Investment Officer, Until June 2019
Mobilization & Distressed Assets Chief Investment Officer,
Innovation Financial Recovery Program Distressed Assets
Institutions Group, IFC (DARP), Financial Recovery Program
Institutions Group, IFC (DARP), Financial
Institutions Group, IFC

ERIC D. CRUIKSHANK MARTA SÁNCHEZ SACHÉ

Consultant, Investment Officer,
Special Operations, IFC Distressed Assets Recovery
Program (DARP), Financial
Institutions Group, IFC

9
EXECUTIVE SUMMARY
The extraordinary growth in credit over the last two decades has resulted in an elevated level of
distressed assets. This can reduce lending and slow down, or even prevent, economic recovery,
creating a vicious circle that can be difficult to break. Robust distressed assets markets can
interrupt this loop, thereby allowing for a return to economic growth and financial stability.
They allow banks to dispose of their non-productive assets and resume lending, enable
borrowers to regain access to the financial system, and create an environment for the successful
restructuring of viable companies. This, however, requires compromises among stakeholders
and collaboration between the public and private sectors.

IFC Plays an Important Role in Creating The Legal Framework Behind Distressed
Distressed Assets Markets Assets Markets
For more than a decade, IFC has supported the A well-developed legal and institutional regime is
development of strong distressed assets markets in key to maintaining an acceptable risk level, allowing
emerging economies through DARP—the Distressed distressed assets markets to develop. Enabling measures
Asset Recovery Program. DARP’s strategy is based for dealing with insolvency, enforcement, and the
on two pillars: first, building the essential servicing ability to achieve out-of-court workouts (OCW) are
infrastructure required across markets; and second, essential. Laws and regulations that favor smooth
deploying capital, including capital mobilized from transactions and loan transfers allow investors to
third-party investors, to acquire and resolve distressed enforce their claims and collateral efficiently and
assets. This work also brings to light any shortcomings provide mechanisms for both out-of-court restructuring
in the applicable legal and regulatory frameworks, and efficient in-court insolvency processes. This is
which can then be addressed to strengthen the overall crucial to attracting investors in the distressed assets
debt resolution ecosystem. In this sense, DARP market. Cross-border legal and tax issues also play
has proven to be an efficient tool for creating new important roles.
distressed assets markets as well as strengthening the
development of existing markets. Public Asset Management Companies as Part
DARP has the tools and resources to address and of an NPL Resolution Strategy
mitigate impediments to healthy distressed assets When coordinated with private sector initiatives, Asset
markets, enabling development over time. Since 2007, Management Companies (AMCs) can enhance the
commitments under DARP have grown to over $7.3 recoveries of distressed assets that have been acquired
billion globally, of which $2.7 billion comes from IFC’s from failed banks and other financial institutions.
own account and $4.6 billion from third-party investors. They can help in the context of a comprehensive NPL
This has allowed banks to offload a face value of more resolution strategy for a national economy. By forcing
than $30 billion in NPLs and is helping normalize banks to recognize losses and making recapitalization
the obligations of about 18 million borrowers. DARP needs transparent, they can help restore confidence
has also fostered best resolution practices for NPLs, in the financial system. They can also improve the
including best environmental and social (E&S) policies asset quality, income, and liquidity of the financial
and procedures. IFC has therefore played a critical institutions transferring assets, while allowing them to
role in the development of NPL markets in emerging refocus on their primary role: financial intermediation.
economies across the world, including, India, Colombia, Political interference is a risk, however, and if poorly
Brazil, and several countries in Eastern Europe. designed or managed, AMCs may undermine credit

10
discipline and generate significant losses for taxpayers. economies, DARP has been able to draw several
A solid institutional and regulatory environment, lessons that can be valuable to all stakeholders in NPL
robust corporate governance, and strong commercial markets. In addition to the preconditions for entering
focus are therefore critical to their success. Public new markets described above, it is also important to
AMCs have been successfully used both in developed have local knowledge, a presence on the ground, close
countries, including the United States (1989) and alignment of stakeholder interests, and a commitment
Sweden (1993), and more recently in Ireland (2008) to use best resolution practices.
and Spain (2012), as well as in emerging economies,
including Indonesia (1998), Turkey (1999), and Nigeria Conclusion
(2010), and in many instances have been able to
successfully co-exist with private sector initiatives. Since its inception, DARP has developed significant
experience, knowledge, and tools that have helped
Attractive Markets for Investments in create vibrant distressed assets markets across the
Distressed Assets globe. Yet much remains to be done, especially today as
the global economy experiences increasing uncertainty
When investors consider entering a new market, they
and large volumes of NPLs continue to be a drag on
evaluate and analyze a number of preconditions, the
key ones being the market size, the macroeconomic many economies. DARP is well-positioned to leverage
environment, the legal and regulatory framework, the its unique global network of partners to attract private
quality of information, as well as the servicing capacity sector capital and expertise to continue developing
and the investor base. With more than a decade of distressed assets markets across emerging economies,
experience in investing in NPLs globally through while tapping the significant opportunity that these
DARP, IFC has identified six countries that have met— markets represent. DARP is now extending its reach
or are working to put in place—the preconditions for into new regions such as Sub-Saharan Africa (SSA) and
large-scale distressed assets resolution, thus warranting the Middle East and North Africa (MENA), as well as
priority focus for investors. These are Brazil, China, further enhancing market development by supporting
Greece, India, Turkey, and Ukraine. the creation of secondary markets for distressed assets
and promoting the adoption of new technologies to
Valuable Lessons Learned and Insights improve the performance of these markets. Through
Having played a key role for over a decade in DARP, IFC will continue to play a leadership role in
developing distressed assets markets in emerging the distressed assets space. n

11
CHAPTER 1
DARP: Creating Markets to Promote
Development and Financial Stability
By Josep M. Julià, Eric D. Cruikshank, and Marta Sánchez Saché

Inherent in all debt is a promise to repay. Yet many expansion and can be exacerbated in times of economic
things can prevent this promise from being honored deceleration. At critical levels, elevated levels of NPLs
and cause financial stress for borrowers, lenders, (in terms of both percentage of gross loans and absolute
and even a country’s financial system. Therefore, the stock) can lead to reduced lending (see Figure 1.1). This
ability to resolve delinquency of financial obligations limits credit to productive sectors and to individuals,
of both individuals and companies has a definite slowing down the economy and negatively affecting
financial benefit—not only to the creditor, but also employment. With the resulting drag on output and
to the borrower through credit repair. There are financial liquidity, cash available for debt servicing
systemic benefits—in addition to the sum of payment declines, leading, via a vicious circle, to more NPLs and
recoveries—when widespread loan delinquencies in the thus further rounds of credit and output contraction.
private sector can be resolved on a large scale. These
include enhanced economic growth, reinvigorated
liquidity, and welfare benefits. These are especially
DARP is Launched in Response
relevant in emerging markets, where private sector debt to the Growing NPLs in
resolution can improve access to finance for the bottom Emerging Markets
40 percent of the population2 (thus increasing financial In 2006, IFC started to systematically explore how to
inclusion), preserve jobs, and stabilize financial systems. be an active player and catalyst to stop this negative
Non-performing loans are an inevitable byproduct feedback loop and its adverse consequences for
of lending. NPLs typically increase with credit emerging economies. IFC identified several significant

Economic slowdown and increasing NPLs reduce bank capital and

discourage new lending, creating a negative feedback loop.

Reduced lending: reduced Economic

access to credit for households deceleration & rising
& SMEs/corporates unemployment

Lack of credit slows down the economy, Economic deceleration and rising
generating unemployment, negatively Effectively unemployment have direct impact on NPLs
impacting households and SMEs/corporates
managing
distressed assets Higher NPLs increase banks’ provisioning
Banks burdened with NPLs are is critical to expenses, leading to lower profitability and
reluctant to make new loans break this loop ineffective use of scarce balance sheet resources

Higher provisioning, more

Higher NPLs
limited balance sheet resources

FIGURE 1.1 High Levels of NPLs Lead to Reduced Lending

Source: IFC

13
CHAPTER 1

positive impacts resulting from the resolution of NPLs, management. The FCI GP provides advisory work on
among which (a) banks were afforded an outlet to banking resolution, asset classification, provisioning
offload non-productive assets, which enabled them to rules, and collateral valuation, as well as legal and
resume and increase lending, (b) borrowers were able to regulatory work on corporate and personal insolvency,
normalize their obligations and become creditworthy foreclosure, debt resolution, and creation of public
again, and (c) best international resolution practices and private AMCs, which are entities established to
were transferred across emerging markets—all of these manage and enhance recoveries of distressed assets
coupled with an attractive financial return. removed from the banking system. The FCI GP
also arranges training for court officials as well as
Subsequently, the global financial crisis of 2008
for banking industry executives, supervisors, and
sparked the formal launch of DARP as an investment
bankruptcy administrators. Please refer to Chapter
platform with global reach. IFC recognized that
2 for more information on the importance of legal
the crisis posed major challenges for the world’s
aspects of NPL resolution and to Chapter 3 for more
economies, including developing markets, requiring
details on the role of AMCs and how they complement
coordinated actions to address liquidity, capital, and
the work done by DARP.
asset-quality issues confronting financial systems
and institutions. DARP was originally conceived
DARP’s Strategy: Building Global Servicing
and approved as a three-year investment program to
Infrastructure and Investment Capacity
address the increasing levels of debt burden, rollover
risk, restructuring needs, and distressed assets in EMs. DARP aims to create an IFC programmatic response
Its success and its importance for developing stable to the increasing levels of debt burden and distressed
assets in IFC member countries. As mentioned above,
financial systems, however, allowed DARP to continue
the objective is to facilitate a positive systemic impact
well beyond the original investment horizon to the
by: (a) helping banks offload non-productive assets
present date, and to become a successful business line
so they could continue lending, and (b) normalizing
within IFC’s Financial Institutions Group.
obligations to allow many distressed borrowers to
Since then, DARP has played a critical role in the regain access to finance. DARP’s objectives further call
development of NPL markets across emerging economies. for reducing the roll-over burden, increasing access
In countries where NPL markets and/or insolvency to funding for viable private enterprises (including
regulation were non-existent or underdeveloped, DARP, restructuring where appropriate), and cleaning up
jointly with the World Bank, has significantly contributed financial systems plagued by a significant build-up
to creating new, vibrant NPL markets. In other countries of distressed assets. As part of this effort, DARP’s
with more developed NPL markets, DARP has helped strategy has been designed based on two main
re-activate dormant markets, which, following the crisis pillars that represent the biggest bottlenecks for the
of 2008, had lost traction, as many of the traditional development of vibrant NPL resolution markets: first,
investors in this space turned their focus to opportunities building the much-needed servicing infrastructure
in mature markets. in EMs, and second, deploying capital efficiently,
including mobilized capital from third-party investors,
Close Collaboration within the World Bank Group for the acquisition and resolution of distressed assets.
A vital component of DARP is the close collaboration Servicing infrastructure tends to be scarce in EMs,
with the Finance, Competitiveness & Innovation with a limited number of active players and resolution
Global Practice (FCI GP) of the World Bank Group. practices that are often inconsistent with international
DARP provides valuable and practical feedback best practices. In this regard, the first pillar of DARP’s
regarding the key elements required or lacking in the strategy focuses on developing a solid servicing
insolvency regime of a country. Such feedback is then capacity, by taking minority equity investments in
incorporated in the work that the FCI GP contributes local servicing firms, and introducing best practices for
to the efforts to improving the framework for NPL distressed assets activities among servicing companies,

14
 CHAPTER 1

Global Platform DARP’s global network of

partners are the following:
Europe and Central Asia:
ADM Capital, APS, EMSA
(regional), EOS (Russia),
Kruk (Romania)
Global: Lapithus
Latin America:
Adamantine (Caribbean),
Covinoc (Colombia and
Peru), Recovery (Brazil
and Argentina), Secorse
(Mexico)
Middle East and North
Africa: Omni Bridgeway
(regional)
Asia: ADM Capital, Altus,
Clearwater (regional),
Altico, Encore, IndiaRF
(India)
Sub-Saharan Africa:
Nimble (regional)

FIGURE 1.2 DARP’s Global Network of Partners

Source: IFC

and banks. As a result, over the last decade, DARP its “willingness to pay.” DARP servicers tend to use
has established a unique global network of partners constructive approaches to determine the capacity of
that provides an important cornerstone to acquire and delinquent borrowers to pay, and work with them to
resolve distressed assets and a critical building block reestablish their eligibility for borrowing. Legal means
for developing the servicing infrastructure across are employed but tend to be used as a last resort or
EMs. This global network (a) provides the capacity to as leverage during negotiations. In addition, servicers
source new investment opportunities, price and manage have more flexibility when trying to reach settlements
acquired distressed assets, compare performance with defaulted creditors. Unlike financial institutions,
among servicers, and share best practices, (b) helps
they benefit by avoiding the risk of contaminating the
align interests between IFC and servicers to maximize
rest of their performing loan portfolio. For example,
recoveries and return on investments, (c) allows IFC to
settlements with even a few borrowers in default
encourage the use of best collection practices, and (d)
involving forbearance or partial debt forgiveness can
contributes to the development of valuable institutional
encourage otherwise performing debtors to default on
knowledge within IFC on the valuation and resolution
payments with the intention of seeking similar terms.
of distressed assets.
The first pillar of DARP’s strategy focuses on From the above, it follows that appropriate efforts
developing a solid servicing capacity. Servicers that towards distressed assets recovery clearly have
are established partners of DARP differ from many the potential to mitigate many of the harmful
traditional lenders in their asset recovery and resolution consequences of the excessive buildup of private sector
approaches. A key difference is the emphasis on credit debt (both household and corporate) and to contribute
repair as opposed to value recovery. At the heart of to a reduction in financial sector fragility, enhancing
such a resolution approach is the effort placed on access to finance and spurring economic growth and
distinguishing between borrower’s “ability to pay” and job creation. 3

15
CHAPTER 1

The second pillar of DARP’s strategy focuses on Types of Interventions

stimulating the development of markets by mobilizing The range of investments that DARP focuses on
and deploying capital for the acquisition and resolution derives from its dual strategy of developing servicing
of distressed assets. DARP aims to crowd-in capital to infrastructure and acquiring and resolving NPLs:
expand the universe of investors for such transactions
1. Minority stakes in servicers: DARP takes minority
in EMs. In addition to offering the potential for
equity stakes in servicers across EMs to establish
attractive returns, the countercyclical nature of
long-term partnerships and secure the capacity to
distressed assets as an asset class offers investors
source, underwrite, and resolve distressed assets;
important diversification benefits as an “alternative
to align interests; and to transfer best practices. In
investment” that correlates weakly with the more
addition, DARP occasionally provides financing
liquid assets typically traded in financial markets. The
to servicers for the acquisition of distressed assets,
combined capital of IFC and third-party investors
which increases their impact and helps develop and
provides market participants with the liquidity needed
strengthen their track record and expertise.
to break the vicious circle described above.
2. Establishment and mobilization of capital into
distressed assets investment facilities: DARP
DARP Approaches establishes these facilities to: (a) enable IFC to
Since 2007, commitments under DARP have respond rapidly to distressed assets needs and
successfully grown to over $7.3 billion globally, making opportunities, and (b) efficiently mobilize substantial
IFC a market leader in distressed assets acquisition and amounts of private capital into this asset class.
resolution in EMs. DARP can structure these investment facilities

BOX 1.1 Benefits of a Distressed Assets Market

Recently, we witnessed an increasing trend where financial institutions seek to offload their NPLs to
specialized investors. There are numerous benefits to a well-functioning and vibrant distressed assets market:
1. For investors, a distressed assets market provides access to potentially attractive returns. It can also
help diversify their investment portfolios because of the countercyclical nature of this asset class. In
addition, in the case of granular, diversified NPL portfolios, recoveries are realized throughout the life
of the investment and therefore returns are not dependent on a single monetization event.
2. For banks, maintaining a high level of NPLs ties up an institution’s capital in non-performing assets,
putting pressure on long-term profitability and making it harder to absorb future losses and strengthen
capital buffers. In addition, large NPL portfolios force banks to retain higher levels of capital, reducing
their ability to provide new credit, which in turn can hinder economic growth as potentially good
investments are postponed or abandoned. Furthermore, NPLs are more expensive to manage in terms
of time and resources, which also affects the banks’ efficiency and profitability.
3. From a policy standpoint, a developed distressed assets market provides for an efficient and effective
process for cleaning up banks’ balance sheets, as it allows for the disposal of NPLs to private investors
who bring greater efficiency, expertise, and financing to the workout process. As shown in Figure 1.1, a
large volume of NPLs can undermine the reliance on the banking system and erode economic growth.
A well-developed distressed assets market is particularly important during financial crises. Investors can
play a valuable role in economic recovery by addressing debt overhang and providing banks with a way to
divest themselves of problem assets. As these assets are cleared from the financial system, recovery ensues,
and lending and job creation can resume. A distressed assets market also encourages the preservation
of distressed but viable businesses, retaining value and generating income. This helps maintain jobs in
the economy and preserves the value the enterprise provides to the community. However, despite these
benefits, many economies around the world still lack a functioning secondary market for distressed assets.

16
 CHAPTER 1

in different ways, including: (a) generic vehicles (typically private equity funds, industry funds,
that target the acquisition and resolution of NPL sovereign wealth funds, and commercial investors);
portfolios from different financial institutions and (b) domestic niche investors; and (c) domestic and
credit originators in a country, region, or globally; international financial institutions.
(b) dedicated vehicles that acquire NPLs from a
particular financial institution, as a strategic tool Areas of Focus
for that financial institution to manage its balance
To achieve its objectives and maximize its development
sheet; or (c) transaction-specific vehicles for large,
impact, DARP focuses on two main channels:
one-off transactions. These different structures can
have one or several capital layers (that is, senior and/ 1. Acquisition and resolution of NPL portfolios: This
or mezzanine and/or junior tranches), and DARP can is the bulk of DARP’s business and accounts for
invest across the capital structure. In addition, DARP approximately two-thirds of the total committed
retains decision-making prerogatives regarding each capital. It helps resolve difficulties that credit
individual investment made by these facilities. originators, ranging from banks, non-bank financial
The type of investments that DARP can make are institutions and others (for example, retailers or
summarized in Figure 1.3 below: utility companies) face, including high levels of
NPLs, reduced lending, balance sheet stress, and
Mobilization poor performance ratios.

DARP has proven to be an effective tool to efficiently 2. Single Assets: The second area that DARP focuses
mobilize significant amounts of capital for the on includes:
acquisition and resolution of distressed assets in EMs. As • Special lending: This focuses on refinancing and
such, the overall level of DARP mobilization has reached mitigating roll-over risk to help maintain market
almost twice IFC’s investment for its own account. stability and support economic recovery by
The mobilization approach adopted for DARP restoring capital flows, thus improving liquidity
draws on: (a) international distressed assets investors and access to finance.

SERVICING CAPACITY INVESTMENT PLATFORMS

Enhance IFC’s distressed assets

OBJECTIVES

resolution capacity Rapidly respond to distressed assets opportunities

Build robust network of servicers Efficiently mobilize funding from other investors
Align interest among partners Achieve balanced risk-reward structures
Promote best practices

Single-Purpose
DARP SOLUTION

Investment in Servicers Recurring Facilities Single Assets*

Facilities
»» Minority equity investments »» Established SPV »» SPV to recurrently buy »» Typically one-off investments
for a particular distressed assets to restructure or (re) finance
»» Board representation transaction (e.g. sizeable assets / companies
»» Each future acquisition
»» Knowledge sharing among acquire large is carried out more »» Direct investment in
servicers in the network NPL portfolios or efficiently based on a distressed assets
participate in a streamlined process through SPV
large auction)

FIGURE 1.3 DARP’s Investments: Building Resolution Capacity and Mobilizing and Deploying Capital
Source: IFC. Note: Single assets include a wide range of investment opportunities, such as special situations, special lending, and corporate
turnarounds.

17
CHAPTER 1

• Corporate restructuring: DARP’s impact at the Strong Market Creation and Development
company level addresses difficulties stemming IFC has played a critical role in the development of
from a lack of financing, reduced demand, or NPL markets in the countries where it has made DARP
pronounced market volatility by: (a) preserving investments. In some countries, like India, Colombia,
employment, (b) supporting key local/regional and countries across the Caribbean and Eastern
entities, and (c) strengthening the company’s Europe, DARP has significantly contributed to creating
competitive position. new, vibrant NPL markets. In other countries, where
• Special situations: These are investment NPL markets were more developed, such as Brazil, the
opportunities that derive from market Philippines, or Mexico, DARP has helped re-activate
dislocations and inefficiencies, including, among dormant NPL markets, which, following the crisis
others, high-yield bond trades, non-core business of 2008, had fallen out of favor with investors, as
sales, or legal claims acquisitions. many of the most active investors switched their focus
to opportunities in the United States and Western
Significant Development Impact Europe. DARP’s presence and successful track record
across EMs has also made it more attractive for new
Since inception, DARP has had a very relevant
investors, both domestic and international, to consider
development impact in the jurisdictions where it has
entering these markets. For example, DARP has been
been playing an active role, providing liquidity, capital,
able to attract leading international investors, such as
and expertise to the financial and real sectors, while Apollo Global Management, Bain Capital, Fortress
complementing other World Bank Group programs and Investment Group, and Deutsche Bank, as well as
initiatives where appropriate. Globally, DARP domestic ones, including Itau Unibanco in Brazil and
• has allowed banks to offload more than $30 billion Bancolombia in Colombia.
face value NPLs, thereby strengthening their balance Despite the progress achieved, much remains to be done,
sheets, freeing up capital, generating liquidity, and especially in the current environment where the NPL
ultimately recovering much scarce capital, which stock in EMs is on the rise. In addition to collaborating
permitted these banks to continue lending. with the World Bank to develop solid legal and
• is helping normalize the obligations of about 18 regulatory frameworks and working with some of the
million borrowers (both households and businesses), largest banks across EMs to encourage them to dispose
allowing them to avoid losing their assets (often of their NPL portfolios, DARP continues to engage
their homes or key productive assets), regain access with many of the leading international distressed assets
to formal credit, and preserve jobs. Banks are investors to facilitate their entry into markets where they
less likely to offer solutions that will successfully hitherto have not been, which will further develop the
normalize client obligations for different reasons: secondary distressed assets market.
(a) banks tend to focus collection efforts on the
Valuable Lessons Learned and Insights
more recent delinquencies, since resolving distressed
assets is not their core business and they seldom With more than a decade of experience investing in
have the expertise or the resources to effectively nascent distressed assets markets around the world,
pursue collections, (b) problem-asset resolution DARP has been able to identify several key lessons
involves a significant amount of management’s time that are fundamental for developing new markets or
and attention, and (c) more importantly, banks fear asset classes.
that reaching settlements with defaulted borrowers First, all stakeholders should heed the preconditions
at a discount can potentially contaminate their required to make a new market viable and attractive, as
performing loan book. described in Chapter 4.
• has fostered best resolution practices for NPLs, Second, it is critical to understand the importance
including best E&S policies and procedures. of having strong local knowledge and presence.

18
 CHAPTER 1

Distressed assets are a very local affair, not only various stakeholders is equally relevant. For global
because of how the legal and regulatory framework investors who must rely on local partners, ensuring
impacts investment and resolution strategies, but also such alignment is key for the success of the partnership.
because understanding the idiosyncrasy of a given This alignment of interests is also critical for other
jurisdiction is crucial for a successful resolution. In relevant stakeholders such as sellers and regulators.
that sense, one pillar of DARP’s strategy has been to Finally, using best resolution practices is crucial, not
build a global network of local partners that provides only because IFC and institutional investors need
IFC with the capacity to source, underwrite, and assurance that business is conducted professionally, but
manage distressed assets. also because treating debtors as clients and partners
Third, the ability to closely align the interests of the leads to better outcomes and returns.

BOX 1.2 DARP, Innovation Across Distressed Assets Markets—Part 1

Latin America: Servicing Infrastructure and of a distressed assets market. Later, in 2009, IFC
Innovative Structures to Develop a Market invested in a local specialized servicer, Covinoc,
to develop the infrastructure required to acquire
Background and resolve NPLs. In addition, IFC mobilized capital
Following the financial crisis of 1999 in Colombia, a from third-party private sector investors and set
number of local financial institutions went through up several platforms to buy retail and SME NPL
the process of restructuring their balance sheets portfolios. In 2010, for example, IFC partnered
and removing their NPL portfolios. The authorities with Bancolombia, one of the leading financial
created Fondo de Garantias de Instituciones institutions in Colombia, to provide an innovative,
Financieras (FOGAFIN)—an agency responsible market-oriented, and highly efficient mechanism
for providing liquidity support to eligible financial to put the bank’s NPL portfolio back into
intermediaries and assisting in the winding-up productive use. In partnership with Bancolombia
of entities that were deemed unable to continue and Covinoc, DARP established a program to
operations—and ultimately, to help stabilize acquire NPLs from the bank on a recurring basis.
the situation and avoid a systemic meltdown in The platform was capitalized with a total of $100
the economy. FOGAFIN, in turn, created Central million, of which half was provided as a junior
de Inversiones S.A. (CISA) to manage the NPL tranche by Bancolombia, Covinoc, and IFC. The
portfolios and the assets received in lieu of other half was provided as a senior tranche by
payment from the various entities to which it Bancolombia and IFC to enhance investor returns
provided credit. and help bridge any potential pricing gap.
By 2006, the regulators decided that it was time to
dispose of the NPLs held by CISA to monetize the
assets and recover the funding that the authorities
had initially provided. In addition, the regulator 2007 2009 2010 2011 2013
IFC supports the Equity IFC & First First multi-
identified an opportunity to leverage this process to CISA transaction, investment Bancolombia multiseller investor
kick-start the distressed assets market in the country. a landmark in Covinoc partnership NPL NPL
closing of largest platform platform
NPL transaction in
DARP Solution Latin America
In response, IFC decided to initiate a
programmatic approach to supporting the
development of the distressed assets market
in Colombia, implementing the two-pillar
strategy. In 2007, as a first step, IFC supported FIGURE 1.4 DARP in Colombia: Timeline
the resolution of the assets held by CISA, which
remains the largest NPL transaction in Latin
America to date, and which sparked the creation Continued on next page

19
CHAPTER 1

Continued from previous page

Outcome bankrupt, causing a significant loss of jobs and a

This innovative approach provided Bancolombia negative economic impact.
with a mechanism to dispose of its NPLs on a
regular basis, ensuring the availability of capital DARP Solution
and facilitating market pricing. In addition, it To fill the financing gap in emerging markets across
allowed Bancolombia to participate in the upside the region, IFC partnered with ADM Capital, a
realized on these NPLs. To date, this platform leading credit specialist investment manager in
has acquired more than 15 consumer portfolios, Asia. Together with ADM Capital, DARP established
helping the bank offload close to $1 billion in an innovative platform of $100 million, with IFC
NPLs at face value, and allowed over 700,000 investing $50 million as a cornerstone investor.
distressed loans from approximately 400,000 This platform had a capital structure composed
debtors to be resolved. 80 percent of a senior revolving credit line and
In addition, this type of structure has been 20 percent of a junior loan tranche with income
replicated with success by many other financial participation, creating options to mobilize
institutions in other markets as an instrument to different types of investors seeking different risk/
manage their balance sheets. return profiles.

Outcome
Asia: A Successful Partnership for Special
The partnership with ADM Capital has been
Lending to Save Stressed SMEs
successful because of its development impact
Background and, more importantly, its demonstration effect.
In 2012, Asian markets were seeing an increasingly Since its establishment, this platform has invested
challenging macroeconomic environment coupled in 33 stressed SMEs and has already successfully
with the broader outflow of foreign investment restructured 16, helping them to obtain essential
from emerging markets and diminishing availability capital to meet liquidity and capital expense
of bank lending. This made it extremely difficult for needs. In addition, this partnership has shown
stressed but, importantly, viable SMEs to access that financing for stressed SMEs can be raised
traditional sources of debt financing. Without this commercially, which has attracted many other
financing, many of these SMEs would have gone investors to these markets.

How DARP Can Address Market that they will be fully compensated for the risk and
Inefficiencies uncertainty associated with the assets—and for the
initially high transaction costs in a nonexistent or
Certain impediments prevent distressed assets markets nascent market. Pricing gaps can be addressed by
from functioning efficiently and effectively. DARP has reducing information asymmetry, strengthening
the tools to address and mitigate these impediments so legal and institutional frameworks, and improving
that distressed assets markets in EMs can develop and the quality of the servicing infrastructure. DARP, in
improve over time. collaboration with the World Bank Group’s Finance,
Competitiveness & Innovation Global Practice,
Pricing Gap contributes unrivalled experience and expertise across
A key challenge in developing a market for NPLs is markets and asset classes to NPL market creation
closing the pricing gap. This is the difference between and development. Identifying and strengthening value
the price that a prospective seller of NPLs believes drivers facilitates the price discovery function while
their assets should command and what is often a reducing transaction friction within the context of
lower price that would convince prospective buyers NPL market development (see Figure 1.5).

20
 CHAPTER 1

POTENTIAL
PRICE
SELLER’S
Creating ASK PRICE
Efficient
Structures DARP’s global
Reducing expertise
Shrinking Value Gaps creates
Information markets by
Asymmetry uncovering
BUYER’S value drivers
BID PRICE that help close
potential
VALUE pricing gaps
GAPS

DARP helps DARP helps close DARP helps build

bridge information value gaps using efficient investment
asymmetry with its innovative capital structures based
unique access to structures and/or on its knowledge of
local knowledge and custom waterfall the local markets
global expertise distributions

FIGURE 1.5 Bridging the Pricing Gap

Source: IFC

Underdeveloped Capital Markets and Appropriate insolvency regimes are particularly

Inadequate Insolvency Regimes important for a nascent secondary debt market and
In addition, DARP plays a critical role in establishing have two main functions: to preserve value and
both the frameworks needed and the required to distribute value. The experience with national
infrastructure for successful distressed assets markets insolvency regimes will have an impact on the prices
in EMs, with the objective of ultimately developing the for NPL portfolios that investors are willing to pay.
local capital markets to reach the scale necessary to This aspect will, among other things, influence the
address the increasing stock of NPLs. Along these lines, number and types of potential investors attracted as
DARP starts by working with the World Bank Group’s participants when developing a secondary market
FCI GP to help establish the required initial building for loans generally, and for distressed obligations
blocks, such as adequate insolvency regimes, as well as in particular. Chapter 2 covers some of the main
robust servicing infrastructure, which in turn attract requirements for a robust regulatory framework.
leading investors to these nascent distressed assets
markets. The objective is to build a track record and Information Required for Distressed Assets
generate sufficient data over time so that capital market Investor Due Diligence
instruments collateralized by distressed assets can be Many of the considerations in offering a portfolio of
rated by credit rating agencies. This will attract and distressed loans for sale are the same as those essential
enable investment by a broader group of institutional for offering a portfolio of performing loans, but
investors such as pension funds and insurance companies some additional issues need to be addressed.4 Banks,
(Figure 1.6). As is the case in more developed distressed as distressed assets sellers, must deal with missing
assets markets such as the United States, the ultimate historical data regarding exposures, discrepancies
use of capital markets instruments will permit sufficient between loan documentation and data records, missing
capital to be mobilized to provide a permanent funding or incomplete documentation, breaks or anomalies
channel for resolving the growing stock of NPLs. in the chain of title, flawed data on loan collateral

21
CHAPTER 1

CAPITAL »» [Going forward] Develop

MARKET active secondary markets
ACTIVATION and securitizations to
expand mobilization to
INVESTOR institutional investors
MOBILIZATION
»» Develop innovative structures
»» Mobilize global investors by demonstrating
MARKET the viability of this asset class
ENABLING
»» Develop the regulatory framework
and servicing infrastructure needed
UNDEVELOPED for distressed assets resolutions
MARKET
»» Underdeveloped institutions & regulations
»» Low liquidity & access to capital

FIGURE 1.6 How DARP Can Create and Deepen Local Capital Markets
Source: IFC

and valuation methods, and frequent changes in When loans are secured by collateral, it is important
data sources. Distressed assets investors will want to check the current state and value of the collateral,
to have information regarding the nature and status hidden liabilities (for example, unpaid property taxes),
of defaults, the history of attempts to enforce the existence of liens that might cap recovery values, state
corresponding legal agreements, lender-borrower of property titles, and several others. It is important
correspondence, inter-creditor communication history, to consider the valuation of collateral in the context of
borrower financial situation, the state of the collateral current market conditions, given that the valuations
(if any), and any other information that allows them reported by sellers can be outdated.
to adequately understand the risk and forecast a The use of the legal system to pursue collections is one
monetization event. One of the biggest challenges, part of the recovery strategy used in distressed assets.
especially present in nascent distressed assets markets, Investors need to develop a good understanding of the
is the lack and quality of the information available for local foreclosure laws, especially in terms of timing and
investors to assess their risk and align financial-return costs. The transfer of all legal processes to the buyer
expectations. of distressed assets ensures that no enforcement rights
As part of the due diligence process, it is also essential to are lost. It is also critical to make sure that the seller
uncover any local restrictions on loan transferring and bank provides all relevant legal documentation for all
necessary debtor consents that, if ignored, could severely distressed assets being sold to empower the new owner
impair the collection process. Loan transfer restrictions to pursue judicial collections, as well as to enforce
can include borrower or co-lender consent requirements, available rights and remedies.
confidentiality or privacy restrictions, consumer protection Finally, and in the context of all the items discussed
law provisions, lender minimum-hold requirements, and, above, it is crucial to understand the local
if the loan has been syndicated, restrictions related to particularities of each market and jurisdiction. In short,
majority lender and/or administrative agent consent and the better the information provided by the seller, the
transference of the agency role. higher the price the buyer will be willing to offer.

22
 CHAPTER 1

BOX 1.3 DARP, Innovation Across Distressed Assets Markets—Part 2

Eastern Europe: A Landmark Transaction in resolution of more than 9,000 distressed loans
Romania that Sparked Distressed Asset Markets from about 6,000 debtors to date, and (c) a strong
in the Region demonstration effect as the largest transaction
successfully executed in the East Europe and
Background Central Asia (ECA) region to date.
The significant stock of NPLs has been an onerous
and chronic problem in Eastern Europe since the Because of the success of this transaction, NPL sales
global financial crisis battered the region. By 2015, took off in Romania, as well as in other countries of
despite increased interest of potential buyers, the the region such as Serbia, Croatia, Bulgaria, Bosnia
NPL market in the region was still characterized and Herzegovina, and Montenegro.
by a record number of failed transactions. At that
time, there was an impending risk that investors Caribbean: Creating Markets in an Untapped
would retreat from the region with the fear Region
that NPL sales would not close despite spending
Background
significant time and resources. In a region where
The high level of NPLs in the Caribbean is a legacy
banks needed to be able to offload their large
of the 2008 global financial crisis and the 2009
stocks of NPLs to continue lending operations,
collapse of CLICO, the largest privately held
the departure of investors could have derailed the
conglomerate in Trinidad and Tobago, and one
prospects for economic recovery.
of the largest privately held corporations in the
DARP Solution Caribbean. Such high NPL ratios result in weak
To show investors that NPL transactions could economic recovery—in some countries in the
be successfully closed in Eastern Europe, IFC region, they were as high as 20 percent. The
leveraged its network of distressed assets region also has inherent challenges (multiple
servicers and investors in the region to create legal and regulatory frameworks, thin servicing
a successful example. Following the failure of a infrastructure, geographical dispersion, and small
market auction, DARP strove to provide a bilateral transaction size) for market creation and capital
solution, resulting in the sale of an NPL portfolio in mobilization, as each standalone country does not
Romania that was the largest in both the country have the critical mass to attract investors. The lack
and the region since the 2008 financial crisis. of a distressed assets market constrains access
Together with Deutsche Bank and APS, DARP’s to finance and credit and intensifies the region’s
servicing partner for the region, IFC purchased vulnerability to shocks.
an approximately €1.2 billion in face value NPL
portfolio of secured micro, small, and medium DARP Solution
enterprise (MSME) loans and real estate owned Since 2010, DARP has been working closely with
assets (REOs) from Banca Comercială Română the World Bank and the International Monetary
(BCR), a large Romanian bank. The successful Fund (IMF) to establish the basic building blocks
completion of this transaction was built on IFC’s of a distressed assets market in the Caribbean.
local market knowledge and experience gained Finally, in 2018, DARP engaged Adamantine, a
through its partnership with APS. Mexican NPL investor and servicer, to launch a $150
million DARP platform to purchase NPLs in the
Outcome Caribbean. This came after several attempts across
With this landmark transaction, DARP helped the region to mobilize other investors, including
BCR efficiently offload a massive stock of NPLs to the creation of a “bad bank”5 for the Organization of
complete the bank’s restructuring, alleviate its Eastern Caribbean States. This new DARP platform
regulatory-capital needs, improve the quality of succeeded in mobilizing a private sector distressed
its assets, and unlock additional lending capacity. assets investor to deploy capital in this region for
Its significant impact included: (a) mobilization the first time. One result is that previously inactive
of almost €100 million in third-party capital, (b) sellers have been encouraged to offload NPLs. As a
Continued on next page

23
CHAPTER 1

Continued from previous page

result, a track record of successful transactions is helping normalize the obligations of about 30,000
developing that will promote an active distressed debtors, both individuals and SMEs. In addition,
assets market capable of attracting capital from 23 percent of the capital was mobilized in IDA
other investors. For example, this platform helped countries (St. Lucia, Dominica, Grenada, and
Scotiabank in the Bahamas reduce NPLs by over 90 Guyana).6
percent through NPL portfolio sales. The work of IFC’s advisory group and the
World Bank on credit bureaus and collateral
Outcome registries is one example of how harnessing the
This platform, the first of its kind in the region, combined efforts of DARP and the World Bank
has already made significant strides. To date, it can dramatically reduce financial sector fragility,
has acquired 19 portfolios in 12 countries, allowing enhance access to finance, and spur much-needed
banks to offload over $300 million of NPLs and economic growth and job creation.

DARP Milestones and Achievements partnership with Apollo Global Management, to

expand and maximize its impact across emerging
Since its inception, DARP has continually expanded
economies. In 2017, after a long collaboration with
its reach geographically, from its origin in Latin
America to the current coverage in Asia, Eastern the World Bank and the IMF, DARP established the
Europe, MENA, and Sub-Saharan Africa. Figure 1.7 first NPL platform in the Caribbean, a region in dire
presents the evolution of DARP from its earliest need of a resolution mechanism for its increasing
transactions in Latin America to its present-day status stock of NPLs. Later, in 2018, DARP played a critical
as a global catalyst for distressed assets markets. role by establishing the first platform focused on
DARP has had a significant role in the creation and resolving corporate distressed assets in India, with
development of many distressed assets markets across a significant demonstration effect regarding the
EMs by bringing innovative transaction structures implementation of a fully revamped new insolvency
and solutions to the marketplace. For example, in code. More recently, in early 2019, DARP established
2006 DARP helped facilitate the largest-to-date NPL its first regional platform in Sub-Saharan Africa,
transaction in Latin America by acquiring the entire which is an important milestone in developing the
NPL portfolio from a Colombian “bad bank,” as NPL market in the region as it provides a solution
explained in Box 1.2. This transaction kick-started the unavailable until now to many local banks.
creation of a market that evolved into one of the most
DARP’s global expansion has been facilitated by
sophisticated in the region. In 2009, DARP made its
its strong financial performance and outstanding
first equity investment in a servicer, putting in place the
foundation for what today is a unique global network developmental impact. With actual total commitments
of partners across emerging market countries. Later, to date of more than $7.3 billion, including $2.7 billion
in 2012, DARP established the first multi-seller NPL from IFC’s own account and $4.6 billion from third-
platform in Brazil that grew to become the market party investors, DARP has secured its global leadership
leader and played a pivotal role in attracting several role as a distressed assets investor in emerging markets.
entrants to the market. Since inception, DARP has acquired more than 150
By 2014, DARP had already committed $1 billion NPL portfolios, ranging from retail unsecured to
for IFC’s own account and mobilized more than corporate secured NPLs, as well as mortgages and
$2 billion from third-party investors. In 2016, commercial real estate-backed NPLs. Some of these
DARP established the first global NPL platform, in achievements are summarized in Figure 1.8.

24
 CHAPTER 1

IFC First servicer Support Expansion $1 billion Launch of First DARP Expansion
launches equity NPL crisis to Asia investment $1 billion Caribbean platforms to Africa
DARP investment in Europe milestone DARP global DARP reach
platform platform $5 billion

2007 2009 2010 2012 2014 2016 2017 2018 2019

Landmark 10 years
closing of First bank- First investing
largest NPL dedicated multiseller globally in
transaction in platform in NPL platform emerging
Latin America Colombia in Brazil markets

$7.3B SINCE INCEPTION, GLOBAL PLATFORM, 10+ YEARS RUNNING

FIGURE 1.7 DARP Key Milestones, 2007–19

Source: IFC

# Portfolios Acquired UPB # Borrowers Mobilized Capital

150+ $30+ Billion 18+ Million $4.6 Billion

»» Acquisitions of NPL »» NPLs offloaded from »» Individuals and SMEs »» Mobilized from third
portfolios across multiple lenders, able to avoid losing party investors,
asset classes in increasing liquidity their assets and remain deepening secondary
Latin America, Eastern and origination of active in the financial markets with improved
Europe and Asia new loans system liquidity

FIGURE 1.8 Selected DARP Results

Source: IFC

25
CHAPTER 1

DARP Going Forward Securitization and Secondary Markets

DARP has made significant contributions to distressed In markets where DARP has played a role establishing
assets and capital markets development during its an NPL track record, the priority will be to continue
brief existence. Yet much remains to be done. Three supporting the creation of a secondary market for
areas that warrant concerted effort in the future are: distressed assets. This could be addressed through
(a) expanding DARP’s reach in underserved regions securitization transactions involving pools of NPLs,
such as SSA and MENA, (b) providing further market either from credit originators (such as banks, other
development by supporting the creation of a secondary financial institutions, retailers, and public utilities) or
market for distressed assets that will accommodate from other investors such as those that have previously
inter alia the securitization of pools of loans and acquired NPL portfolios, a portion of which they
other distressed assets (including real estate and may be prepared to sell. Through securitization, the
other physical assets used as loan collateral), and (c) liquidity available for the asset class will increase,
leveraging potential synergies with Fintech initiatives. which in turn should stimulate additional interest
from new and existing investors. The need for an
Expansion in Sub-Saharan Africa and the active secondary market is key to maintaining an
Middle East and North Africa Regions active investor base to ensure a consistent demand for
After starting in the Latin American region where distressed assets.
it established a strong presence and then extended
activities to Eastern Europe and Asia, DARP is Fintech
now focusing on the untapped market potential of As distressed assets markets develop within emerging
undeveloped distressed assets markets across SSA and
markets countries, servicers are increasingly
MENA. These two regions have many countries that
adopting tools enabled by recent technologies that
could materially benefit from a dynamic distressed
were unavailable just a few years ago. By applying
assets market, provided that the requisite groundwork
digital engagement and artificial intelligence, they
is laid. Priorities in these markets are: (a) collaborating
are making vital strides to improve performance.
with the World Bank to develop sound legal and
Despite the growing awareness of this potential, this
regulatory frameworks, (b) establishing a solid debt-
area has just begun to be developed and substantial
service infrastructure, and (c) mobilizing dedicated
efficiency improvements have yet to be realized. Digital
capital. In SSA, after having successfully established its
engagement provides servicers with additional channels
first regional platform, DARP is focusing its efforts on
effectively helping banks offload their NPLs, as well as to connect with debtors and clients, allowing them to
expanding its reach into other less-developed markets tailor their resolution and recovery strategies to clients’
in the region. DARP has also explored possibilities specific needs. Artificial intelligence affords servicers
in Nigeria—the largest economy in Africa—and the opportunity to leverage existing data to materially
will continue this effort to address the needs of the improve their pricing models and enhance collections.
region. In MENA, DARP has established the first NPL Furthermore, many fintech companies are generating
resolution platform of its kind, which initially focuses loan portfolios which, in part, as they mature, will
on Pakistan, Egypt, Lebanon, and Morocco. This has result in NPLs. DARP will seek to work with these
been a joint World Bank-IFC effort, which ensures fintechs to help them manage their balance sheets, as it
that the insolvency regime and servicing capacity are does with other credit originators. To this end, DARP
in place to attract investors interested in investing in has begun to work with IFC’s Fintech team to sharpen
distressed assets. its strategic approach in this area. n

26
CHAPTER 2
The Legal Framework Behind a
Distressed Assets Market: Insolvency,
Enforcement, and Workouts
By Andrés F. Martínez

Over the past decade, we have seen a large and assets investments.9 This is partly because the expected,
dynamic market for distressed assets develop that and eventually realized, returns of this asset class
represents a relatively small but important sector are a combination of the investor’s ability to unlock
within the investment community. Investors can the intrinsic value of the asset, the risk premium for
purchase these assets at a significant discount because holding the asset, and the liquidity premium—given
of their inherent risks, which creates the potential for that distressed assets are generally relatively illiquid
attractive returns. Given the countercyclical nature investments. The risk premium is, in turn, composed
of this market, in which opportunities appear as an of various market factors (such as valuation risk).
economy slows, the most fruitful period for investors is However, one of the most prominent factors is the
typically during or following a financial crisis.7 legal regime upon which the monetization of the asset
relies. Although distressed assets markets are becoming
Generally speaking, there are two prevalent strategies
increasingly global, local laws and regulations—and
among investors engaged in the distressed assets
their practical application—can have a significant
market.8 The first is to purchase these assets with
impact on investor returns.10 Laws and regulations
the goal of accumulating a significant position in
that favor smooth transactions and loan transfers
a company that is either insolvent or on the verge
allow investors to enforce their claims and collateral
of insolvency. The second involves the trading of
efficiently and provide mechanisms for both out-of-
distressed debt. Transactions in this market may
court restructuring and efficient in-court insolvency
involve the purchase of distressed debt securities
processes that are crucial to attracting investors in any
and/or NPLs, which may be sold or securitized into
given distressed assets market.
instruments composed of multiple retail and/or
corporate loans. This debt is purchased at a discount
to face value under the assumption that the face The Legal Framework Behind a
value is overvalued relative to its fundamentals. The Distressed Assets Market
discount that the investor will apply will depend on the Investments in distressed assets are primarily attractive
investor’s return expectations and expected ability to for their substantial return potential, which is derived
enhance the debt’s value through negotiations in the from the risk undertaken by the investor. However, there
resolution process, either through the enforcement of is a tipping point when even a highly discounted offer
the debt or by profiting from the piecemeal liquidation price comes with too much risk and uncertainty. At this
of non-core assets. In either of these strategies, the legal point, even the most aggressive, risk-bearing investors
and institutional aspects play a key role. will withhold investment in the asset because of the level
Effective legal and institutional regimes help maintain a of risk. This is where the legal and institutional factors
risk level that is acceptable for distressed assets markets related to insolvency and financial distress come into play.
to develop. The insolvency regime, the enforcement The legal challenges that an investor may encounter are
system, and the environment to achieve out-of-court many. Examples of threats to the smooth functioning
workouts are essential when looking at distressed of distressed assets markets include:

28
 CHAPTER 2

• Regulatory challenges related to NPL portfolio Debt Enforcement

purchases (for example, requirements of a financial
Legal systems should enable debtors to borrow against
entity or unfavorable tax treatment)
their assets and ensure that creditors can successfully
• Requirement of the ultimate debtor’s consent to enforce against those assets in case of default. This is
transfer purchased assets not only essential for a credit market, but also for the
• Difficulties in enforcing the debtor’s assets in an development of the secondary debt market. Distressed
extra-judicial or judicial process (either because assets markets are unlikely to thrive in a jurisdiction
of weak laws or because of poor enforcement) with a poorly designed enforcement system that hinders
and procedural barriers in transferring ongoing orderly and efficient debt resolution. Such a system
enforcement actions to purchasers of the claims would diminish any realistic prospect of capitalizing
on the asset. Having effective debt enforcement
• Poor collateral legislation and/or malfunctioning
mechanisms requires that all elements of the framework
registries
(legal, tax, regulatory) are mutually reinforcing and
• Difficulties in restructuring a company due to work in sync to arrive at a timely, efficient, and cost-
impediments in the insolvency system or in tax effective resolution. Moreover, it relies on a strong
legislation institutional infrastructure with an independent and
• Difficulties in restructuring a company due to competent judiciary that applies the law in a fair,
the lack of capacity of key local players such as transparent, predictable, and consistent manner.
insolvency practitioners or judges In most legal systems there are several avenues for
• Challenging consequences in cases of liquidation, enforcement that creditors can pursue depending on
which frequently occur due to unclear repayment the situation. Two stand out: (a) enforcement outside of
priorities—for example, privileged creditors (such court—if the original contract or a written agreement
as government tax and employee wage claims) may allows, provided there is a statutory provision
have priority over other creditors permitting this type of enforcement; or (b) enforcement
through judicial proceedings or some sort of
• An environment unconducive to workouts
compulsory enforcement services (that is, administrative
• Central bank (or supervisory) regulations that tribunals or notaries). Enforcement is most effective
discourage distressed asset sales when parties can agree on the rights and remedies
The roots of the distressed assets market can be traced upon default through out-of-court enforcement. This
back to changes in legal and institutional frameworks expedites the enforcement process and preserves the
surrounding insolvency. Although investing in value of the asset. Importantly, regulators should seek
distressed assets goes back centuries, only after to remove impediments, such as having foreclosures
reorganization procedures were introduced worldwide that rely heavily on cumbersome judicial procedures,
(as opposed to the concept of insolvency processes complex procedural requirements for auctions, or
equaling liquidation) did the distressed assets market deep-rooted cultural traditions that hinder the adoption
really take off. Some commentators have identified the of purely out-of-court enforcement mechanisms.
passage of Chapter 11 of the United States Bankruptcy According to the World Bank Principles for Effective
Code in 1978 as being a key trigger.11 It is essential Insolvency and Creditor/Debtor Regimes, “A modern,
that insolvency systems encourage reorganization so credit-based economy requires predictable, transparent
that financially distressed but viable companies can and affordable enforcement of both unsecured and
continue to operate, while at the same time aiming to secured credit claims by efficient mechanisms outside of
maximize returns for creditors. insolvency, as well as a sound insolvency system. These
Some of the key issues that relate to the importance of systems must be designed to work in harmony.”12
the legal system for the development of the distressed Beyond the legal aspects, there are multiple
assets markets are listed below. institutional aspects that also play a significant role.

29
CHAPTER 2

In countries where bailiffs oversee enforcement, combine the advantages of both formal and informal
it is paramount that they are adequately trained, procedures and are an efficient alternative or a useful
supervised, and remunerated. In countries where complement to purely formal insolvency proceedings.14
the bailiffs are to be paid in advance, it is essential OCWs thrive outside of the judicial system but rely
that there are carrots and sticks in place (via the on an effective insolvency and creditor rights system
introduction of adequate incentives) to compel them to to provide the backdrop against which any workout
perform their job competently and fairly. can be achieved. Effective enforcement and insolvency
systems can provide indirect incentives or persuasive
Out-of-Court Workouts force to achieve reorganization.15 Under the right
Out-of-court workouts are non-judicial processes that conditions, OCWs allow for a quicker resolution of
allow debtors and creditors to negotiate restructuring distressed assets, leading to reduced costs and better
arrangements outside of formal insolvency recovery rates for creditors. From a policy standpoint,
proceedings.13 OCWs may be purely contractual or OCWs help avoid overburdening the judicial system,
may involve some degree of judicial intervention. which is particularly important during financial
The latter, often referred to as “hybrid” procedures, crises, when corporate distress and NPLs are high.

BOX 2.1 The London Approach

The London Approach, developed by the Bank Under the London Approach most of the form,
of England, has influenced the evolution of structure, and industry practice of OCWs was
government-sponsored OCWs.16 The objectives developed by private sector participants themselves
of the London Approach are to minimize losses (with the role of the U.K. Central Bank/regulator
through coordinated negotiations and avoid the being limited to encouragement and facilitation
unnecessary liquidation of viable companies.17 rather than creating a formal legal framework).
The approach provides informal guidelines that
While the London Approach was considered
enable a collective process to restructure18 and
successful in the specific context of the United
has been used as a basis for countries to develop
their own formal and informal guidelines that Kingdom, one of its shortcomings is that its
encourage OCWs. Since its conception in the 1970s, guidelines are purely voluntary and that banks
this approach has been complemented by other decide whether to participate on a case-by-case
instruments that guide OCWs, including INSOL basis. In some countries, where similar non-binding
International’s Statement of Principles for a Global guidelines were put in place by the regulator, banks
Approach to Multi-Creditor Workouts II, the World disregarded them and continued to act in their own
Bank’s A Toolkit for Out-of-Court Workouts, as well as self-interest. Given these shortcomings, regulators
selected sections of the World Bank’s Principles for in other countries have turned to legally “enhanced”
Effective Insolvency and Creditor/Debtors Rights System, forms of the London Approach to resolve the
and the UNCITRAL Legislative Guide on Insolvency Law. problem of “holdouts” (dissenting minority financial
More detailed guidelines on OCWs have been creditors). These approaches relied on either a legal
introduced in various forms in countries including basis or inter-banking framework agreements with
Indonesia, South Korea, India, and Turkey. They legal effect that are likely to help overcome issues
establish principles for debtors and creditors to related to banks failing to cooperate with one
follow through the restructuring process. The another or “holding out.” Encouraging and setting
result is a more formalized approach than the up an approach of this nature can thus increase the
London Approach, one that relies on regulatory likelihood that companies will restructure debt and
forbearance, the provision of central bank liquidity, the quality of the agreed restructuring. Regardless
and the regulator’s power of “moral suasion” to of the technical differences among well-functioning
encourage OCWs on the part of banks in accordance OCWs, investors require an effective in-court
with a loose set of unwritten and/or informal rules. insolvency system should OCW mechanisms fail.

30
 CHAPTER 2

This less-formal option for restructuring encourages secured creditors, majorities and cramdown for plan
debtor-creditor cooperation and contributes to the voting, and effective treatment of executory contracts).
development of a rescue culture, which provides If successful, reorganization allows investors to realize
greater opportunities for all stakeholders involved to higher returns through either the continued operation
benefit from an optimal outcome. of a reorganized and more valuable asset, or through its
Giving investors the opportunity to reach agreements sale (including the sale of restructured debt obligations,
to resolve or restructure their assets outside of formal newly-issued securities and/or sale of its currently-
insolvency proceedings is the linchpin of a distressed held securities). The advantages of the reorganization
assets market. An essential objective for policymakers process must be balanced with the advantages of
is thus to create a framework that facilitates out-of- near-term debt collection through liquidation. 21 The
court restructurings that are timely, fair, and reliable.19 possibility of reorganization as an alternative to
Such a system requires legislative and regulatory liquidation should be provided to investors in situations
frameworks that are comprised of measures conducive where the value to be derived through reorganization
to workouts. is greater than what they would receive through
liquidation (the “no creditor worse off” rule).
The imposition of a stay can prevent the premature
An Effective Insolvency and
dismemberment of a debtor’s assets. The application
Creditor/Debtor Regime of this stay facilitates the continued value-generating
An effective insolvency regime lays down the function of these assets and provides breathing room
foundation for building a viable distressed assets so that interested parties can evaluate the situation
market. It provides a robust framework and a time- and develop a plan of action. Moreover, the system
bound roadmap that allows investors to deal with should have a defined mechanism in place that permits
their distressed assets. The recognized best practices the injection of capital to the distressed company to
described below are intended to help regulators ensure its continued viability, even after the insolvency
to establish an effective and efficient insolvency proceedings have begun (DIP financing). For this to
framework that will facilitate distressed assets be possible, significant protection should be given to
markets. These have been derived from the Insolvency the lender or investor that provides the capital. The
and Creditor Rights (ICR) Standard, developed system can provide certainty by respecting the pre-
by the World Bank in conjunction with the United existing security rights and priorities of creditors, while
Nations Commission on International Trade Law granting priority for fresh money injected into the
(UNCITRAL). 20 distressed company. Similarly, achieving the objectives
An insolvency system should promote the use of of maximizing the value of the asset and allowing
reorganization to maximize the value of the underlying the asset to survive may also imply allowing for the
assets. Reorganization provides investors with a greater interference in the performance of contracts. This may
variety of tools to maximize the value of the non- involve allowing an insolvency representative to take
performing assets and thus achieve better outcomes. advantage of beneficial contracts that contribute value
The value is derived from the ability to keep the to the estate and reject those that are burdensome
essential components, both tangible and intangible, (except in situations where performance or rejection of
of an asset together rather than disposing of it in the contract is contrary to public policy).
fragments. Since bankruptcy law was traditionally The system should also include provisions that
designed with a “punishing” spirit towards the debtor, allow the insolvency representative to avoid certain
many outdated laws still do not fully envisage an transactions retroactively from a specific date (look-
appropriate path for reorganization, with the most back period or “suspect” period) so that unfavorable
salient features (for example, commencement of or fraudulent transactions can be overturned. This
insolvency process, automatic stay, debtor-in-possession protects investors by preserving the integrity of the
(DIP) financing, relief and adequate protection for insolvency estate and ensuring that the collective effort

31
CHAPTER 2

results in a fair allocation of the proceeds from the means that the investor recuperates only a fraction of
distressed asset. Creditor committees must be formed the investment. The recovery value from the piecemeal
to represent the interest of the creditors. The priority liquidation is, in the great majority of cases, lower
of claims using a predictable and established process than it would have been under a going-concern sale.
must be respected with equitable treatment of similarly Similarly, the more extended the insolvency period
situated creditors. drags on, the lower the potential recoveries. A look
The insolvency framework should provide for efficient at the average recovery rate in over 190 countries,
conversion between the different types of proceedings, based on time and outcome, shows that while going-
where appropriate, so that if reorganization fails, concern sales yield higher recoveries than liquidations,
an efficient and effective liquidation will ensure that both yield lower recoveries over time and, eventually,
investors are able to recover some value. Some critical liquidations become the only option (Figure 2.1). 23
elements of an effective reorganization scheme include
providing a structure that encourages fair negotiation
The Importance of Cross-Border
of a commercial plan and a platform where the plan
can be voted on and approved if accepted by an
Insolvency
appropriate majority of creditors. 22 Lastly, in today’s globalized economy, special attention
An effective distressed assets market requires an should be given to cross-border dimensions. There
insolvency system that is predictable, timely, impartial, are notable differences in the insolvency regimes of
efficient, and cost-effective to maximize the potential individual countries, which may significantly impact a
returns to investors, increase liquidity, and promote transaction. Knowledge of what laws and procedures
investment. Delays in insolvency proceedings impact apply is particularly important when the distressed
the recovery potential of distressed assets, as costs situation has a multinational dimension. Investments
escalate and outcomes are limited. The longer a in distressed assets abroad require investors to perform
business is in distress, the more the asset value declines. due diligence on the legal regime and, if necessary,
This is because capital flees, business ties break, and price the heightened risk presented from a lack of
brand equity deteriorates. This loss of value eventually effective legal, regulatory, and institutional frameworks.
results in a situation where piecemeal liquidation of Fortunately, some instruments have been developed
the asset becomes the only option, which in most cases in the field of cross-border insolvency that provide

100

78
80
(cents on the dollar)
Recovery Rate

60
46
38
40 31
28
16
20

0
Piecemeal Going Piecemeal Going Piecemeal Going
Concern Concern Concern
0–2 YEARS 2–4 YEARS 4–6 YEARS

FIGURE 2.1 Recovery Rate Based on Time to Resolve Insolvency and Outcome
Source: Doing Business 2019.

32
 CHAPTER 2

more predictability to investors and assist regulators

in developing frameworks to address cross-border
BOX 2.2 Regulatory and Tax
dimensions. This includes the UNCITRAL Model Law
Impediments
on Cross-Border Insolvency, and European Union (EU)
Regulation 2015/848 on insolvency proceedings.24 Tax impediments may act as barriers to the
These laws and regulations focus on encouraging efficient transfer and resolution of distressed
assets. As a result, policymakers should seek
cooperation and coordination among jurisdictions to
to tailor their tax measures to promote the
ensure a more efficient and certain process, rather than effective resolution of distressed assets.
attempting to unify the substantive law of different Although tax regimes vary by jurisdiction,
countries. Legislation based on the UNCITRAL Model there are two key impediments which are
Law on Cross-Border Insolvency, for example, has been common to many countries around the
adopted by 44 countries.25 It assists in identifying the world. First is the ability of banks to take
tax deductions for write-offs and provisions
laws and procedures that will apply to the transaction
on loans, and the ease with which those
(through the center of main interest principle) and deductions can be taken. 27 The second relates
helps to determine which person or entity has the legal to the ability of banks to utilize losses from
authority to sell the debtor’s assets. As states continue provisions and write-offs and offset them
to adopt legislation based on these instruments, it is against future taxable income. 28 Change of
expected that distressed assets markets will continue to ownership restrictions and time limits on a
bank’s ability to carry these losses forward
develop by providing greater certainty surrounding the
will impact the transfer of NPLs from banks to
insolvency process in today’s globalized environment. other entities. Regulators should thus consider
Beyond procedural coordination, there are also making their tax regimes more favorable to
some early attempts to unify substantive insolvency investments in distressed assets by removing
these impediments. Other tax impediments
legislation around the world. The latest attempt to
to consider include other transfer taxes (such
homogenize certain insolvency aspects comes from as stamp duty and real estate taxes) and the
the “Directive of the European Parliament and of withholding of tax on interest. 29 Another
the Council on preventive restructuring frameworks, critical tax issue is the income tax that the
on discharge of debt and disqualifications, and on debtors must pay in the case of debt reductions
measures to increase the efficiency of procedures (haircuts). Often, the income tax in these cases
is asymmetrical when looking at the insolvency
concerning restructuring, insolvency and discharge
system and the out-of-court restructuring
of debt, and amending Directive (EU) 2017/1132” framework. This may encourage more “judicial
(Directive on Restructuring and Insolvency). This reorganizations” while discouraging OCWs
Directive, once implemented by the member states, will (when tax income applies if restructuring is out
have a direct impact on the market for distressed assets of court, vis-a-vis an in-court exemption).
(for example, the mandatory three-year discharge will
directly impact retail loan distressed operations). n

33
CHAPTER 3
Public Asset Management Companies
By Caroline Cerruti

Introduction provisioning, and valuation) are equally critical to

by Eric D. Cruikshank develop a distressed assets market.
In the World Bank policy brief30 that constitutes The recent examples in Europe show how public and
the core of this chapter, we take an in-depth look at private asset management initiatives can strengthen each
situations where national authorities are faced with other with a conducive enabling environment. These
systemic financial distress and how the use of public public AMCs were established at a time when their
asset management companies, or AMCs, can be an distressed assets markets were not developed enough to
effective tool to help address financial crises and resolve cope with the large stock of NPLs. The establishment
the attendant elevated level of NPLs, especially when of these AMCs, in combination with a number of
they complement private sector solutions. An AMC is
regulatory measures taken, resulted in the creation of
an entity established to acquire distressed assets from
fertile ground for private distressed managers to enter
financial institutions with excessive levels of NPLs,
these markets. These regulatory measures included,
particularly banks, with the objective of managing and
among others, the supervisory responsibility assumed by
enhancing recoveries from these assets.
the European Central Bank to (a) increase transparency
Properly designed, the launch of one or more AMCs and uniformity around asset valuation and banks’
in a market can promote a healthy symbiosis between financials, (b) strengthen prudential regulations, and (c)
public sector and private sector initiatives dedicated reform the insolvency procedures in several countries.
to asset resolution during a financial crisis. Successful AMCs by themselves are not always the answer, and
examples of AMCs, such as the Resolution Trust in countries where preconditions for an AMC were not
Corporation (RTC) in the United States during the met (such as Greece), a strong supervisory approach to
Savings and Loans crisis of the 1980s, Sweden’s reduce NPLs is starting to attract private players.
experience of the 1990s with its “bad bank,” Securum,
or, more recently, the National Asset Management Therefore, to ensure a public AMC can also enable—
Agency (NAMA) established in Ireland in 2008, or and not hamper—private sector solutions, the
Sociedad de Gestión de Activos Procedentes de la following questions should be considered:
Reestructuración Bancaria (SAREB) in Spain in 2012, • If public AMCs are confined to countries and
are testimonials in support of this assertion. Scrutiny is situations characterized by financial crisis, what is
warranted, however, as to how an AMC can potentially the appropriate metric for suitably determining a
affect either ongoing or intended private sector “go/no-go” decision?
initiatives, including those supported by DARP. Simply
• If private sector solutions are already playing a role
requiring that an AMC should run on commercial
in resolving distressed assets, is there a risk that
principles may not be enough to address this issue.
the creation of a public AMC produces unintended
Even with the best of intentions to value and transfer
consequences?31
assets at market prices, there is unavoidably a “public-
good” element involved with establishing and operating • Are there ways to safeguard the potential symbiosis
an AMC that has the potential to distort the market between AMCs and private sector initiatives,
and its price levels. Therefore, governance of the AMC especially where the latter already have ongoing
and enabling environment (such as robust prudential operations (other than merely relegating their activities
standards on credit underwriting, risk management, exclusively to a role of buying AMC portfolios)?

34
 CHAPTER 3

In addition to the examples mentioned above, over financial system and should be complemented by
the years several emerging economies have established a comprehensive set of reforms to strengthen bank
public AMCs, including China, Indonesia, Malaysia, resolution and supervision, enhance creditor rights and
Nigeria, Turkey, and Vietnam. Currently, other debt enforcement, and facilitate corporate insolvency
countries, such as Bangladesh and India, are also and restructuring.
considering setting up their own public AMCs. As they
do so, the questions above should be considered.
What is an AMC?
An AMC is a corporate entity established to manage
Public Asset Management and enhance the recoveries of distressed assets removed
Companies: International from the banking system. It can be established either
Experience as an entity tasked with resolving failed financial
This chapter looks at the experiences of public AMCs institutions and liquidating their assets (RTC in the
as a tool to help address financial crises and solve the United States, Securum in Sweden, the Savings Deposit
accompanying high level of non-performing loans. Insurance Fund [SDIF] in Turkey), or as an entity that
AMCs have a mixed track record. They can lessen purchases assets from open banks (KAMCO in Korea,
the cost of a crisis by managing assets whose value and recent EU cases in Ireland, Spain, and Slovenia).
has temporarily declined. However, improper design, In the first case, the AMC does not select and purchase
political interference, and poor management can erode the distressed assets. Instead, under the banking law, it
any benefits, which increases the burden on taxpayers. is appointed to restructure or liquidate insolvent banks,
The decision to create an AMC should not be taken in whole or in part (usually after the protected deposits
lightly. Experience has shown that successful AMCs are have been transferred). Thus, no financial transaction
subject to meeting certain preconditions, designed with or purchase takes place, and the AMC’s assets are
a commercial focus, and require adequate funding, remarkably diverse in size and type. In the second case,
strong governance, and a high level of transparency. the AMC purchases assets that meet certain criteria as
Public AMCs alone cannot solve all NPLs in a broadly defined by legislation and/or more specifically

Bank resolution AMC Asset purchasing AMC

Government guaranteed bond issued by AMC

to pay for the assets. Provides relief to banks
Assets transferred Open by improving asset quality and providing
Failed Resolution/ for management,
banks with regular revenue stream
banks closure no payment, no need
NPLs
for transfer price

Government AMC Government

injects Sale of selected
equity for AMC Government assets at a discount,
AMC working based on agreed
capital transfer prices
Government injects equity
for working capital but
is liable for the bonds if
AMC does not perform

FIGURE 3.1 Two Types of Public AMCs

Source: Cerruti and Neyens, 4. Note: The asset-purchasing AMC reflects the KAMCO, Danaharta, and EU-model. In the 1990s these
AMCs did not issue bonds to the banks; instead the government issued these bonds, as in the case of Eastern European countries and the
Indonesian Bank Restructuring Agency (IBRA). In Ireland and Spain AMCs were created as public-private entities to avoid consolidation in
the public accounts.

35
CHAPTER 3

by the AMC itself from banks that are still operating. as collateral for borrowings from the central bank
Usually the AMC issues a government-guaranteed (as is the case of all AMCs in the EU).
bond to pay for the purchase. In both cases, the value • A centralized AMC manages assets more efficiently.
of the assets must be established by a prior assessment
By gathering a large volume of homogeneous
or valuation of the assets by the supervisor, or by
distressed assets, the AMC can package them for
the AMC through a transparent, market-based due
sale to outside specialist investors. It has enhanced
diligence process conducted by an independent third
bargaining power with both purchasers and
party experienced in valuation. Figure 3.1 illustrates
borrowers, especially when all debtor connections
the two types of AMCs.
are transferred (case of NAMA). This reduces the
fixed cost of asset resolution.
Possible Benefits and Drawbacks of • It may enable banks to refocus on financial
a Public AMC intermediation. When NPLs reach systemic
A public AMC, complemented by comprehensive bank proportions, banks stop originating credit. By
resolution and restructuring tools, may provide various carving out the largest and most complex exposures,
benefits: the AMC allows banks to refocus on financial
• It forces banks to recognize losses and may restore intermediation, as long as their credit underwriting
confidence in the financial system by making bank practices are significantly strengthened (to prevent
recapitalization needs transparent. In Ireland, more bad loans from being originated).
this was the primary reason for the establishment However, if not designed and managed properly,
of NAMA. The banking crisis was fueled by a a public AMC may generate significant losses for
property boom. Neither banks nor developers had taxpayers and undermine credit discipline:
the ability to work out the distressed exposures.
• Undue political interference may undermine the
In late 2008, the government announced a blanket
AMC. This may happen when the AMC’s purchases
guarantee of all Irish banks’ liabilities, then
are politically and not commercially driven and
amounting to €440 billion, or twice the country’s
are designed to provide relief to well-connected
annual gross domestic product (GDP). But this
companies. Robust governance and specific
blanket guarantee was ineffective at decisively
protection against political interference in the
addressing capital needs. Applicable accounting
underlying law may prevent this.
rules did not require banks to make forward-
looking provisions, and as a result, banks unveiled • The AMC may engage in “mission creep.” For
losses slowly, only when they were effectively instance, the law of the Asset Management
incurred. The lack of a clear exit strategy and the Corporation of Nigeria (AMCON) allows the
uncertainty on bank recapitalization needs weighed purchase of performing loans in strategic sectors,
heavily on the creditworthiness of the government, but it is not clear how this purchase helped restore
which was expected to recapitalize the banks. financial stability. Mission creep can be addressed
NAMA was thus created to cap the government’s by a narrow mandate in the enabling law and a
exposure by crystallizing losses on the banks’ strict definition of eligible assets.
balance sheets, thereby making recapitalization • The AMC may weaken credit discipline with
needs transparent. successive asset purchases at inflated prices. Banks
• It improves the asset quality, income, and liquidity may hold on to their assets expecting a better deal
of the banks transferring assets. The use of cash or a from the AMC at the next purchase. During the
coupon-paying, government-guaranteed security to Asian crisis, borrowers who were in a position to
purchase non-earning assets improves asset quality meet their obligations would default (“strategic
and provides income to open banks. Also, these defaulters”) in hopes of being transferred to the
securities may provide liquidity if they can be used AMC where they could repurchase their obligations

36
 CHAPTER 3

at a deeply discounted price. Inflated asset purchases stripping, thereby increasing the losses). Political will
may end up building contingent liabilities for the should extend to a comprehensive package of reforms
government that funds the AMC. A thorough to address existing weaknesses in bank regulation and
valuation process to determine the transfer price supervision and creditor rights, as well as the resolution
and a one-time purchase can mitigate this risk. The of impaired assets.
Malaysian AMC (Danaharta), NAMA in Ireland, The second precondition is a systemic crisis and public
and SAREB in Spain had one-time asset purchases. funds at risk. A high level of NPLs is not in and of itself
• Failure to dispose of assets in a timely manner, a sufficient condition to establish a public AMC. If
or “warehousing.” There is an inherent trade-off banks are well capitalized but plagued with high NPLs,
between warehousing and rapid disposition or they should be required to provide higher provisions,
“fire sales.” An AMC is created because assets are set up dedicated workout units, and draw on external
deemed to have lost value temporarily and that this expertise to solve their own problems. To limit the
“impairment” will be recovered as markets improve. ultimate cost to the taxpayers of resolving financial
Successful AMCs, however, recognize that for this sector failure, the use of a public AMC should only
to happen the loans need to be repaired during be considered when financial system weaknesses are
this holding period either through restructuring in systemic.
line with the borrower’s capacity to repay and the
A third precondition is a solid diagnostic of the
viability of the business, or the institution of legal
banking system and a critical mass of homogeneous
proceedings for debt enforcement or liquidation.
impaired assets. The diagnostic is necessary to
The more passive approach of just waiting for
determine the mandate of the AMC, either as a bank
market recovery leads to further deterioration
resolution entity if many institutions need to exit, or
in the assets and overall lower recovery rates. A
as an asset-purchasing entity in case most of them
good practice consists of fixing a sunset clause
can continue operating. The diagnostic will identify
in the AMC legislation in line with the nature
whether there is a critical mass of homogeneous NPLs
of the assets (seven years for Danaharta, largely
that can lend themselves to recovery and the quality
commercial exposures; 15 years for SAREB—real
of the security attached to these NPLs. The recovery
estate exposures) and requiring the AMC in its
process is costly and best implemented on large
strategic plan and operations manual to develop
and complex loans. To attract professional buyers,
specific timebound strategies for the disposal of each
assets have to be bundled according to common
category of assets it holds.32
characteristics (for example, hotels or commercial
offices). Thus, the ideal targets for AMCs are large
Preconditions and Specific Design and complex NPLs that can gain in value through the
Features Required application of specialized expertise and share similar
characteristics (real estate backed loans or large
Preconditions in the Enabling Environment industrial loans). For instance, Danaharta removed
The first precondition is the political will to recognize about 70 percent of the banking sector’s NPLs with
losses and undertake comprehensive reforms. only 3,000 loans. The SAREB acquired about 40
Governments, particularly those in weak fiscal percent in value of the REOs held by banks.
condition, may be unwilling or unable to recognize A fourth precondition is a tradition of institutional
credit losses that have already occurred but have independence. An AMC is created within a local
not been recognized due to weak regulation and institutional framework and culture. As its business
supervision. However, the longer it takes to recognize is prone to interference, since it often must collect
the problem, the larger the losses (Czech Republic from politically connected parties, it should enjoy
and Slovakia in the 1990s delayed the recognition strong protection from any third-party influence (the
of NPLs, which opened room for substantial asset law of NAMA provides for such protection). One

37
CHAPTER 3

way to protect an AMC is to require transparency of mandate to emphasize the need to recover assets
and accountability for its performance in its enabling quickly to avoid fire sales, but prevents warehousing
law. Countries that have a challenging governance of NPLs and protects the AMC against any political
environment and weak rule of law are not good interference.33 The AMC should employ professional
candidates for a public AMC. distressed assets management34 and be required
to adhere to good governance practices, robust
A final precondition is a robust legal framework
transparency, and strong internal controls. Strategic and
for bank resolution, debt recovery, and creditors’
operating plans should be aligned with its mandate as
rights. Many countries that created AMCs launched
well as the internal and external environment in which
comprehensive reforms of their bank resolution
it operates. The AMC should also be provided with
framework, insolvency, foreclosure laws, and out-of-
adequate and timely funding in line with its mandate.
court restructuring process for firms (for example,
To ensure public support and oversight, the AMC
Korea, Ireland, Spain, Indonesia, and Turkey). A
should be subject to frequent reporting such as public
corporate restructuring process is particularly needed
quarterly reports, bi-monthly reports to legislature,
when the assets are loans to large distressed corporates.
periodic progress evaluations conducted by an external
These reforms not only support the work of the AMC
auditor, and public annual audited reports.35
but are also critical for banks to manage the NPLs left
on their balance sheets. Robust corporate governance practices support a
commercial focus. Legal provisions on the composition,
Latvia and Greece show the need to find different
term, appointment, and removal of the board and
solutions when preconditions are not met. In Latvia,
key management staff should be clearly spelled out
NPLs reached 18 percent of total loans by the end
in the founding act. Fit and proper criteria, relevant
2010—and 90 percent of residents had loans in experience, and declarations of interest should be
foreign currency. But public funds were not at risk: required of board members and key management. The
60 percent of banking sector assets were held by large law should also spell out the responsibilities of the
Scandinavian banks that could be recapitalized by their board as well as the establishment of key committees
parent. Banks created specific distressed assets units such as the audit committee. The Indonesian Bank
funded by their parents and took early provisions. In Restructuring Agency (IBRA) case shows the difficulty
Greece, NPLs reached 45 percent of total loans in the of enforcing good governance when the law is silent.
third quarter of 2016. Arrears are scattered across Multiple practices have been developed to strengthen
all types of borrowers (that is, non-homogeneous) good governance. These have included the appointment
with the highest concentration in SMEs and small of international experts on the board (as was done
businesses/professionals for which a public AMC has for Danaharta, NAMA, and IBRA to correct initial
no competitive advantage. However, as few of the deficiencies), or as advisers to the board; the adoption
preconditions for a successful AMC exist, alternative and publication of key performance indicators
solutions to a single, national, multi-asset-classes AMC (KPIs) to measure the success of the AMC (such as
are being explored. These consist of strengthening the in Danaharta); and internal staff rules requiring that
insolvency and debt-enforcement frameworks including all communications that attempt to influence staff be
out-of-court solutions, setting bank specific supervisory reported to the board (in the case of SAREB). AMCs
targets for NPL reduction, and strengthening credit may also benefit from periodic progress evaluations
underwriting practices as well as bank governance to conducted by third parties.
reduce political interference.
Public AMCs work best if they are part of a
comprehensive NPL management strategy. Several
Commercial Focus, Robust Governance, and
AMCs (Indonesia, Malaysia, Turkey) were provided with
Comprehensive NPL Management Strategy
special powers—such as transferring loans in and out
Experience shows that a strong commercial focus is of the AMC without borrowers’ consent or appointing
a key success factor. This requires the AMCs’ legal a special administrator in debtor companies—without

38
 CHAPTER 3

the need for judicial approval to speed up corporate payment of interest on their bonds; in year two or three
restructuring. However, in the case of IBRA (Indonesia) of the AMC’s life, cash collections should pay for any
and SDIF (Turkey), many banks refused to participate recovery expenses and financial cost. AMC examples
in an informal out-of-court corporate restructuring show that initial capital primarily came from the
process as they feared that the AMC’s powers would government because the banking sector was very weak.
place other creditors at a disadvantage. Therefore, the In Ireland and Spain efforts were made to enhance the
AMC’s special powers should be subject to oversight private sector’s “skin in the game.” In Ireland, NAMA
to ensure they are not abused,36 and should be issued 5 percent of the purchase price of its assets in the
complemented by a comprehensive NPL management form of subordinated debt payable only if performance
strategy consisting of: (a) tighter bank supervision to targets were met. The banks were required by the
recognize and provision early for NPLs, (b) a bank supervisor to write this debt off. In Spain, SAREB’s
resolution framework to facilitate the exit of failed capital is 55 percent owned by international and local
banks and incentivize the transfer of NPLs to the banks and insurance companies.
AMC, (c) out-of-court workout processes to save viable
businesses,37 (d) personal and corporate insolvency EU Guidance and Rules for
reform to rehabilitate viable enterprises and facilitate Transfer Price
the liquidation and exit of nonviable ones, and (e) tax
The European Commission published an AMC
reform to allow the restructuring of loans (for instance,
blueprint in March 2018 to provide practical guidance
by preventing a “gift tax” whereby the borrower may
for member states when considering the design and set-
be taxed on the portion of the loan that is forgiven and
up of a public AMC. AMCs should be fully compliant
forgone by the financial institution).
with the EU legal framework including the State Aid
The funding of the AMC should provide time to realize Rules, the Bank Recovery and Resolution Directive,
the underlying value of the assets while preventing a and the Single Resolution Mechanism Regulation.38
permanent warehousing of bad loans. Asset purchasing The Commission envisions four scenarios of transfer of
AMCs need initial capital for working capital and NPLs from a bank to a publicly supported AMC:

Out of court
frameworks;
London Approach

Bank regulation and Personal and

recapitalization give an corporate
incentive to transfer insolvency law

Bank regulation and AMC Tax treatment of losses

supervision recognition of by banks and borrowers
NPLs; credit underwriting and asset transfers

FIGURE 3.2 Comprehensive NPL Management Strategy

Source: World Bank

39
CHAPTER 3

• Scenario 1: No State Aid. Publicly supported AMC the basis of underlying cash flows and the broader time
purchases NPLs from a bank at market value. horizon.”39 It is intended to be the market price without
• Scenario 2: Resolution. In the context of a the illiquidity and credit risk premium required by
private investors due to the absence of reliable market
resolution of a bank, the use of the asset separation
prices. Simply put, the discount rate to value the assets
tool requires the creation of an AMC to take over
using a discounted cash flow (DCF) methodology
selected assets of the bank.
would be higher in a market price scenario than in a
• Scenario 3: Insolvency Proceedings under National REV scenario.
Law. Separation of the “good” part of an ailing
Figures 3.3 and 3.4 illustrate how the amount of state
bank for sale from the “impaired” part managed by
aid is determined and was applied in previous cases. In
an AMC, under ordinary insolvency proceedings.
the case of Ireland, the European Commission granted
• Scenario 4: Precautionary Recapitalization. the maximum amount of state aid since the transfer
Exceptional state aid when a bank is not failing price was at the estimated REV of €31.1 billion out of a
or likely to fail but is likely to become distressed gross asset value of €74.4 billion. The transfer price was
if economic conditions were to worsen materially. 8.3 percent higher than the estimated market price (NB:
Transfer of NPLs to an AMC can be associated the difference between 35 and 43 percent on Figure 3.3).
with a state recapitalization of a bank under certain
The analysis of asset purchasing AMCs shows a
conditions.
significant discount on the gross value of assets. These
Scenario 4 reflects the cases of Ireland, Spain, and range from 52 percent (SAREB) to 68 percent (Bank
Slovenia where the creation of a public AMC was Asset Management Companies [BAMC/DUTB])
associated with the public recapitalization of banks even after applying an uplift factor. This discount
which continued to operate (most as state-owned does not only depend on the level of distress of the
institutions). To comply with state aid rules, the borrower, but also on the strength of creditors’ rights.
transfer price of assets to the AMC may be above The main lesson is that the transfer price must result
the market price, as long as it is not above the “real from a thorough process of asset valuation, involving
economic value,” or REV. The REV is defined as the third parties experienced in valuation, a consistent
“underlying long-term economic value of the assets, on methodology, and public disclosure. The lower the

Impaired assets on
bank’s balance sheet Nominal/Gross book value
GBV 100%
Other recent
Provisions impaired asset
(write-downs already
occurred on bank’s measures in
balance sheet) 80% favour of
Net book value single banks
NBV
Loss for bank
at transfer
Impaired assets on 60%

REV Transfer price AMC’s balance sheet

TP 48%
REV 43%
40% =TP* State aid ~¤5.9 billion
State aid State aid ~¤20 billion State aid ~¤0.6 billion
Market price MP 35% 32%
MP 30%
REV
20% 22%
Transfer price minus market price MP
(the top up over the market price
is covered by the state)
0%
*In these cases the transfer price was equal to the real economic value (REV)
Impaired assets Impaired assets i.e. the maximum compatible amount of state aid was granted.

FIGURE 3.3 State Aid in the Transfer of Impaired FIGURE 3.4 Real Economic Value from Previous
Assets Cases
Source: European Commission Source: Galand, Dutillieux, and Vallyon. “Non-Performing Loans
and State Aid Rules.”

40
 CHAPTER 3

purchase price, the easier for an AMC to recover the 90 percent of the face value of NPLs, illustrating the
purchase price and show financial success, but the chaebol economy.40 KAMCO is credited with creating
higher the capital deficiency of the selling institution. a distressed debt market, but its recovery efforts
were overshadowed by high operating expenses that
averaged 30 percent of collections.
Examples of Public AMCs
Danaharta was a successful asset-purchasing AMC
Early stage: RTC (United States) and Securum with a clear mandate and strong governance. It was
(Sweden) part of a comprehensive framework to recapitalize
viable banks, merge them, and support voluntary
The RTC and Securum represent bank resolution
corporate workouts. It carved out 70 percent of banks
AMCs that received a portfolio of diverse loans
NPLs with only 3,000 loans. It also benefitted from
from failed banks. They were both very successful
an economic recovery that helped borrowers to stay
at disposing of the assets (at termination they had
afloat. Danaharta adopted a strong system of corporate
3 percent and 2 percent of the initial assets left,
governance with quarterly reports, publication of KPIs,
respectively) and at recovering on their gross value.
collegial decisions in committees, and professional staff
The RTC’s high recovery rate was in part due to the
remunerated on the benchmark of local banks.
high-quality assets it received. Only 20 percent of the
loans were classified as non-performing and less than 7 IBRA epitomizes the lack of preconditions, poor
percent were in the form of distressed real estate. The governance, and a too-large mandate that undermined
the AMC’s performance. None of the preconditions
RTC’s disposal strategies were also supported by the
for effective AMCs (political consensus, strong bank
deep and liquid capital markets which allowed it to
resolution and corporate insolvency framework,
dispose of a large volume of assets without disrupting
credit culture, institutional independence) existed in
real estate prices or relying on individual transactions.
Indonesia. IBRA was tasked with resolving banks,
Securum’s success was due to various factors: (a) recovering the misused liquidity support, supporting
homogeneous portfolios being transferred (large corporate restructuring, and managing distressed
corporates with commercial real estate including assets. As a result, it only focused on asset management
the Nobel industries); (b) a strong tradition of rule in the last two years of its life when it realized 87
of law which allowed the restructuring of state- percent of its sales. IBRA was intended to represent a
owned companies without political interference, and new approach in the spirit of reformasi,41 but a lack
an efficient insolvency framework so that Securum of transparency coupled with political interference
did not require any special powers (70 percent of in many of the loan restructurings harmed IBRA’s
the companies with loans in Securum were forced credibility in its early years. In the end it only recovered
into bankruptcy); and (c) a rapid economic recovery 22 percent of the face value of NPLs transferred.
following the banking crisis, which helped the
The SDIF shows that asset management can be
corporate sector to get back on its feet. performed by an existing institution. The SDIF
is the deposit insurance fund that was given the
Asian and Turkish Crisis: KAMCO (Korea),
mandate to resolve failed banks and manage their
Danaharta (Malaysia), IBRA (Indonesia), assets in 1999. The use of an existing agency avoided
SDIF (Turkey) a prolonged start-up period. However, the SDIF’s
KAMCO is an example of AMC purchasing from a bank restructuring mandate forced it to focus on
wide variety of financial institutions. It purchased resolving the banks as quickly as possible—and asset
over 300,000 NPLs from commercial and merchant management activities only started four years after the
banks, investment trust companies, and securities crisis began. A special power to collect former bank
companies, which was explained by the severity of the owners’ NPLs—most of which related to the misuse
crisis in a corporate sector exposed to multiple financial of liquidity support in the early stages of the crisis—as
institutions. One percent of borrowers accounted for state receivables (no discount coupled with the ability

41
CHAPTER 3

to seize assets not serving as collateral) allowed SDIF to revaluation of assets after they were assumed by
realize 72 percent of its collections from these loans. SAREB and allowed SAREB to remain solvent.
• Issues of independence have been raised in the
Latest Examples: NAMA (Ireland), AMCON case of BAMC after several senior management
(Nigeria), SAREB (Spain) and BAMC (Slovenia) resignations. In late 2015 amendments were made
All these AMCs arising from the 2008 global financial to the BAMC law clarifying that (a) BAMC is
crisis were set up as asset-purchasing entities. They operationally independent, as the Ministry of
purchased assets from open banks at a predetermined Finance (representing the state) may not issue
price through the issuance of government-guaranteed instructions to BAMC for action on individual
bonds. The EU AMCs share common features cases, (b) responsibility for management of BAMC
with asset transfer at real economic value, and rests with its executive directors, and (c) BAMC
recapitalization of the banks following state aid rules. has broad powers to restructure companies in its
But they faced different challenges. portfolio. BAMC received a more challenging asset
mix compared to NAMA or SAREB, mainly large
• Seven years after starting operations, NAMA
conglomerate loans in various sectors.
redeemed its senior debt in October 2017 ahead
of schedule. It benefitted from strong political • Though set up as a purchasing asset management
consensus and its founding law enshrined company, AMCON also had to absorb the negative
independence, accountability, and a strong equity of eight failed banks. It is thus carrying
commercial focus. NAMA was also helped by a a significant negative equity on its books, one
concentrated portfolio (19 percent of debtors in which has no prospect of recovery. The definition
number represented 78 percent of the nominal of eligible assets in its founding law was broad
debt acquired), a sizable portfolio in the United and allowed AMCON to purchase strategically
Kingdom that generated 80 percent of sales in the important assets that were not NPLs. AMCON
first two years, and a consolidation of all debtor also purchased unsecured loans and loans backed
connections so that 20 percent of all loans acquired by shares (margin loans) in 2010–11, which do not
were performing and generated income in early require active asset management. Successive asset
years. The share of NPLs remained high within purchases raise the question of the adequacy of the
the banking sector after NAMA’s intervention transfer price. Information on the transfer price
(culminating at 27 percent of total loans in 2013), is not available; nor are online audited financials.
and therefore personal insolvency reforms and Finally, the significant powers of the Central Bank
supervisory guidance on NPL reduction on a bank- over AMCON as the mandate setter, regulator, and
by-bank basis has complemented NAMA’s efforts. creditor (it is the only institution holding AMCON
bonds) create conflicts of interest with the mandate
• SAREB came into existence as a last resort tool
of supervisor. Overall AMCON’s experience gives
under an EU and IMF program designed to restore
the impression that it was created with the intention
financial stability. It took on its balance sheet about
of hiding losses arising from the resolution of banks
200,000 assets, a much higher number than NAMA
rather than to protect the taxpayer.
or Danaharta. The same banks that transferred assets
were servicing them at inception, which was fraught In conclusion, AMCs are not a silver bullet for a
with conflicts of interest. Thus, SAREB launched high level of NPLs. They can help in the context of
a competitive process in 2014 to consolidate its a comprehensive NPL resolution strategy if certain
servicing agreements with professional companies. As preconditions are met to ensure they do not represent an
of the end of 2017, SAREB had redeemed 25 percent undue burden on the taxpayers, and if they are not used
of its government guaranteed debt, but reported as a tool to hide losses. When preconditions are met,
losses due to financial and operating costs in each experience shows that a commercial focus and robust
of its fiscal years. Specific accounting treatment governance practices are critical success factors. Table
from the Bank of Spain was required to address the 3.1 on the next page summarizes key data on AMCs. n

42
 CHAPTER 3

BOX 3.1 AMCs of Vietnam and China

China. A critical element of the recapitalization of expanded to include corporate restructuring
the banking sector in the late 1990s and early 2000s and investment advisory service. Currently,
was the creation of the big four asset management China Great Wall offers acquires, manages,
companies. They were initially charged with the and disposes NPLs in state-owned commercial
task of acquiring NPLs from the four major state- banks. It also provides debt collection, asset
owned banks and progressively restructuring them. exchange and leasing, asset assignment
They had no lifespan and no disclosed acquisition and sale, debt restructure and enterprises
price. These companies have now diversified into reorganization, debt-equity swap, and asset
financial conglomerates. securitization services.
• China Huarong was established in 1999 for the • China Orient was founded in 1999 for the Bank
acquisition and settlement of NPLs of Industrial of China. It runs two major business units since
and Commercial Bank of China (ICBC). It resolved 2006, one for general commercial activities
NPLs in various ways, including NPL pooling, and another for the management of the
asset backed securities, debt-equity swaps, and shares that converted from NPLs, which was
JV-AMC establishment. It later became a limited classified as assets under management. In 2015
company in 2007 and continued to pursue listing the group expanded as a full-service financial
on the stock market. China Huarong raised conglomerate by acquiring the Bank of Dalian.
HK$17.8 billion through an initial public offering In 2016 the corporation was re-incorporated as
(IPO), offering 5.77 billion new shares in Hong a company limited by shares, China Orient Asset
Kong SAR, China, in 2015. Management Co., Ltd from China Orient AMC.
• China Cinda was established in 1999 to resolve Vietnam. Central Bank of Vietnam established
NPLs of China Construction Bank Corporation the Vietnam AMC (VAMC) with an initial capital
(CCBC). Initially it was a major task to acquire of 2 trillion Vietnamese dong in 2013 with the
and clean up the NPLs of CCBC through the goal to purchase and clean up bank bad loans of
issuance of government-guaranteed bonds, but a total cumulative value of D 330 trillion by 2020
since the late 2000s, it expanded its business to stabilize the banking system. As of 2017, VAMC
scope to buy bad loans from other commercial acquired non-performing loans of D 301 trillion
banks as well as to dispose of large-scale bad from a total of 42 financial institutions, of which D
assets of non-financial institutions. Since then, 60 trillion were recovered. VAMC’s purchase of NPLs
it has been the first among AMCs in China to has had the effect of lowering banks’ nominal NPL
implement $2.5 billion in IPO on the Hong Kong ratios, but it still shows operational limitations,
Stock Exchange in 2013 and has undertaken with unresolved NPLs reaching 80 percent. In
a transition to a comprehensive financial response, the Vietnamese government is seeking to
holding company through the establishment of revitalize the VAMC’s handling of NPLs by preparing
insurance and securities subsidiaries. a special parliamentary resolution that calls for the
rapid disposal of NPLs.
• China Great Wall was founded in 1999 for the
resolution of NPLs of Agricultural Bank of China. Source: Forthcoming World Bank Policy Note on Centralized
Since the late 2000s, the scope of business was Asset Management Companies in Asia.

43
CHAPTER 3

TABLE 3.1 Examples of Public AMCs

Recovery
Special Asset transfer Eligible from face
Mandate powers Lifespan price loans value
RTC Resolve thrifts None 7 years Did not purchase n.a. 87% (on
(U.S.) (banks) assets only)
1989
Securum Restructure NPLs None 10–15 years Did not purchase n.a. n.a.
(Sweden) of state-owned envisioned,
1993 Nordenbanken, reduced to
later expanded to 5 years
include Gota bank
KAMCO Asset management None None Internal pricing Priority to 46.8%
(Korea) specified based on DCF sizeable NPLs
1997
Discount = 64% & with multiple
creditors
IBRA Resolve banks, Yes 6 years Did not purchase n.a. 22% (on NPLs)
(Indonesia) administer deposit
1998 guarantee, recover
misused liquidity
support
Danaharta Asset management Yes 7 years Appraisals Large and 58%
(Malaysia)
Receiver for 2 Discount = 54% industrial loans
1998
banks

SDIF Resolve banks, Yes None Did not purchase n.a. 16% (NPL
(Turkey) administer deposit specified sales only)
1999 guarantee, recover
misused liquidity
support
NAMA Asset management Yes Expected Appraisals. REV Large real 54% (as of
(Ireland) (but not to close in uplift of 8.3% estate loans June 2017)
2008 used) 2020, but Discount from Book
ahead of Value = 57%
schedule
AMCON Asset management; Yes None Guidelines from Any loan n.a.
(Nigeria) recapitalize failed specified Central Bank reasonably
2010 banks; invest in Discount = 54% expected
equities to become
substandard
SAREB Asset management None 15 years BoS & independent Large real 19% (as of
(Spain) valuation. estate loans June 2017)
2012
REV with uplift ~18%
Discount = 52.4%
BAMC Asset management None 10 years Independent Large loans 23% (as of
(Slovenia) (until 2022) valuation multi-sector June 2017)
2013
REV with uplift ~10%
Discount = 68%

44
CHAPTER 4
Attractive Markets for Investing in
Distressed Assets
By Josep M. Julià, Eric D. Cruikshank, and Marta Sánchez Saché

Non-performing loans are found in virtually every Macroeconomic Environment

country. However, the prospect of them being resolved The macroeconomic environment of any given economy
effectively through wholesale approaches depends is critical to attracting investors to the distressed assets
on certain preconditions. When investors consider space. Investors will consider the economic growth
entering a new market, they ascertain and analyze a outlook and current and expected macroeconomic
number of these preconditions, the key ones being the policies (fiscal and monetary) in the country, as well
market size, the macroeconomic environment, the legal as other global forces and any political challenges
and regulatory framework, the quality of information, within the investment horizon that may affect the
as well as the servicing capacity and the investor base. macroeconomic outlook. For example, an incipient
In this chapter, we will briefly examine these five economic recovery could offer better prospects for
crucial elements.42 returns on investments, as distressed assets can be
priced conservatively, with increased room for upside.
Market Size
Although financial crises often generate distressed assets
The size of the NPL pool in terms of potential in quantities sufficient to stimulate the development or
recoverable value is clearly important in attracting expansion of a distressed assets market, the private sector
institutions with knowledge of and expertise in players that are key to NPL resolution initiatives are
distressed assets resolution. Some of these will unlikely to become fully engaged43 until they see signs
be entities that have established track records in that a financial crisis has bottomed and that asset values
designing and implementing a variety of recovery are no longer in free fall—investors understandably want
strategies (settlements, enforcement, OCWs, judicial to avoid trying to “catch a falling knife.”
reorganizations, or liquidations). Others will be
institutional investors that have the mandate and Legal and Regulatory Framework
familiarity with distressed assets as an investment Effective NPL resolution depends on having the
class to allow them to participate as investors in support of a well-designed legal and regulatory
NPL transactions. Most of the distressed assets framework in place. Such a framework should address:
investors look for a minimum potential market size (a) the enabling environment, as discussed in Chapter
to justify the effort and associated costs of entering a 2, (b) macroprudential regulation, (c) supervisory
new market. However, while the face value of loans guidance and action, and (d) direct intervention. A
outstanding is the starting point in ascertaining the framework that can accommodate strong private sector
size of the NPL pool, other preconditions will be participation in the resolution of distressed assets
crucial in determining the likely recoverable value requires, first and foremost, a government stance in
of those assets and the actual potential investment favor of such an approach. Governments committed
opportunity. This chapter focuses on the size of to effective debt enforcement will at least lay the
the opportunity specific to NPLs. As such, the groundwork for: (a) improving predictability and
opportunities for investors in distressed assets transparency, (b) facilitating the reduction of NPLs, (c)
markets are much larger when also considering special encouraging new business relationships, (d) enabling
situations and special lending opportunities. rapid real-asset redeployment, and (e) promoting

46
 CHAPTER 4

financial sector stability. Similarly, investors will place Quality of Information

a significant weight on regulatory frameworks when Accounting standards—in terms of the country’s
assessing the actual recoverable amount and, as a
adoption of international best practices as well as
result, the potential market size.
enforcement—are essential for early identification of
Table 4.1 presents the main layers of a legal and problematic (and potentially problematic) assets on the
regulatory framework. At the broadest level—shaping balance sheets of banks, other lending institutions, and
the enabling environment—is the framework that credit originators. Lending institutions must also have
regulates financial institutions and the relevant tax clear and comparable systems for loan classification
regime. Also, at this level is the framework directly in place, along with consistent and binding rules for
relevant to corporate debt recovery and asset classifying loans. Clear and well-enforced rules for
resolution, which includes the insolvency regime, loan-loss provisioning are also essential. Collection and
collateral debt enforcement framework, and provisions reporting of this information will usually be enforced
for out-of-court restructuring. The next level pertains by the concerned regulatory agencies—the public
to macroprudential regulation, which effectively limits sector entity responsible for bank supervision and the
the different types of risks associated with lending
entity responsible for overseeing non-bank financial
activities. These range from regulatory ceilings imposed
institutions (NBFIs).
on loan-to-value ratios, debt-to-income ratios, loan
growth, net foreign-exchange exposure, and reserve In addition, there is often a lack of publicly available
requirements. Supervisory guidance at the following information on important value drivers, such as value
level of the overall framework deals with measuring of properties or employment status of debtors, that
and reporting asset quality in accordance with an may limit the analysis of the assets to be acquired,
established loan-classification system as well as how negatively impacting their pricing. Therefore, when
NPL income is recognized and problem loans are either there are material deficiencies in timely and reliable
provisioned or written off. The final and most direct loan information—or when such information is
level (from the perspective of public sector involvement) not made available to potential investors—then the
includes ad hoc and systemic conditions that trigger perceived recoverable value will be much lower than,
bank interventions, mandated asset-resolution for example, a stock of similar face-value loans in a
approaches, and the formation of public AMCs, as country where information is generated earlier and is of
covered in Chapter 3. better overall quality.44

TABLE 4.1 Legal and Regulatory Framework

Enabling Macroprudential Supervisory Direct

Environment Regulation Guidance & Action Intervention
Prudential regulation Loan-to-value ceilings Asset quality reviews Bank interventions
Sound bank supervision Debt-to-income ceilings Supervisory guidance on: Mandated strategies
Insolvency regimes Limits to lending growth • Provisions Public AMCs
Collateral enforcement FX lending limits • NPL income
Tax regime Reserve requirements • Recognition
Out-of-court settlement Macroprudential supervisory • Collateral valuation
framework review tools
Counter-cyclical buffers • Write-offs
Source: Karlis Bauze, “A Holistic Approach to NPL Resolution.” Presentation to the FinSAC NPL Conference, May 15–16, 2018,
Vienna, Austria.

47
CHAPTER 4

Servicing Capacity and Investors Base Brazil

Two factors play a significant role in facilitating
NPL sales. First, servicers hold information that Market Size
is valuable to investors for pricing purposes and Over the past two decades, banking penetration in
have the expertise and necessary local knowledge Brazil has increased significantly, accompanied by a
to manage NPLs. At the time of underwriting corresponding increase in the total stock of NPLs. In
new NPL portfolios, availability of prior data on addition, it is expected that NPL volumes will continue
historical collections is a critical component for increasing both organically with credit expansion,
interested investors to accurately price these assets. as well as being further fueled by Brazil’s economic
Once NPLs have been acquired, an appropriate recession of the past few years.
servicing infrastructure is required for investors to The NPL market in Brazil is characterized by a large
manage the underlying assets and monetize estimated critical mass. The volume of E–H45 rated credits,
recoveries. Therefore, the wider the installed servicing which stands at 6.4 percent of total loans, grew at a
infrastructure, the easier it is for investors to consider compound annual growth rate (CAGR) of 12.4 percent
transactions in that market. from 2008 to 2018, from R$65.3 billion (equivalent
Second, the level of competition is, as in any other to approximately $27.8 billion) to R$210.8 billion
industry, a key consideration when assessing the (equivalent to approximately $54.3 billion)—a figure
attractiveness of a distressed assets market. As that becomes much larger when considering off-
the preconditions described above evolve in the balance-sheet exposures. This growth pattern exceeds
right direction, investors feel more comfortable the comparable growth rate of 10.1 percent for the
in deploying capital and, over time, the nature of total volume of loans over the same time period.
these investors changes. In the initial stages of the In parallel with the increase in the NPL volume,
development of a distressed assets market, when the distressed assets market has been growing and
some of the needed preconditions emerge, only a evolving in Brazil. In its initial stages, only a limited
handful of investors will consider venturing into that number of banks would sell NPL portfolios on a
market. These are usually specialized investors that regular basis. At first, they sold small portfolios and,
are willing to take a higher level of risk in exchange as the market evolved, these banks increased the size
for higher returns. As the market matures, the of the portfolios as well as the range of asset classes
competition increases, and over time these specialized available for disposal. Eventually, other large banks,
investors are joined or replaced by institutional including state-owned banks and non-financial
and strategic investors in search of more stable and institutions, began selling loans. Subsequently, as
developed distressed assets markets and that usually has also been the case in many other markets, banks
have lower return requirements. began to explore more strategic solutions to develop
efficient tools to manage their increasing stock of
Future IFC Focus—Attractive Markets for NPLs. In addition, with the introduction of IFRS
Distressed Assets Resolution 9 (an international financial report standard that
addresses the accounting for financial instruments), it
With more than a decade of experience in investing is expected that large-scale sales will be more likely,
in NPLs globally through DARP, IFC has identified as financial institutions will have less room to rely
six countries that have met—or are working to put in on restructurings to manage their NPLs, increasing
place—the preconditions for large-scale distressed- pressure to dispose of them. However, given that the
asset resolution, thus warranting priority focus. These largest banks in Brazil have recently acquired servicing
countries—Brazil, China, Greece, India, Turkey, and companies specialized on the retail space, they may
Ukraine—are briefly reviewed below in terms of these offload some of their retail NPLs to their own servicers
market preconditions. and not necessarily make them available to the market.

48
 1,500

R
1,000

500

CHAPTER 4
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Gross loans

3,500 240 8.0%

6.5%
210 7.0%
3,000

180 6.0%
2,500
CAGR: 10.1% 150 5.0%
CAGR: 12.4%
R$ BILLION

R$ BILLION
2,000
120 4.0%
1,500
90 3.0%

1,000
60 2.0%

500 30 1.0%

0 0 0.0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Gross loans E F G H E-H ratio

240 8.0%

FIGURE
210
4.1 Brazil—Total Loans 6.5%
7.0%
FIGURE 4.2 Brazil—E–H Rated Loans
Source: Brazilian Central Bank. Source: Brazilian Central Bank.
180 6.0%

150 5.0%
CAGR: 12.4%
R$ BILLION

Given
120 that these acquisitions are still recent, involving 4.0%pre-recession levels before 2024. A combination of
an inevitable
90 transition period, it is too early to tell 3.0%
heavy debt throughout the economy, deteriorating
what60
the final impact in the evolution of the distressed 2.0%
public finances, and structurally weak productivity
assets market will be. growth are hindering growth. Political uncertainty also
30 1.0%
contributes to the challenging outlook.
In the
0 past few years, other asset classes have emerged 0.0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
and are becoming more relevant
E F Gin the
H distressed
E-H ratio assets The World Bank cut its 2019 GDP growth forecast
space, notably, real estate owned assets, legal claims, to 1.5 percent (from 2.2 percent in its January 2019
and precatórios. REOs are collateral already foreclosed forecast). Public finances are the greatest immediate
by banks, which banks are increasingly willing to threat to economic stability. The IMF forecasts a
dispose of. The estimated volume of REOs is R$26.7 budget deficit of 7.3 percent of GDP this year (up from
billion (equivalent to approximately $6.9 billion). 6.8 percent of GDP in 2018), and projects public debt
Precatórios are payment orders issued by the judiciary to reach 90 percent of GDP, up from 88 percent of
to the executive branch or its agencies due to a final and GDP in 2018. The government has submitted social
unappealable decision. Precatórios can be federal, state security reforms to Congress, a key step toward
or municipal. The uncertainty regarding precatórios is stabilizing public finances. Its proposal would lower the
about the timing of the payment, while the uncertainty system’s annual deficit of 6 percent of GDP.
regarding legal claims, in addition to the timing of the The government also plans major asset sales,
payment, is about the decision of the judge (that is, the privatizations, and budget cuts. It aims to raise Brazil’s
merit of the claim and/or the amount under dispute). long-term growth rate through ambitious productivity-
According to market estimates, the volume of legal enhancing reforms liberalizing trade, deregulating
claims and precatórios is approximately R$300 billion domestic markets, and reforming tax and labor laws.
(equivalent to approximately $77.3 billion). Other key economic indicators are relatively sound but
consistent with weak growth.
Macroeconomic Outlook
Other key economic indicators are relatively sound,
Brazil is expected to post its third year of weak growth consistent with weak growth. Inflation is within
in 2019 following a deep recession in 2015–16, during the Central Bank’s central target of 4.25 percent
which the economy contracted by 8 percent in real (±1.5 percentage points.) The current account deficit
terms. GDP per capita is not expected to return to is forecast at 1.7 percent of GDP in 2019. It is not

49
CHAPTER 4

expected to widen significantly and is easily covered • Despite the appearance of a tight timeline for key
by expected FDI inflows of $84 billion. The currency milestones in the judicial restructuring process, the
depreciated by 1.7 percent in the year through May 31 entire process can involve lengthy delays.
after weakening 14.6 percent in 2018. • Whereas the failure of key stakeholders to reach an
agreement should trigger court-ordered liquidation
Legal and Regulatory Framework as a subsequent step, the judicial administrator, who
Brazilian legislators promulgated the existing is appointed by and who reports to the bankruptcy
bankruptcy law, Nova Lei de Falências e Recuperação judge, often will provide the judge with grounds for
de Empresas, on February 9, 2005, replacing a 1945 avoiding liquidation.
law. This improved the outlook for companies seeking • There are practical aspects in the application of the
bankruptcy protection in several ways, primarily law that leave creditors unprotected, often due to
by introducing to Brazil (presumably inspired by judicial “creations.” Some of these aspects entail
U.S. Chapter 11) the concept of an organized court- “substantive consolidation” of assets in cases of
supervised restructuring process. groups of companies and the exclusion of certain
Prior to the 2005 law, Brazil’s bankruptcy system (the creditors from voting the reorganization plan
concordata) offered little recourse to creditors other than because they have been deemed “abusive,” very
stretching out payments over longer maturities and at often for arbitrary reasons.
higher interest rates, rather than restructuring the debt or With acquired knowledge of the judicial process
the business. Troubled firms, therefore, were invariably and the help of specialized advisors, creditors do
destined to fail as secured creditors foreclosed on their have several ways of improving their recovery rates
collateral to recoup what little they could. The 2005 law within this framework. In part, this hinges on
with its specialized restructuring process—Recuperação them understanding which parts of the process are
Judicial (translated as “judicial recovery”)—provides an negotiable and which are not. Creditor prospects can
incentive to creditors to play an active role in preserving a also be enhanced by their careful recourse to providing
troubled firm’s value rather than bleeding it dry. well-structured DIP financing. Currently, this law is
being amended to address issues identified by market
Although the 2005 law represents a positive development
participants, based on over 10 years of experience since
for asset resolution in Brazil, legal specialists nonetheless
its enactment.
flag a few caveats regarding ways the Brazilian
insolvency system is inconsistent with good practices:
Quality of Information
• Controlling shareholders can exert greater influence
In Brazil, accounting standards are strong, bank asset
over the judicial restructuring process than can their classification is reliable and financial information
counterparts in the United States. They can present collection and reporting systems are well developed.
a plan, veto adjustments, or unilaterally choose In addition, the amount of information being made
a buyer for their assets—in contrast to the rights available by sellers to prospective buyers is generally
of secured and unsecured creditors that have less sufficient and of a quality that allows investors to
latitude for action and a relatively less-influential properly assess the value of the NPLs being offered
role in the process. for sale.
• Bankruptcy courts have widely-varying familiarity
with bankruptcy law from state to state within Brazil. Servicing Capacity and Investor Base
The result is that legal outcomes can vary extensively While the servicing infrastructure in Brazil has evolved
and lack consistency. Compounding this, the law significantly over the last decade, it is currently in
requires troubled companies to file their petition for the midst of a major shakeup that could change the
bankruptcy in the state in which their headquarters is layout of the industry. A decade ago, the Brazilian
domiciled—unlike in the United States. NPL market was emerging with very limited servicing

50
 CHAPTER 4

capacity that mainly consisted of collection agencies

providing third-party servicing to banks. Gradually, BOX 4.1 DARP Involvement in Brazil
as the market developed, some master servicers that
DARP has played a critical role in the
specialized in the retail NPL space were established, development of the distressed assets market
and they focused on partnering with investors to in Brazil through its programmatic approach,
underwrite and manage NPL portfolios. As such, only complementing the efforts of the World Bank
Group’s FCI GP to help improve the country’s
a few sophisticated servicers currently operate in the
insolvency regime and creditors’ rights. In
country, mainly focused on retail NPLs, while the 2010, IFC made an equity investment in a
servicing capacity for corporate NPLs remains scarce. local specialized servicer, Recovery do Brasil
Consultoria (Recovery), which over time
Over the last three years, a change in the servicing
became one of the leading servicers in the
industry has occurred. The largest banks in Brazil have country. The second step in this strategy was
been acquiring these independent retail NPL servicers ensuring that this servicing platform had the
to build their own captive resolution infrastructure appropriate funding to acquire NPL portfolios
with a dual objective of: (a) improving the collections across financial institutions and react quickly as
opportunities arose. For this purpose, in 2012,
of their own NPL portfolios, and (b) acquiring NPL
IFC established a DARP platform in partnership
portfolios of other financial institutions and credit with Banco BTG Pactual. In March 2016, Itau
originators to invest in an asset class with an attractive Unibanco, the largest Brazilian privately-owned
return. This new environment poses the following bank, acquired a controlling stake in Recovery as
questions: where is the Brazilian NPL market heading? well as in this DARP platform, and became IFC’s
partner for distressed assets investing in Brazil.
Will it become a captive market where each bank
This platform is one of the leading platforms
ends up resolving its own NPLs or will bank-owned in the country through which IFC has made
servicers continue buying NPLs from third parties? As a material development impact, as it: (a) has
the stock of REOs continues to grow on their balance allowed Brazilian banks to offload R$45 billion
(equivalent to approximately $20 billion) in face
sheets, will Brazilian banks follow the trend of some of
value NPLs, while (b) is helping normalize the
their European counterparts and spin off and sell their debt obligations of over 15 million households
REO management units? and SMEs. This platform has acquired NPL
portfolios from several of the largest financial
Brazil’s distressed assets market is a moderately
institutions, including Banco Santander (Brasil)
competitive one. After a few years during which and Bradesco.
international investors had an active presence in the
market, domestic investors dominate. Lately, several
foreign investors have been exploring the market, with
China
only a few currently active. Given its potential size, the
Brazilian distressed assets market can easily accommodate Market Size
additional domestic and international investors.
From 2010 to 2018, Chinese bank NPLs have grown at
a CAGR of 24.6 percent, from Y434 billion (equivalent
Going Forward
to approximately to $66 billion) to Y2,025 billion
Provided that the incipient economic recovery does (equivalent to approximately to $294 billion), while
not derail, Brazil justifiably appears to qualify as gross loans have grown at a CAGR of 16.3 percent.
an attractive distressed assets market. In addition Since the mid-2000s until 2015, NPLs remained below
to banks selling NPL portfolios, more non-financial 1 percent, reflecting the fact that many problem loans
institutions are expected to join them. Also, new asset were not captured in the published data. The current
classes are expected to be traded in scale, including NPL ratio of 1.8 percent, which banks have been able
mortgages and REOs, for which the market, so far, to effectively stabilize during 2018 due to the elevated
has only seen a handful of trades. level of write-offs, reflects a combination of adverse

51
CHAPTER 4

economic conditions causing borrower distress as well the disposition and acquisition of distressed assets, in
as improved loan classification and reporting. In this addition to the AMCs, are being established, such as:
context, since 2017, the China Banking and Insurance • Securitization: This is the only route for investors to
Regulatory Commission (CBIRC) has requested that tap into the consumer NPL market, as banks cannot
banks ensure that lending classified as investments is sell this type of NPLs.
reflected in their balance sheets properly. This process
has forced banks to recognize a higher NPL ratio. It is • Over-the-counter sales: A number of financial
also worth mentioning special mention loans (SMLs), exchanges across China allow the exchange of
which are loans that have been classified as of being NPLs.
better quality than NPLs but with signs of potential • Debt-to-equity swaps: Debt-to-equity swaps are
problems. The SML ratio stood at 3.3 percent of becoming an increasing avenue for resolution
the total loan portfolio, amounting to Y3.4 trillion of NPLs, following the establishment of Asset
(equivalent to approximately $494 billion). In June Investment Companies (AICs). These are
2018, regulators improved bad-loan recognition by subsidiaries of the largest commercial banks
abolishing the “overdue but not impaired” category for established to focus on debt-to-equity swaps related
loans overdue more than 90 days, with these exposures to their large or strategic non-performing assets.
now being treated as NPLs rather than as SMLs. In NPL prices rose aggressively throughout 2017, such
addition, according to market estimates, there are that AMCs that at the end of 2016 typically sold NPL
another Y4.3 trillion (equivalent to approximately $625 portfolios for about 30 percent of their face value were
billion) of NPLs on the books of public sector AMCs. able to realize as much as 80 to 90 percent in some
The banks’ volume of NPLs and SMLs combined with parts of the country a year later, when inflated prices
these AMCs’ stock of distressed assets amounts to accompanied by a spike in real estate prices drove
approximately $1.4 trillion, representing a high volume transaction prices upward. Over the last few months,
of loans that these institutions may want to dispose of. NPL prices seem to have slightly moderated, although
As described in Chapter 3, for the most part, NPL they are still at relatively high levels.
resolution has been concentrated in the hands of
these public sector AMCs that were formed with Macroeconomic Outlook
the approval of China’s banking regulator: first, After more than three decades of unprecedented
in the 1990s when the four large national AMCs economic growth and poverty reduction, structural
were established, followed later in 2013 when the problems have reduced China’s previously strong GDP
government allowed the creation of a limited number double-digit growth rates to a still-strong 2017 annual
of licensed AMCs in each province. In fact, banks growth rate of 6.9 percent. Economic activity remained
cannot sell portfolios of NPLs directly to investors resilient in the first half of 2018 with GDP growing
and must use the AMCs, unless they are selling by 6.8 percent year-on-year but declined in the latter
portfolios of three assets or less. Since 2013, 61 half to end the year at 6.6 percent, its lowest level since
provincial AMCs have been established. Initially, 2009. This has transpired while the country reorients
they had to resolve the acquired NPLs internally, but itself from being predominantly export-focused to
after 2016, they can also on-sell them to third-party developing its internal markets and rebalances itself to
investors. In addition, new regulations governing accommodate stronger consumption and services-led
provincial AMCs are expected to be introduced, growth. Yet some signs of fragility persist (including
which are likely to further level the playing field financial leverage in the non-financial sector and
between national and provincial AMCs. One of the ongoing trade tensions) with GDP growth forecasted
key changes will be lifting restrictions for provincial to decline further to 6.2 percent over 2019–20 (World
AMCs to participate in NPL portfolio sales that are Bank). The country’s economic prospects, nonetheless,
auctioned by nationwide banks in other regions. remain positive over the medium term, provided
As the market continues to develop, new channels for the economy continues to move up the value chain

52
 CHAPTER 4

2,500 2.0%
1.8%
2.0%
1.8% 100,000
1.8% 100,000 2,000 1.6%
1.6% 80,000
1.4%
80,000 CAGR: 24.6%
1.4%
CAGR: 16.3% 1,500 1.2%
60,000

Y BILLION

Y BILLION
1.2%
60,000 1.0%
Y BILLION

1.0% 40,000
1,000 0.8%
0.8% 40,000
0.6%
20,000
0.6%
500 0.4%
20,000
0.4%
0.2% 0
0.2% 0 0 0.0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018
0.0%
8 Gross loans
NPLs NPL ratio

FIGURE 4.3 China—Total Loans FIGURE 4.4 China—NPLs

Source: Financial Soundness Indicators, IMF, and China Banking Source: Financial Soundness Indicators, IMF, and China Banking
and Insurance Regulatory Commission. and Insurance Regulatory Commission.

and new drivers of growth can lead to productivity The following summarizes the EBL’s main features:46
improvements. Moreover, the likelihood of a financial
• Either a debtor or creditor may apply to the people’s
crisis unfolding in ways like other larger markets is
courts for bankruptcy protection on the grounds of
considerably attenuated by the resiliency that the sheer
debtor inability to honor all its debt obligations on a
size of China’s economy affords, as well as the latitude
timely basis.
available to the country’s economic authorities to
intervene helps to mitigate risks of potential and abrupt • The debtor and relevant creditors will appoint
financial and macroeconomic shocks. an independent administrator whose duties must
be approved by the court and a separate creditor
Legal and Regulatory Framework committee, if appointed.
On June 1, 2007, China put into effect its Enterprise • A nine-member creditor committee, including at
Bankruptcy Law (EBL), prior to which there was least one employee or labor-union representative,
no formal bankruptcy law in the country. This was will oversee the management, disposal, and
a watershed moment for China in that the EBL distribution of the debtor’s assets, and will
introduced concepts into its bankruptcy regime that adjudicate certain actions pertaining to these
previously did not exist. These concepts include, functions by the independent administrator.
among others, the appointment of an administrator
• A petition to the court can be filed for the troubled
and creditor committee, balance sheet restructuring
company’s balance sheet to be restructured
as an alternative to liquidation, and recognition of
cross-border enforcement of bankruptcy court rulings instead of liquidated by the debtor, a creditor, or
and judgments. The new legislation brought China’s a shareholder holding more than 10 percent of the
insolvency regime closer to global standards. debtor’s capital or liability.

The EBL is the first piece of bankruptcy legislation that • The recognition and enforcement of cross-border
uniformly governs state-owned enterprises (SOEs) and bankruptcy rulings and judgments applied to a
non-SOEs, including collectively-owned enterprises, non-bankrupt company in China is subject to
private companies, Sino-foreign joint equity enterprises, certain conditions and is quite limited. Along these
Sino-foreign cooperative enterprises, and wholly lines, it is important to note that China has not yet
foreign-owned enterprises. It does not cover individuals adopted the UNCITRAL Model Law on Cross-
or partnerships. Border Insolvency.

53
CHAPTER 4

While the EBL in China augurs well for the future as the NPL market began to pick up over the last two
treatment of bankruptcy situations, its implementation years, some of the large international investors that
continues to be work in progress and bankruptcy cases have recently entered the market are establishing their
are extremely rare in China, despite the EBL having own servicing capacity, either by acquiring or entering
been in place since 2007. Its successful implementation into strategic partnerships with existing independent
unquestionably requires the support of the local servicers or by building their own recovery teams.
authorities. During the first wave of NPL sales in the early 2000s,
Recently, the government of China requested the support several of the specialized international investors
of the World Bank Group’s FCI GP to improve some actively participated in the market. However, most
aspects related to resolving insolvency and a diagnostic left as the market slowed down, leaving the space in
report was delivered to the Chinese authorities. the hands of predominantly domestic players, with
most activities carried out by local public and private
Quality of Information investors. Today, China’s distressed assets market
Undertaking a current distressed assets market continues to be dominated by authorized AMCs.
assessment in China is made difficult by the scarcity Although there has been growth in the number of
of public information regarding operations of the provincial AMCs, they remain challenged from a
AMCs and banks that may be interested in working capital perspective, particularly when considering the
with investors in structuring an NPL portfolio sale. potential volume of distressed debt that is expected to
While the CBIRC has taken actions to improve the become available in the coming years.
recognition of NPLs by banks, both in terms of In the past couple of years, foreign investors are
timeliness and nature of the assets to be considered as beginning to show renewed interest in the Chinese
NPLs, specific total amounts, characteristics, and the NPL market with several high-profile buyers actively
actual tradeable amount are still challenging to assess. engaging in the acquisition cycle. On average, these
Given the sheer size of the country, data quality also transactions have been relatively small—likely
may vary from province to province, which, among undertaken to test the market as well as to establish
other reasons, will require investors to partner with servicing capabilities. However, larger deal sizes
local servicers, including law firms. and a larger number of deals are available, and
this environment is expected to develop as investor
Servicing Capacity and Investor Base sentiment continues to build and as the regulator
The servicing capacity in China is rather fragmented, continues to support credit tightening by restricting
as most of the servicers are focused on specific shadow banking and offshore bond issuances, among
provinces, with no countrywide coverage, for three other measures. In any event, given the large size of
main reasons: (a) the large size of the Chinese market the opportunity, it is expected that more distressed
allows each province to offer the critical mass needed assets investors will continue to enter this market in
by the servicers to operate, (b) the specificities of the near future.
the implementation of the legal framework in each
province encourages servicer specialization, and (c) Going Forward
local market knowledge and a relationship network at Despite the scarcity of publicly available information
that level is essential for NPL resolution. on companies and debt, the sheer size and anticipated
Over the last decade, the servicing industry in China has growth of the distressed assets market in China
been focused on two main types of players. First, the combined with recent modernization of the legal
four national AMCs (and subsequently the provincial and regulatory framework, promising indications
AMCs) developed the country’s servicing capacity, of investor interest, and growing servicing capacity,
complemented by a number of independent domestic qualify China as a prospective attractive market for
servicers, both private and publicly owned. Second, distressed assets investors.

54
 CHAPTER 4

Greece
BOX 4.2 DARP Involvement in China
IFC was active during the first wave of NPL sales Market Size
in the early 2000s. This pre-DARP involvement Greece is one of the largest distressed assets markets
did not follow a programmatic approach, but
in Europe. In the aftermath of one of the most severe
rather focused on supporting some of the
initial efforts in the distressed assets space, liquidity crises in the recent history of developed
including partnerships with two of the four markets, from 2010 onwards, asset quality deteriorated
national AMCs. IFC took a leading role in one sharply. As of December 2018, Greece’s asset quality
of the first sales of distressed assets initiated was the worst of all countries in the EU with an NPL
by the government of China, the success of
which established a precedent for future
ratio of 45.4 percent, having grown at a CAGR of 18.8
NPL sales and helped provide much-needed percent since 2008 while credit fell at a CAGR of 3.4
momentum to the development of the NPL percent over the same period. With NPLs at €81.8
market. IFC participated in a consortium billion (equivalent to approximately $93.7 billion), only
(China One) that included Morgan Stanley,
about half of this value was covered by cumulative
Lehman Brothers, and Salomon Brothers
that established a partnership with Huarong reserves. The business segment of this stock amounted to
AMC. Later, IFC invested in Rongde Asset €45.9 billion (44.7 percent NPL ratio); consumer loans
Management Company (Ramco), a joint-venture accounted for €8.8 billion (53.0 percent NPL ratio); and
AMC formed between China Huarong Asset
the balance of €27.1 billion comprised residential loans
Management Corporation, Deutsche Bank,
and American International Group. Ramco was
(44.5 percent NPL ratio). Unlike in other EU countries
established as the first equity joint-venture (such as Ireland and Spain), in Greece NPLs are spread
AMC that was intended to be a long-term, across all asset classes and systemic banks. This has been
multi-pool platform, allowing for the efficient one of the main reasons why, unlike other countries, the
acquisition, transfer, servicing, and resolution
concept of a public AMC has not materialized in Greece.
of NPLs. In addition, IFC invested in a second
equity joint venture to continue supporting
the development of the local distressed assets Macroeconomic Outlook
market with China Orient Asset Management
Following one of the deepest and longest recessions
Corporation and CFS Investment Holding, a
wholly-owned subsidiary of General Electric. in modern history, Greece’s macroeconomic outlook
Following IFC’s support to that first wave of is improving. In August 2018, the country graduated
NPL resolution in China, DARP has continued from the financial support program47 as agreed between
to participate more opportunistically in the Greece and the three negotiation partners—also known
market through some its Asian regional
as the “Troika”—the European Commission representing
platforms with Clearwater, ADM Capital, and
Fortress. These DARP platforms have invested the European Union, the European Central Bank, and
in several opportunities, including high-yield the IMF. After seeing real GDP contract by more than
bonds and special lending. Now, after several one-quarter (with government consumption contracting
years of no significant NPL activity in the
similarly, household consumption by 20 percent, and
country, DARP has re-engaged to extend its
global strategy into this market, including gross fixed investment by almost two-thirds), Greece’s
developing the required servicing infrastructure incipient recovery, underway since 2017, remains
as well as mobilizing capital and expertise for constrained by the very high level of nonperforming
this space in China. exposures in the banking sector (47 percent of
outstanding loans). This limits banks’ capacity to lend,
constraining investment and contributed to sluggish
growth and job creation. Even so, Greece’s real GDP
growth is forecast by the IMF at 2.2–2.4 percent per
annum during the period 2019–20.

55
CHAPTER 4

300 120 60%

CAGR: -3.4% 45.4% 50%
250 100

200 80 40%
BILLION

BILLION
150 60 30%
CAGR: 18.8%
100 40 20%

50 20 10%

0 0 0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Consumer loans Residential loans Business loans Consumer loans Residential loans Business loans
NPL ratio

FIGURE 4.5 Greece—Total Loans FIGURE 4.6 Greece—NPLs

Source: Bank of Greece. Source: Bank of Greece.

Despite the significant fiscal consolidation, government transfers. In December 2015, the so-called NPL
debt remains very high at 183 percent of GDP. However, law entered into force. It set out the framework
three-quarters of this debt is owed to EU lenders on what for the establishment and operation of specialized
are essentially concessional terms. The government also NPL management companies—Loan Management
has a large cash buffer of €45 billion and has recently Companies (LMCs), subject to licensing in
accessed financial markets with a well-received €2.5 accordance with a rigorous approval process, and
billion bond issuance. On March 1, Moody’s upgraded Loan Transfer Companies (LTCs), which are not
Greece’s sovereign rating to B1 (stable outlook) from B3 licensed and may purchase pools of NPLs if they
citing an entrenched reform program, a strengthening have an agreement in place with an LMC. The NPL
economy, strong fiscal performance, and enhanced public law is considered to have been the major “game
debt sustainability. changer” for the debt-servicing industry.
• The management and sale of all performing
Legal and Regulatory Framework
and non-performing loans were liberalized as of
The Greek legal and regulatory framework has January 1, 2018.
undergone significant improvements in recent years to
• The option for OCWs was introduced.
create a satisfactory environment for NPL transactions.
The key changes include: • Also introduced were: (a) criteria-based
safeguards to protect individuals and institutions
• Reforms of the Greek Code of Civil Procedure,
from unwarranted civil/criminal liability as
passed and adopted between 2014 and 2017,
a consequence of their involvement in debt
were introduced to: (a) simplify the enforcement
restructuring, (b) simplified process and
framework and expedite the auction process, (b)
documentation for the licensing and operating of
improve ranking and recoveries of secured claims,
servicing platforms for banking receivables, and (c)
and (c) reduce enforcement costs.
electronic auctions for foreclosed properties.
• Improvements were introduced to enhance the
effectiveness of the pre-bankruptcy rehabilitation Quality of Information
process. The information available on Greek debt obligations
• Legislation was enacted enabling the licensing and is well developed in accordance with accounting,
regulation of non-bank service providers and loan regulatory, and reporting standards imposed by the EU.

56
 CHAPTER 4

TABLE 4.2 Greece: Summary of NPL Sales

Portfolio Eclipse Venus Amoeba Earth Arctos Jupiter Zenith Galvin

Year Oct-17 Mar-18 May-18 Jun-18 Oct-18 Oct-18 Dec-18 Jun-19
Seller Eurobank Alpha Piraeus NBG Piraeus Alpha Eurobank Piraeus
Bank Bank
Asset class Retail Retail SME Retail Retail SME Retail Retail &
Unsecured Unsecured Secured Unsecured Unsecured Secured Unsecured Commercial
Outstanding 2,900 3,700 2,100 5,200 2,300 1,200 2,000 27,000
total balance
(€ million)
Source: IFC.

Servicing Capacity and Investor Base The Greek market is rapidly becoming more competitive
Facilitated by the significant overhaul of the legal and as the first NPL portfolios are being sold, especially in
regulatory framework, the servicing infrastructure in the unsecured retail and secured corporate spaces. Table
the country is being developed. Until two years ago, 4.2 summarizes the sales completed over the last two
the servicing capacity in Greece was limited, with years in Greece. For the most part, the investors that
only a handful of local debt collection agencies and are becoming active in the country are large, foreign-
law firms. In fact, most of the NPL servicing was specialized investors attracted by major investment
managed by the banks themselves. Over the past two opportunities and the high levels of anticipated returns
years, during which servicing has been regulated, 17 compared to other more mature markets, such as the
servicing licenses have been issued by the National United Kingdom, Spain, and Ireland. Recently, banks
Bank of Greece. However, the development of servicing have started to explore more structured transactions
capacity takes time and, as such, real servicing capacity to accelerate the disposal of their NPLs, including,
has not yet been significantly established, with many for example, establishing strategic partnerships with
licensed servicers employing existing but unlicensed investors for the management of their distressed assets
“sub-servicers” in order to perform collections activity. through the carve-out of their servicing units coupled
Nevertheless, it is expected that as these new players with long-term servicing contracts.
start ramping up their operations, the servicing
infrastructure will grow to meet the market’s needs. Going Forward
As mentioned above, the first retail and corporate
distressed assets sales have been successfully closed.
BOX 4.3 DARP Involvement in Greece As the new legal and regulatory framework is tested
IFC adopted a wholistic approach to support and the macroeconomic environment improves,
the Greek financial system, with a two-pronged together with increased certainty, investors will feel
strategy to: (a) help capitalize banks with more comfortable investing and sellers will have
equity investments, and (b) help clean up their more willingness to sell. In addition, banks and
balance sheets through solutions provided by regulators are exploring new structures that allow
DARP. Along these lines, IFC is playing an active
for an increased volume of sales as well as generation
role to support the mobilization of capital and
expertise in the Greek NPL market, both in the of additional capital for banks. These include the
retail and corporate segments of the NPL market securitization of NPL portfolios with different
where IFC has already acquired two of the tranches, the introduction of guarantee schemes for
largest portfolios sold to date. these securitizations, as well as the spinoff and sale of
banks’ recovery units.

57
 CHAPTER 4

India facilities. Many of the country’s key strategic industries

are in default, which results in a critical barrier to
Market Size economic growth in India. However, there are signs
that asset quality may improve over the next quarters
As of September 2018, the NPL stock of Indian
as a result of recoveries from cases resolved under the
banks reached 9.7 trillion Indian rupees (equivalent
new insolvency code.
to approximately $134 billion) or 10.8 percent of
total credits. NPLs have grown at a CAGR of 34.8 Another relevant element to keep in mind is the
percent from March 2010 to March 2018, exceeding instability of the non-bank financial company sector in
the comparable growth rate of 13.8 percent of total India, which started in the second half of 2018, when
loan volume originated by banks over the same Infrastructure Leasing & Financial Services, one of the
time period. Problem loans have created a negative largest NBFCs, defaulted on some of its obligations.
feedback loop that dampens credit expansion as well This triggered an immediate shortage of liquidity
as financial inclusion, economic growth, job creation, across the entire sector that is affecting the capacity
and fiscal consolidation. of NBFCs to keep growing their loan books, which
may lead to a potential deterioration of their asset
The NPL problem has precipitated a spike in loan-loss
quality. Such deterioration is expected to have a greater
provisions, causing banks’ profitability and capital
negative impact on property developer and structured
to decline sharply. The banks’ loan-recovery capacity
corporate loans, with a more limited effect on retail
remains weak, and efforts to contain the rise in NPLs
loans. All of this could contribute to an overall increase
have mainly involved write-offs, leading to credit
of the total NPLs in India, even above of the volume
growth in 2017 falling to its lowest rate in 60 years.
described here.
While the problem is pervasive throughout India’s
banking sector, over 80 percent of total NPLs are held
Macroeconomic Outlook
by public sector banks, thus creating an additional
fiscal burden. With corporate loans accounting for India faced a confluence of negative factors that
about 90 percent of total NPLs, credit to this sector weakened economic performance in recent years. GDP
has been tightened. This has caused losses in both growth rate slowed to 6.8 percent in FY2019 from 7.2
production and productivity, as many project sponsors percent in FY2018, down from around 8.2 percent
are deferring planned investments in new projects or in FY2017. Despite a short-term slowdown, GDP
expansion and modernization of existing production growth is projected to strengthen to around 7.5–7.7

12.0% 90,000 12,000 12.0% 90,

10.8%
80,000 80,
10.0% 10,000 10.0%
70,000 70,

8.0% 60,000 8,000 8.0% 60,

CAGR: 13.8%
Rs BILLION

Rs BILLION

Rs BILLION
50,000 50,
6.0% 6,000 6.0%
40,000 40,
CAGR: 34.8%
4.0% 30,000 4,000 4.0% 30,

20,000 20,
2.0% 2,000 2.0%
10,000 10,

0.0% 0 0 0.0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018

Gross loans NPLs NPL ratio

FIGURE 4.7 India—Total Loans FIGURE 4.8 India—NPLs

Source: Reserve Bank of India. Source: Reserve Bank of India.

58
 CHAPTER 4

percent during FY2020—23, driven by prudent • Introduction of the new Insolvency and Bankruptcy
macroeconomic policies and ongoing reforms. A pick- Code (IBC). The IBC, promulgated in 2016,
up in investment as corporate and bank balance sheets provides for a clearly defined time-bound path for
are cleaned up will support the recovery in economic resolution, with a well-defined waterfall mechanism
momentum. However, economic weakness in FY2019 for payment of debt in case of liquidation of a
has already led to a delay, until FY2021, on plans company. It also facilitates setting up specialized
to reduce the fiscal deficit to 3 percent of GDP—the courts and creates the role of the insolvency
target has been increased to 3.4 percent of GDP for professional to deal with distressed assets cases
FY2019 and FY2020. General government debt is
on a timely basis through a restructuring process
high; in 2018 it was around 70 percent of GDP but
called the Corporate Insolvency Resolution
is projected to decline over the medium term. Private
Process. Since the new code was approved, several
debt, meanwhile, amounted to another 68 percent of
improvements have been implemented. Notably,
GDP in 2017. Foreign exchange reserves, excluding
a common concern in the early stages of the
gold, are $396 billion—around seven months of
implementation of the IBC was the uncertainty
import cover—providing the necessary cushion.
Prudent macroeconomic policies, continuation of about the continuing role of existing sponsors in
structural reforms, and improved investor confidence these companies. As a result, in November 2017,
post elections should support capital flows and the Reserve Bank of India (RBI) amended the IBC
support maintaining exchange rate stability. However, to prevent defaulting sponsors from bidding for
the escalation of global headwinds—including a their assets in resolution proceedings and regaining
sustained and meaningful rise in global crude oil control at a deep discount. In addition, in February
prices, the ongoing global growth deceleration, and 2018, the RBI introduced significant changes in the
intensification of global trade tensions—could lead to handling of distressed assets by banks, including
increased risk aversion, thereby exerting pressure on the overhaul of the distressed assets resolution
spreads and the rupee. framework by withdrawing all previous out-of-
To revive private investment, strengthen the financial court restructuring schemes.
system, and arrest the slowdown in rural and urban • Amendment of the Banking Law. The GoI issued an
consumer demand, the government needs to iron ordinance that gives wide-ranging legislative powers
out supply side bottlenecks. This would include to the RBI to issue directions to lenders to initiate
strengthening the goods and services tax revenues insolvency proceedings for the recovery of NPLs.
by further simplifying its structure and tightening Under this scheme, the RBI notified a list of 12
compliance, improving operational efficiency of the
companies that were forced to go into bankruptcy
public sector banks, strengthening the bankruptcy
proceedings, followed by another 28. Together,
resolution process, supporting financial sector liquidity,
these forty companies represent around 60 percent
channeling increased credit to SMEs, and improving
of the total NPLs in the system.
the terms of trade for the agriculture sector.
• Much more stringent NPL recognition and
Legal and Regulatory Framework provisioning. Among other requirements, the RBI
The NPL issue has been recognized by the government enforced quarterly asset quality reviews to identify
of India (GoI) as an important issue that needs early stress and make provisions, while banks were
fast and effective resolution. Thus, over the past required to provide for 50 percent for all assets
couple of years, the GoI has implemented a series of referred to IBC. Furthermore, a default against one
important reforms to revamp the legal and regulatory lender now triggers classification of the account as
environment for distressed assets resolution, an NPL by all other lenders, even if their accounts
including: are classified as current.

59
CHAPTER 4

In addition, efforts have been directed to establishing are referred to the National Company Law Tribunal
an AMC to increase asset resolution capability in (NCLT), thus helping retain value and freeing up
the country. The objective of the AMC is twofold: NCLT capacity, making the overall distressed assets
(a) to transfer NPLs from banks to AMC-managed resolution process more efficient. The AMC will
funds at market price instead of book value to avoid aim to resolve NPLs above Rs5 billion (equivalent
market distortions, and (b) to do so before these NPLs to approximately $72 million) under consortium

BOX 4.4 Insolvency, Bankruptcy, and NPL Resolution Progress in India

By Sriram Balasubramanian
The Insolvency and Bankruptcy Code (IBC) was direct or indirect interest in the companies after
one of the most anticipated reforms by the Indian going through the IBC process.
government in recent years. With an increasing
The second issue involves the integration of
number of NPLs creating enormous pressure in the
insolvency resolution professionals (IRPs) into
banking sector, there was a need for a streamlined
stressed companies. There have been instances of
insolvency and bankruptcy process.
backlash between the sponsors and creditors with
How has the performance been? the IRPs as they take control of the companies to
The NCLT, established under the Companies Act initiate the insolvency proceedings. Even though
2013 and implemented in June 2016, is a quasi- NCLT courts have helped IRPs in these cases, there
judicial body with eleven benches across India that should be a more robust mechanism to protect
adjudicates issues relating to stressed companies, IRPs when doing their jobs. Stringent action should
expected to be scaled up in the near future. As of be taken by the IBBI in response to sponsors who
March 31, 2019, 1,858 corporates had been admitted indulge in such actions.
into the resolution process. Of these, 97 have had The third challenge regards legal processes. Six
their resolution plan approved, 243 were closed on of the 12 biggest cases are stuck in legislative
appeal or review, and 378 resulted in liquidation. processes in various courts in the country. Even
The remaining 1,143 cases are undergoing if the law mandates that within 270 days the
resolution. The lenders of the 97 resolved cases, on processes must be completed, the slow legal
average, received 51 percent of their outstanding system in India works against the IBC. Some of the
debt, while it took more than 270 days for companies are appealing the verdicts by NCLT in the
approximately 70 percent of these cases to get their Supreme Court, delaying the process further. More
resolution plan approved. These cases are filed in fast-track courts are needed to handle the high
NCLT by creditors under the aegis of the Insolvency number of cases that come to NCLT for initiation of
and Bankruptcy Board of India48 (IBBI). Some of the insolvency proceedings, as is a more coordinated
significant insolvency resolutions include Bhushan mechanism for resolving these pending cases
Steel Ltd., which was acquired by the Tata Group between the Supreme Court and the NCLT.
for a majority stake. Lenders received around 63
The fourth major challenge is the ability of local
percent of their outstanding debt. As IBBI matures
banks to take haircuts to resolve their NPLs. While
into an organization dealing effectively with
the recent recapitalization drive by the government
stressed assets, there has been a considerable
improvement in its public perception. is welcome, more haircuts will be required until
the IBC mechanism is streamlined and NPL issues
What are the challenges? How can it be made better? are sorted out. Furthermore, bankers’ fear of being
The first challenge relates to the ability of sponsors investigated for their actions to resolve these
to regain control of their companies, often at steep cases also serves as a deterrent in the complex
discounts, or disrupting the process. Despite an bureaucratic system in India. It is important that
amendment made to the IBC in 2017, there are still the regulator provides unambiguous support for
loopholes that need to be addressed to bolster the bankers involved in terms of both legal and job
transparency by barring sponsors from having any protection for doing their respective jobs.

60
 CHAPTER 4

lending. It will be an independent entity with a robust Quality of Information

governance structure with the expectation that at least While laws for recognition and provisioning of NPLs in
51 percent is privately owned. The AMC has been India are at par with Basel III, banks have traditionally
already incorporated under the name of Sashakt India underreported NPLs. However, the RBI has become
Asset Management Limited. more stringent in the classification of NPLs and insists
In addition, recently a new Inter Creditor Agreement on standardized NPL reporting. These measures have
(ICA) has been implemented that also aims to help created an enabling environment that can attract
overcome some of the existing issues in the resolution private capital at scale for investment in distressed
of distressed assets. The ICA seeks to resolve loans assets resolution.
of Rs500 million (equivalent to approximately $7.2
million) or more which are under consortium lending. Servicing Capacity and Investor Base
The approach of the ICA is completely in line with On paper, the servicing infrastructure in India has been
IBC and existing regulations and focuses on arriving established for over a decade. In fact, more than a dozen
at a consensus among multiple lenders and reducing Asset Reconstruction Companies (ARCs) have been
the delays in resolution that exist today. For that, roles operating in the country for several years. However,
have been assigned to each of the key stakeholders most of these ARCs limited their strategies to the pure
involved to ensure efficiency in the pre-resolution liquidation of the underlying assets. Therefore, not much
process. As of December 2018, 34 banks and other actual servicing capacity and workout expertise was
financial institutions had signed up the ICA. developed. As a result of the implementation of the IBC,
a new generation of ARCs and new distressed assets
It is important to note that in April 2019 the Supreme
managers are being established. These include a few of
Court of India overruled the RBI circular from
the previous ARCs that have stayed active, coupled with
February 12, 2018, which stipulated that banks
unable to arrive at a debt-resolution plan within 180
days for loan accounts of Rs20 billion (equivalent to BOX 4.5 DARP Involvement in India
approximately $287 million) or more had to bring the
IFC and the World Bank have developed a
defaulter into the IBC process. The Court judgment programmatic approach that includes a series
stated that the provisions in the RBI’s circular were of initiatives to help develop a distressed
ultra vires, that is, beyond the RBI’s legal authority, assets market in India. The World Bank Group’s
and all cases currently in the resolution process could FCI GP is providing technical assistance to
strengthen the credit environment, particularly
therefore not continue through the IBC process.
by improving implementation and operational
On June 7, 2019, RBI issued another circular by use of the IBC to improve debt recovery. For
which it revised its guidelines on distressed assets instance, they have assisted IBBI in developing
resolution, facilitating workouts and out-of-court its insolvency practitioner regulation. IFC
negotiations among stakeholders. Some of the key has been systematically supporting a range
of solutions for distressed assets through its
changes are: (a) the size threshold of cases for which
DARP program. In 2015, IFC invested in a non-
a debt-resolution plan needs to be implemented bank financial company, Altico, that focuses on
within 180 days has been lowered to loan accounts providing special lending to stressed SMEs in
of Rs15 billion (equivalent to approximately $215 partnership with Clearwater Capital Partners.
million), (b) the share of lenders needed to approve In the same year, IFC, together with Encore
Capital, set up an ARC that targets distressed
the debt-resolution plan has been reduced, (c) lenders
assets resolution in the retail and MSME sectors.
can reverse provisions at the time of filing and at the Finally, in 2018, IFC invested in IndiaRF, a joint-
time admission of the case under IBC, and (d) after venture fund between Bain Capital Credit and
a default, the number of days that lenders have to Piramal Enterprises, focused on restructuring
discuss and decide on the resolution plan has been large businesses in distress.
increased to 30 days.

61
 CHAPTER 4

a number of new ARCs that are being established by Turkey

new entrants in the market.
Competition in the distressed assets market in India Market Size
is still limited. International investors have started to Following a decade of elevated economic growth
establish their presence in the market and, more often in Turkey, the total volume of loans increased
than not, are doing so through partnerships involving significantly because of rising demand for credit, both
domestic investors with the goal of combining track from individuals and households, as well as SMEs
record and expertise in distressed assets resolution with
and corporates. In December 2018, total loans in
the required local knowledge to successfully operate in
Turkey reached 2.4 trillion Turkish lira (equivalent
India. Most of these new investors are focusing their
to approximately $453 billion), having increased at a
attention on the larger distressed cases that are coming
CAGR of 20.9 percent since 2010. The main drivers
to market. However, in the smaller corporate spaces,
behind such growth were commercial and SME
as well as the retail and SME space, competition is still
loans. In addition, the volume of foreign-currency
quite limited.
denominated loans has also been growing in Turkey,
which poses an increasing risk to the credit quality of
Going Forward
the overall loan book given the significant volatility
As mentioned above, resolving the issue of elevated
that the Turkish lira has been experiencing.
levels of NPLs is a priority for the GoI. With the new
insolvency code in place and the active role of the RBI, Because of the recent negative macroeconomic situation,
some of the largest distressed assets situations have the NPL levels have continued to rise in Turkey. The
already been or are on their way to being resolved, total stock of NPLs grew from TL 64 billion (equivalent
despite taking more time than anticipated. A positive to approximately $16.9 billion) in December 2017,
outcome will result in more trades coming to market, representing a an NPL ratio of 2.9 percent, to TL 97
both related to large corporate and SMEs, while in billion (equivalent to approximately $18.3 billion) as
parallel new players will want to play a role in the of December 2018, representing an NPL ratio of 3.9
Indian distressed assets market. In addition, bilateral percent. In addition, based on the result of a stress test
structured transactions, which require more skilled performed by the Banking Regulation and Supervision
asset managers, are also taking place. Agency (BRSA), the NPL ratio could reach as high as

5% 2500 120 5%

100 3.9%
4% 2000 4%

80 CAGR: 21.8%
CAGR: 20.9%
3% 1500 3%
TL BILLION
TL BILLION

TL BILLION
60
2% 1000 2%
40

1% 500 20 1%

0% 0 0 0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018

TRY loans FX loans Consumer loans Residential loans Business loans

NPL ratio

FIGURE 4.9 Turkey—Total Loans FIGURE 4.10 Turkey—NPLs

Source: BRSA. Source: BRSA.

62
 CHAPTER 4

6 percent by the end of 2019. To add to the potential size Legal and Regulatory Framework
of the NPL problem in Turkey, there is the worrisome The Turkish Execution and Bankruptcy Law,
increase of Stage II loans (defined as loans whose credit promulgated in 1932, has been amended many times
risk has raised significantly). In fact, total Stage II loans since enactment, most recently in March 2018.
within the thirteen largest banks in Turkey have reached Key amendments in the latest reform included the
TL 238.5 billion (equivalent to approximately $45.1 abolishment of the postponement of bankruptcy
billion) in December 2018 and are expected to increase mechanism and the modernization of the already
further to an estimated TL 275 billion (equivalent to existing restructuring proceeding (Konkordato), which
approximately $47.3 billion) in December 2019. This had barely been used in recent years. Konkordato
rapid increase in Stage II loans is a clear symptom that is a court-led process aimed at restructuring the
the quality of the loans across the Turkish banks is outstanding debt of viable but distressed companies.
rapidly deteriorating. Therefore, when adding the loans Either the debtor or a creditor can apply to the court to
already classified as NPLs and the Stage II loans, the put the debtor into Konkordato.
total ratio gets closer to 15 percent, which is a clear
The Konkordato is not suitable for many large-scale
indication of the large NPL problem in the country.
corporate group restructurings, as it is only available
Macroeconomic Outlook to restructure obligations of a single legal entity. In
addition, two other downsides are: (a) the excessive
Macroeconomic and political vulnerabilities continue
degree of involvement of the court and (b) the strong
to weigh on Turkey’s economic outlook. Currency
protections afforded to privileged creditors, including
weakness recurred ahead of the March 31, 2019
tax and labor claims.
municipal elections, driven by renewed tensions with the
United States, a sudden reduction in already low levels To mitigate the shortcomings identified in the
of gross and net foreign exchange reserves, and ongoing Konkordato, Turkish authorities decided to promote
unconventional anti-inflationary policies. Uncertainty out-of-court restructurings as a meaningful alternative
was not eased by local elections held in May, given to address corporate distress. The ultimate objective
victories by the opposition in several cities and a was to replicate the experiences observed under the
decision to rerun Istanbul’s municipal election on June Istanbul Approach in the early 2000s, when the
23. On the economic front, a recession in the second Turkish banks were able to work with other financial
half of the year reduced full-year growth in real GDP institutions outside of formal procedures to restructure
to 2.6 percent in 2018, the lowest since 2009. Output their outstanding debts. With this objective in mind,
is set to contract by 2.5 percent this year, according to the BRSA enacted the Regulation on the Restructuring
the IMF, as tight credit continues to negatively impact of Debts to the Financial Sector (Regulation). The
domestic spending along with high interest rates and Regulation instructed the Turkish Banking Association
inflation. Low foreign exchange reserves will require to develop a Framework Agreement establishing
the Central Bank of Turkey to keep interest rates high the general principles and rules applicable to the
to steady the lira and prevent 12-month inflation from restructuring of large corporate debtors by domestic
rising from 18.7 percent in May. The IMF projects the financial institutions. The Framework Agreement
economy to recover in 2020, with growth averaging was signed in October 2018 by the Turkish banks,
just 3.1 percent between 2020 and 2024, that is, 3.7 accounting for 90 percent of the total loan volume
percentage points below the 2010–17 average. There are in the market. As opposed to the Konkordato, the
significant downside risks to the outlook, however, with Framework Agreement allows the restructuring of
higher inflation expectations, constrained Turkish lira multiple debtors in the same corporate group as part of
bank credit given increasing dollarization of deposits, a single process. Some of the most important features
significant uncertainty about bank asset quality of the Framework Agreement include:49
including future capital positions, and significant • A standstill on framework creditors upon
external and domestic challenges. application by a debtor to start a restructuring

63
CHAPTER 4

• The formation of a consortium of framework creditors constitutes an NPL and a Stage II loan, showing a gap
• A cram-down mechanism where dissenting between local and international practices with respect
framework creditors can be forced to reschedule to NPL classification. As a result, official NPL figures
their debts if two-thirds (by value) of the consortium may not reflect the actual level of NPLs on banks’
of framework creditors enter into a financial balance sheets, as many Stage II loans are loans that
restructuring agreement; higher thresholds are have been restructured or that are benefiting from
required for specific restructuring measures standstill provisions.

• The obligation on all framework creditors to

Servicing Capacity and Investor Base
provide new money to the debtor if such decision
is approved by lenders representing 90 percent (by There is a long tradition of NPL sales in Turkey. Sales to
value) of consortium framework creditors the local asset management companies started in 2004,
when a large stock of NPLs resulting from the financial
• A requirement to complete the process in 90 days, a
crisis of 2001 was sold by the Savings Deposit Insurance
period that may be extended by 60 additional days
Fund. This sparked the creation of the NPL market in
by the consortium of framework creditors
Turkey. Following some regulatory changes, in 2008
• A limit to debtors of two applications within the regular sales of NPLs to AMCs by banks and other
two-year period in which the Framework Agreement
financial institutions started. Since then, it is estimated
remains in force
that a total NPL volume of TL 38 billion (equivalent to
Although the Regulation was a strong endorsement to approximately $6 billion) have been sold to AMCs.
out-of-court restructuring in Turkey, a number of key
Enabled by the development of the NPL market, a
factors remain unclear, including whether creditors
number of AMCs were established. Currently there are
that have not signed up to the Framework Agreement
sixteen active AMCs, although the two leading ones,
may be bound by agreements adopted by the majority,
Hayat and Gelecek, have the lion’s share of the market.
especially international lenders. The Framework
Agreement permits the participation of international Historically, the bulk of these sales have been in
lenders in Turkish restructurings, but it explicitly states unsecured retail NPLs, the asset class in which many
that they are not bound by the creditor voting matters
under the Framework Agreement unless they have
explicitly elected to opt in. Other questions remain, BOX 4.6 DARP Involvement in Turkey
including details of the viability test that the debtor Since the inception of the market in 2008,
needs to comply with to access the procedure and DARP has closely followed the market, but,
successfully approve a restructuring plan. given the high levels of liquidity that the AMCs
have traditionally enjoyed, there has not been
The lack of tax incentives and the excessive disclosure a market need for IFC to engage. However,
requirements imposed on distressed applicants have following the country’s macroeconomic
prevented the adoption of any restructurings under deterioration and the reduction in available
the Framework Agreement during its first months liquidity to AMCs from local banks, coupled
with the rising level of NPLs, DARP is getting
of operation. As of June 2019, the authorities were
more involved in both (a) collaborating with
considering the possibility of adopting a law that would other units of the World Bank Group to support
address these shortcomings. the Turkish authorities in the development
of an adequate regulatory framework for NPL
Quality of Information restructuring and (b) exploring areas where
it can play a role to support the development
Generally speaking, the quality of information of the required resolution infrastructure and
available is adequate. However, given the increasing the mobilization of capital from private sector
volume of Stage II loans, as described above, it has distressed assets investors.
become clear that there is a lack of clarity on what

64
 CHAPTER 4

of the AMCs have specialized. However, this new Ukraine

wave of NPLs is expected to be composed mostly of
secured SME and corporate loans. Therefore, there is Market Size
a potential lack of resolution infrastructure for these
Ukraine’s NPLs were reported at 630.8 billion
asset classes that will have to be developed. Ukrainian hryvnias (equivalent to approximately $22.8
It is worth noting that AMCs are not only pure billion) in December 2018, with an NPL ratio of 52.8
servicing companies, but also investment companies, percent. In addition, the Deposit Guarantee Fund,
as they must acquire the NPLs on-balance sheet. established in 1998 to manage the assets of the insolvent
Therefore, this poses a potential impediment for banks in the country, has an additional approximately
foreign investors to enter the market. In fact, the $20 billion of NPLs under management. While NPLs
investor base has been traditionally dominated by have been increasing at a CAGR of 35.3 percent since
local investors. 2008, credit growth has been lagging well behind,
increasing at a CAGR rate of 4.3 percent over the same
Going Forward period. Legacy foreign-currency denominated loans
issued years ago account for close to half of corporate
As the NPL problem becomes more acute in Turkey,
NPLs and about three-quarters of retail NPLs.
a number of different options are being explored to
reduce the burden that such a large stock of NPLs is Macroeconomic Outlook
imposing on lending in the economy. Some of these
Ukraine’s economic outlook remains uncertain. The
options are:
14-month, $3.9 billion IMF standby program approved
• Sales to AMCs: This has been a very common in late 2018, has bought time by providing a policy
avenue used by financial institutions to dispose of anchor and much-needed funding. However, medium-
their NPLs. However, the bulk of these sales has term risks loom large. On April 21, 2019, Volodymyr
involved unsecured retail NPLs, which raises the Zelenskiy, a comedian with no political experience,
question of whether AMCs are equipped to deal won a landslide victory to become the next president
with the increasing volume of potential sales of SME of Ukraine. On May 20, 2019 he was inaugurated and
and corporate NPLs. promptly dissolved parliament. The new parliamentary
election is set for July 21, 2019. As a result of the
• Debt-to-equity swaps: For certain large exposures,
elections, the first review of the IMF program has
where there is more than one bank lending to a
been delayed, postponing much-needed disbursements.
common borrower, debt-to-equity swap structures
Ukraine has substantial external financing needs with
are being explored to be able to take control of the
principal payments on government and private external
company and implement a sound restructuring plan
debt due in 2019 and in 2020 amounting to $15.9
under new management. So far, these are being
billion and $18.7 billion, respectively. IMF funding,
considered in the case of energy and real estate
therefore, is essential for sustaining debt servicing and
related exposures. accessing international capital markets.
• Securitizations: Following the example of what has Real GDP growth picked up to 3.3 percent in 2018
happened in other markets such as Italy, Ireland, from 2.5 percent in 2017, partly driven by an unusually
or Spain, banks are exploring securitizations as high harvest. The IMF forecasts growth to slow to 2.7
a mechanism to offload large volumes of NPLs. percent in 2019, before increasing to 3 percent in 2020.
However, securitization is currently only available However, the outlook is subject to downside risks,
for performing loans, while the domestic investor in particular from a lack of progress on structural
base is insufficient to absorb the expected volumes. reforms, political risks, and the continuing conflict
Furthermore, offshore securitizations looking to in eastern Ukraine. Inflation remains high, averaging
attract larger investors are still very costly. 11 percent in 2018, well above the 5 percent target

65
 CHAPTER 4

1,600 1,600 700 700 60% 60%

52.8% 52.8%
1,400 1,400 600 600 50% 50%
1,200 1,200 500 500
CAGR: 4.3%
CAGR: 4.3% 40% 40%
Hrv BILLION

Hrv BILLION

Hrv BILLION

Hrv BILLION
1,000 1,000
400 400
800 800 CAGR: 35.3%
CAGR: 35.3% 30% 30%
300 300
600 600
20% 20%
200 200
400 400
100 100 10% 10%
200 200
0 0 0 0 0% 0%
2008 2009 2008
2010 2009
2011 2010
2012 2011
2013 2012
2014 2013
2015 2014
2016 2015
2017 2016
2018 2017 2018 2008 20092008
20102009
20112010
20122011
20132012
20142013
20152014
20162015
20172016
20182017 2018
Gross loansGross loans NPLs NPLsNPL ratio NPL ratio

FIGURE 4.11 Ukraine—Total Loans FIGURE 4.12 Ukraine—NPLs

Source: Financial Soundness Indicators, IMF. Source: Financial Soundness Indicators, IMF.

which, accompanied by a widening external deficit, A locally based administrative secretariat has
led to aggressive monetary tightening in 2018. Even been set up and is responsible for managing the
though international reserves have increased over the restructuring framework, including processing
past four years, they only account for three months of individual restructuring cases. The law also provides
imports, or 66 percent of the IMF’s adequacy metric. for an arbitration committee to manage any disputes
Beyond 2020, Ukraine faces external challenges related between parties by appointing an independent and
to the loss in fees for transiting Russian natural gas to qualified arbitrator.
Europe, potentially increasing depreciation pressures In addition, a March 2017 review of the overall legal
(consensus forecast a 11.6 percent depreciation against and regulatory framework for distressed assets was
the U.S. dollar over the next two years). The new conducted by the World Bank Group and updated in
government will likely need to secure a larger IMF early 2018. The 2017 review identified 17 areas for
program to meet escalating external debt servicing improvement.50 The 2019 monitoring update found
needs beyond 2020, when the current IMF program is that progress had been made in several areas with other
due to expire. areas still needing improvement. The main areas where
almost definitive progress was achieved included debt
Legal and Regulatory Framework enforcement and foreclosure, the tax regime, as well as
Ukraine’s new law on financial restructuring (approved public registers. Other areas where significant progress
by its parliament on June 14, 2016 and put in place was recognized include corporate and household
October 19, 2016) was drafted with the help of insolvency and restructuring, debt counseling and
both the European Bank for Reconstruction and outreach, as well as NPL governance and workout.
Development (EBRD) and the World Bank. Under In April 2019, the new insolvency code was approved
the new law, lenders and borrowers can restructure and will come into force later in the year. This
their loan agreements through voluntary out-of-court code revamps the Ukrainian insolvency system and
mechanisms. The law aims to help distressed Ukrainian introduces, for the first time in Ukrainian history, a
companies regain viability through mechanisms such personal insolvency process. While this amendment
as loan rescheduling, partial-debt forgiveness, and intends to strengthen the development of a robust
the conversion of debt to equity. A limited standstill legal and regulatory framework for NPL resolution in
on lender action is provided as well as protection to Ukraine, its adequate implementation (strengthening the
borrowers from new bankruptcy proceedings while performance of courts and insolvency administrators)
restructuring negotiations are in progress. will be critical to improve the system in practice.

66
 CHAPTER 4

Quality of Information
Data collection in Ukraine is disciplined in most areas, BOX 4.7 DARP Involvement in Ukraine
but the quality of information suffers from legacy Shortly after the global financial crisis, DARP
regulations (including definitional problems, such as identified Ukraine as one of the economies
for NPLs) as well as from ambiguous and inconsistent where it could play a significant role in
banking practices. Furthermore, the lack of public developing a distressed assets market. Several
attempts were made to put in place structures
registries and absence of registration requirements
for acquiring and resolving NPLs. However,
for loan sales place limits on the data available for while the market size was sufficient, neither
assessing meaningfully the commercial potential of the quality of the information nor the legal and
alternative distressed assets investment strategies regulatory framework allowed for transactions
prior to undertaking transaction due diligence. These to be consummated. Since then, DARP has
worked closely with the World Bank Group’s
problems do not preclude investor interest but raise the
FCI GP to identify improvements that should be
upfront costs of transactions. implemented for developing a distressed assets
market. As these operational building blocks are
Servicing Capacity and Investor Base put in place, DARP is seeking ways to extend its
global strategy to Ukraine.
The distressed assets market in Ukraine is embryonic,
as is the servicing infrastructure of the country. After a
few years during which some servicers were established
by both local and international investors, with some of to this market. Consequently, the level of competition
them even expanding their operations internationally, needed to develop an orderly and efficient distressed
the development of the servicing infrastructure has assets market will still take time.
recently stalled. As the regulatory framework is
strengthened and the need to clean up the banks’ Going Forward
balance sheets becomes increasingly pressing, activity
The framework for investing in distressed assets in
in the servicing industry is picking up, with some
Ukraine is not yet fully in place. However, the fact that
transactions recently taking place.
the different stakeholders are aligned to undertake the
Similarly, the potentially active investor base in required improvements, together with a large volume
Ukraine is still very limited, mostly involving local of NPLs and a recovering economy, makes it highly
investors looking to diversify their asset base. likely that attractive investment opportunities will be
International investors, for the most part, are not yet identified in the short- to mid-term, especially in asset
comfortable enough to take on significant exposure classes that are less reliant on the judicial system. n

67
CONCLUSION
Increasingly, high NPL levels in emerging economies are foster and promote the development of robust and
limiting the ability and appetite of financial institutions credible insolvency and legal resolution frameworks—
to extend new credit. Consequently, across emerging prerequisites for well-functioning distressed assets
markets, access to financing is significantly reduced, the markets. Moreover, collaboration in setting up well-
stability of the financial systems of these economies is designed AMCs effectively complements private sector
threatened, and their economic growth or recovery is efforts led by DARP.
severely hindered. In this context, robust distressed assets
In addition to the significant development impact
markets are essential for recycling these large amounts
achieved by creating these distressed assets markets,
of non-productive assets, allowing economies to restore
there are attractive investment opportunities. And
financial stability and enable economic growth. Given
the magnitude and the severity of the issue, collaboration while opportunities for distressed assets investments
among all stakeholders involved, including, including are present across all emerging markets, countries
both the public and private sectors, is critical. such as Brazil, China, Greece, India, Turkey, and
Ukraine currently warrant special consideration for
DARP has been playing a crucial role in creating and
investors. DARP will also continue to expand its reach
developing such distressed assets markets as a tool to
in underserved regions such as Sub-Saharan Africa and
foster economic development across emerging markets.
MENA, contributing to making these markets more
As part of its strategy, DARP has been focusing on
attractive for the private sector.
two main pillars. First, it has been building essential
servicing infrastructure and resolution capacity, the Much has been achieved by DARP with support from
lack of which is a major bottleneck for the development various partners and stakeholders. However, given
of vibrant distressed assets markets. Second, it has the scale of the NPL issue, much remains to be done
been mobilizing the required capital and expertise from for emerging economies to regain financial stability
the private sector, both internationally and in local and economic growth. In pursuing its goal to create
markets, to have a meaningful impact on the resolution and develop strong distressed assets markets, DARP
of these large volumes of NPLs. will continue to exercise its leadership in this space,
One of the key aspects of DARP’s success has been leveraging its unique global servicing infrastructure
the close collaboration with the World Bank to and its capacity to mobilize private sector players. n

69
REFERENCES
1 For a more comprehensive description of IFC 3.0 and the Cascade, see: IFC. 2019. “IFC Strategy and Business Outlook Update FY20–
FY22 : Gearing up to Deliver IFC 3.0 at Scale,” 11–19. http://documents.worldbank.org/curated/en/567541556555433909/IFC-Strategy-
and-Business-Outlook-Update-FY20-FY22-Gearing-up-to-Deliver-IFC-3-0-at-Scale.
2 World Bank. 2017. “Growth for the Bottom 40 Percent: The World Bank Group’s Support for Shared Prosperity.” World Bank Group,
Washington, DC., March. https://ieg.worldbankgroup.org/sites/default/files/Data/Evaluation/files/sharedprosperity.pdf.
3 It is essential to recognize that distressed assets resolution of and by itself cannot carry the full burden of improved quality of credit
expansion. Loan origination and underwriting standards in lending institutions, the quality of regulatory institutions, their rules and
execution, as well as the design and execution of features of the national insolvency regime all play a key role in the health of financial
sector expansion.
4 The discussion of differences between portfolios of distressed loans and performing loans that follows draws from or was inspired by
Milam, Robert. 2007. “How to Trade Loans and the Strategies to Use” in Allison Taylor and Alicia Sansone, “The Handbook of Loan
Syndications & Trading.” 2007. McGraw Hill, 404.
5 A bad bank is an entity established to acquire distressed assets from either failed financial institutions or from banks with excessive levels of
NPLs, with the objective of managing and enhancing recoveries from these distressed assets.
6 The International Development Association (IDA) is the part of the World Bank that helps the world’s poorest countries. See http://ida.
worldbank.org/.
7 Ibrahim, Moe. 2006. “An Overview of Distressed Debt.” Eurekahedge, August. http://www.eurekahedge.com/Research/News/921/An_
Overview_of_Distressed_Debt.
8 DePonte, Kelly. 2007. “An Overview of the Private Equity Distressed Asset Markets.” In the Guide to Distressed Debt and Turnaround
Investing, edited by Kelly DePonte. London: Private Equity Capital. http://probitaspartners.com/pdfs/distressed_debt_kd_2006.pdf.
9 Jain, Sameer. 2011. “Investing in Distressed Debt.” UBS Alternative Investments, June 15. https://papers.ssrn.com/sol3/papers.
cfm?abstract_id=1865378.
10 DePonte, Kelly. 2007. “An Overview of the Private Equity Distressed Asset Markets.” In the Guide to Distressed Debt and Turnaround
Investing, edited by Kelly DePonte. London: Private Equity Capital. http://probitaspartners.com/pdfs/distressed_debt_kd_2006.pdf.
11 DePonte, Kelly. 2007. “An Overview of the Private Equity Distressed Asset Markets.” In the Guide to Distressed Debt and Turnaround
Investing, edited by Kelly DePonte. London: Private Equity Capital. http://probitaspartners.com/pdfs/distressed_debt_kd_2006.pdf.
12 World Bank. 2018. “World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes” (the “WB Principles”), A1. World Bank,
Washington, DC. http://www.worldbank.org/insolvency.
13 World Bank. 2018. “World Bank Out-of-Court Toolkit.” World Bank, Washington, DC. http://documents.worldbank.org/curated/
en/851561511964075432/A-toolkit-for-out-of-court-workouts.
14 Garrido, Dr. Jose Maria. 2011. “Out-of-Court Debt Restructuring.” Paper presented at roundtable at World Bank ICR Task Force meeting,
Washington, DC, January 2011. https://www.insol.org/_files/Africa%20Round%20Table/outofcourt.pdf.
15 I Garrido, Dr. Jose Maria. 2011.
16 IMF. 2010. “Approaches to Corporate Debt Restructuring in the Wake of Financial Crises.” Washington, DC. https://www.imf.org/
external/pubs/ft/spn/2010/spn1002.pdf.
17 PwC. 2016. “The Use of Restructuring to preserve value.” PwC, June. https://www.pwc.com/ng/en/assets/pdf/restructuring-to-preserve-
value.
18 Bank of England. 1996. “The London Approach and trading in distressed-debt.” https://www.bankofengland.co.uk/-/media/boe/files/
quarterly-bulletin/1996/the-london-approach-and-trading-in-distressed-debt.
19 I Garrido, Dr. Jose Maria. 2011.
20 World Bank and UNCITRAL. 2011. “Creditor Rights and Insolvency Standard.” Revised draft, World Bank, Washington, DC., January
20. http://siteresources.worldbank.org/INTGILD/Resources/ICRStandard_Jan2011_withC1617.pdf.
21 Garrido, Dr. Jose Maria. 2011. “Out-of-Court Debt Restructuring.” Paper presented at roundtable at World Bank ICR Task Force meeting,
Washington, DC, January 2011. https://www.insol.org/_files/Africa%20Round%20Table/outofcourt.pdf.
22 World Bank. 2018. “The World Bank Principles of Effective Insolvency and Creditor rights.” World Bank, Washington, DC. http://www.
worldbank.org/en/topic/financialsector/brief/the-world-bank-principles-for-effective-insolvency-and-creditor-rights.
23 Data in the chart comes from the Doing Business Report. See: World Bank. 2018. Doing Business 2018. Washington, D.C.: World Bank
Group. http://www.doingbusiness.org/en/reports/global-reports/doing-business-2018.
24 European Commission. 2018. “New rules facilitating cross-border insolvency proceedings enters into force today.” Européen Commission.
Brussels, June 26. http://europa.eu/rapid/press-release_IP-17-1743_en.htm.
25 Garrido, Dr. Jose Maria. 2011. “Out-of-Court Debt Restructuring.” Paper presented at roundtable at World Bank ICR Task Force meeting,
Washington, DC, January 2011. https://www.insol.org/_files/Africa%20Round%20Table/outofcourt.pdf.

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26 European Commission. 2016. “Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on
preventive restructuring Framework, second chance and measures to increase the efficiency of restructuring, insolvency and discharge
procedures and amending Directive 2012/30/EU.” European Commission. Strasbourg, November 22. https://eur-lex.europa.eu/legal-
content/en/TXT/?uri=CELEX:52016PC0723.
27 KPMG. 2017. “Tax impediments to the sale of non-performing loans (‘NPLs’) in Central and South Eastern Europe (‘CESEE’),” September.
http://npl.vienna-initiative.com/wp-content/uploads/sites/2/2016/09/NPL-Tax-Article-KPMG-08092016.pdf.
28 I KPMG. 2017.
29 I KPMG. 2017.
30 This policy brief was prepared for the World Bank/FINSAC conference on a comprehensive approach to NPL resolution held in Vienna on
May 15–16, 2018.
31 For instance, banks will wait for the AMC to “give them a better deal.”
32 For instance, assets may be grouped by specific location, borrowers’ repayment capacity, maturity,. and assigned a time frame for disposal.
33 Example in the NAMA act (Article 10): NAMA should “deal expeditiously with the assets acquired by it and protect or otherwise enhance
the value of those assets in the interest of the State.” Section 221 states that any attempt to influence NAMA is an offence.
34 Providing market-based compensation to management has proven a challenge to many AMCs particularly during times of fiscal constraint.
Danaharta instituted staff bonuses tied to meeting Key Performance Indicators. More recently, BAMC came under fire when it was
disclosed that key staff members were receiving fees from BAMC borrowers for services such as directorships as part of their compensation.
Beyond compensation, another important feature is the legal protection of their staff to allow them to pursue recovery actions effectively.
35 The European Commission’s recently published AMC blueprint provides a comprehensive discussion of reporting requirements to meet
both EU and national standards.
36 For instance, an oversight committee composed by three representatives (one from the Ministry of Finance, one from the Central Bank, and
one from the Securities Commission) did oversee, approve, and terminate appointments of special administrators by Danaharta.
37 Out of court workouts are nonjudicial, private contractual arrangements between the debtor and its creditors (all or just some of the
creditors). They are not typically provided for in insolvency legislation, but are instead the result of consensual negotiations, which is why
many workouts are considered “informal.” Parties are free to negotiate the terms of their restructuring agreement without involving the
court. This typically means that workouts are flexible, fast, and less expensive than litigation.
38 Directive 2014/59 EU on bank recovery and resolution; EU regulation 806/2014 establishing uniform rules and a uniform procedure for the
resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution
Fund.
39 Impaired Asset Communication, Section 40.
40 Chaebols are family-owned large conglomerates which dominated the South Korean economy and played a significant role in politics (for
example, Daewoo, Hyundai).
41 Reform movement in the post-Suharto era.
42 Throughout this chapter we have used the foreign exchange rate corresponding to the periods referred to in each specific section. Source:
Reuters.
43 Some investors, however, will risk further declines in asset values to make opportunistic plays.
44 Quality includes having information on borrowers and collateral that is timely (regularly updated), comprehensive and reliable.
45 The rating system in Brazil not only considers arrears, but also the borrower’s risks: financial and economic situation, indebtedness level,
capacity to generate results, etc. It also considers the nature of the transaction and collateral, if any. The scale goes from AA to H, with AA
being the highest quality.
46 Tanner DeWitt Solicitors. 2007. “Reform of the Bankruptcy Regime in the People’s Republic of China.” https://www.tannerdewitt.com/
reform-of-the-bankruptcy-regime-in-the-peoples-republic-of-china/.
47 In July 2015, the Troika agreed with the Greek government on a third three-year financial aid program, expiring on August 20, 2018.
48 IBBI. 2019. “The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, January–March 2019,” Volume 10. https://ibbi.
gov.in/.
49 Wallace, Ian et al. 2019. “Restructuring in Turkey: A new paradigm?” White & Case, April 11. https://www.whitecase.com/publications/
insight/restructuring-turkey-new-paradigm.
50 These were: judicial system, tax regime, NPL write-offs, collateral valuation, debt enforcement/foreclosure, corporate insolvency, and
restructuring, NPL governance/workout, sale of loans, public registries, household insolvency and restructuring, and debt counselling and
outreach.

71
FURTHER READING
Additional reports about investing in challenging markets, the role of technology in
emerging markets, as well as a list of EM Compass Notes published by IFC Thought Leadership:
ifc.org/thoughtleadership

Creating Impact: The Promise of

Impact Investing
April 2019, 82 pages

Impact investing has emerged as a significant opportunity to mobilize

public and private capital into investments that target priority development
needs, particularly in emerging markets. Investors are increasingly
looking to invest with impact by aligning their strategies to achieve the
UN Sustainable Development Goals. To better understand what it would
take to scale up credible impact investing, IFC published the “Creating
Impact: The Promise of Impact Investing” report, which offers the most
comprehensive assessment to date of the potential global market, along
with practical suggestions for next steps.

Reinventing Business Through

Disruptive Technologies: Sector Trends
and Investment Opportunities for Firms
in Emerging Markets
March 2019, 108 pages

Technology disrupts and transforms. And disruptive technologies are critical to

achieving the Sustainable Development Goals, many of which can be advanced
and accelerated through technological innovations.
For a comprehensive examination of the ways these innovations alter private
sector business models in emerging markets, IFC conducted a tour of the
technology horizon in eight selected sectors—power, transport, water and
sanitation, digital infrastructure, manufacturing, agribusiness, education, and
financial services—and six selected themes, from gender and climate-smart
cities to e-logistics and personal identification, among others.
This report examines each of these sectors and themes in terms of what true
disruption looks like, which technologies are most likely to have a dramatic
impact, and the specific opportunities they offer. It also identifies the challenges
and constraints that will need to be surmounted if the private sector is to
seize these opportunities. Lastly, it presents how IFC supports companies and
investors in their efforts to enter into or expand in emerging markets.

72
Blockchain: Opportunities for Private
Enterprises in Emerging Markets
January 2019 (Second and Expanded Edition), 88 pages

Over the course of two years, IFC worked with key influencers and experts in
the worlds of distributed ledgers and digital finance to create a series of nine
papers examining the potential and perils of blockchain. An initial report with six
chapters was published October 2017. Since then, three additional in-depth notes
have been added to broaden and deepen our understanding of this burgeoning
technology, its enormous potential, and its many challenges. These documents
collectively examine the general contours and technology underlying blockchain
and its implications for emerging markets.
Specifically, this report provides an examination of blockchain implementation
in financial services and global supply chains; a regional analysis of blockchain
developments in emerging markets; and a new focus on blockchain’s ability to
facilitate low-carbon energy solutions, as well as a discussion of the legal and
governance issues associated with the technology’s adoption.

How Technology Creates Markets:

Trends and Examples for Private
Investors in Emerging Markets
April 2018, 100 pages

Technological progress is often associated with the creation of novel and useful
products through innovation and ingenuity. Yet in many emerging markets,
including low-income economies, it is often more common to adopt, adapt, and
scale technologies that were created elsewhere.
This report focuses on how technology is contributing to market creation and
expansion in emerging markets. It includes analysis and examples of increased
access to products and services—energy, financial, and other types—that have
been unavailable to large population segments. The report also looks at the
impact of technology on market participants, ecosystems, and existing players.

73
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Cerruti, Caroline and Ruth Neyens. 2016. “Public Asset Management Companies—A Toolkit. World Bank
Group, 2016. https://openknowledge.worldbank.org/bitstream/handle/10986/24332/9781464808746.
pdf?sequence=2&isAllowed=y.

EU Commission Staff Working Document. 2018. “AMC Blueprint—Accompanying the document ‘Communication
From the Commission to the European Parliament, The European Council, and the European Central Bank.’”
Second Progress Report on the Reduction of Non-Performing Loans in Europe. March 14, 2018. http://ec.europa.
eu/finance/docs/policy/180314-staff-working-document-non-performing-loans_en.pdf.

European Commission. 2009. “Communication from the Commission - On the Treatment of Impaired Assets in
the Community Banking Sector.” http://ec.europa.eu/competition/state_aid/legislation/impaired_assets.pdf.

European Parliament—Council of The European Union. 2014. “Regulation (EU) No 806/2014 Establishing
Uniform Rules and a Uniform Procedure for the Resolution of Credit Institutions and Certain Investment Firms
in the Framework of a Single Resolution Mechanism and a Single Resolution Fund and Amending Regulation
(EU) No 1093/2010.” Official Journal of the European Union, July 30, 2014. https://publications.europa.eu/en/
publication-detail/-/publication/59d36bcd-17b3-11e4-933d-01aa75ed71a1/language-en.

Galand, Christophe, Wouter Dutillieux and Emese Vallyon. 2017. “Non-Performing Loans and State Aid Rules.”
European Economy—Banks, Regulation, and the Real Sector, July 5, 2017. http://european-economy.eu/2017-1/
non-performing-loans-and-state-aid-rules/.

IMF. 2017. “Greece 2016 Article IV Consultation, Press Release, Staff Report, and Statement by the Executive
Director for Greece.” February 2017, IMF. https://www.imf.org/en/Publications/CR/Issues/2017/02/07/Greece-
2017-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-44630.

IMF. 2017. “Republic of Slovenia: 2017 Article IV Consultation, Press Release, Staff Report, and Statement by
the Executive Director for the Republic of Slovenia.” May 2017, IMF. https://www.imf.org/en/Publications/
CR/Issues/2017/05/15/Republic-of-Slovenia-2017-Article-IV-Consultation-Press-Release-Staff-Report-and-
Statement-44921.

IMF. 2017. “Spain—Financial System Stability Assessment.” October 6, 2017. https://www.imf.org/en/

Publications/CR/Issues/2017/10/06/Spain-Financial-System-Stability-Assessment-45321.

World Bank Group. 2016. “A Toolkit for Out-of-Court Workouts.” http://documents.worldbank.org/curated/

en/851561511964075432/pdf/121753-WP-PUBLIC-OCWToolkitFINALENGLISHWEB.pdf.

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Additional EM Compass Notes
SEPTEMBER 2019 JULY 2018
Note 71: Artificial Intelligence: Investment Trends and Note 56: A Practical Tool to Create Economic
Selected Industry Uses Opportunity for Low-Income Communities

JULY 2019 JUNE 2018

Note 70: How Insurtech Can Close the Protection Gap Note 55: Peru’s Works for Taxes Scheme: An
in Emerging Markets Innovative Solution to Accelerate Private Provision of
Note 69: The Role of Artificial Intelligence in Infrastructure Investment
Supporting Development in Emerging Markets
MAY 2018
JUNE 2019 Note 54: Modelo Peru: A Mobile Money Platform
Note 68: Basic Business Models for Banks Providing Offering Interoperability Towards Financial Inclusion
Digital Financial Services in Africa
APRIL 2018
APRIL 2019 Note 53: Crowding-In Capital Attracts Institutional
Note 67: The Case for Responsible Investing in Digital Investors to Emerging Market Infrastructure Through
Financial Services Co-Lending Platforms
Note 52: Crowding-In Capital: How Insurance
MARCH 2019 Companies Can Expand Access to Finance
Note 66: Blended Concessional Finance: Governance Note 51: Blended Finance—A Stepping Stone to
Matters for Impact Creating Markets
Note 65: Natural Gas and the Clean Energy Transition
JANUARY 2018
FEBRUARY 2019 Note 48: Increased Regulation and De-risking are
Note 64: Institutional Investing: A New Investor Impeding Cross-Border Financing in Emerging Markets
Forum and Growing Interest in Sustainable Emerging
Markets Investments OCTOBER 2017
Note 47: From Farm to Fork: Private Enterprise Can
JANUARY 2019 Reduce Food Loss Through Climate-Smart Agriculture
Note 63: Blockchain and Associated Legal Issues for Note 46: Precision Farming Enables Climate-Smart
Emerging Markets Agribusiness
Note 62: Service Performance Guarantees for Public
Utilities and Beyond—An Innovation with Potential to SEPTEMBER 2017
Attract Investors to Emerging Markets Note 45: Beyond Fintech: Leveraging Blockchain for
More Sustainable and Inclusive Supply Chains
NOVEMBER 2018
Note 44: Blockchain in Financial Services in Emerging
Note 61: Using Blockchain to Enable Cleaner, Modern Markets—Part II: Selected Regional Developments
Energy Systems in Emerging Markets
Note 43: Blockchain in Financial Services in Emerging
Note 60: Blended Concessional Finance: Scaling Up Markets—Part I: Current Trends
Private Investment in Lower-Income Countries
AUGUST 2017
OCTOBER 2018
Note 42: Digital Financial Services: Challenges and
Note 59: How a Know-Your-Customer Utility Could Opportunities for Emerging Market Banks
Increase Access to Financial Services in Emerging
Markets JULY 2017
Note 58: Competition Works: Driving Microfinance Note 41: Blockchain in Development—Part II: How It
Institutions to Reach Lower-Income People and the Can Impact Emerging Markets
Unbanked in Peru Note 40: Blockchain in Development—Part I: A New
Mechanism of ‘Trust’?
SEPTEMBER 2018
Note 39: Technology-Enabled Supply Chain Finance
Note 57: Blockchain Governance and Regulation as an
for Small and Medium Enterprises is a Major Growth
Enabler for Market Creation in Emerging Markets
Opportunity for Banks

75
MAY 2017 SEPTEMBER 2016
Note 38: Can Blockchain Technology Address Note 20: Mitigating Private Infrastructure Project
De-Risking in Emerging Markets? Risks
Note 19: Creating Mobile Telecom Markets in Africa
APRIL 2017
Note 18: Seven Sisters: Accelerating Solar Power
Note 37: Creating Agricultural Markets: How the
Investments
Ethiopia Commodity Exchange Connects Farmers and
Note 16: Congo Call Center—Business Amid Fragility
Buyers through Partnership and Technology
Note 15: How Emerging Market Leaders Can Spur
Note 35: Queen Alia International Airport—The Role
Technological Gains
of IFC in Facilitating Private Investment in a Large
Airport Project Note 14: How to Make Infrastructure Climate
Resilient
MARCH 2017 Note 13: Insurance Options for Addressing Climate
Note 34: How Fintech is Reaching the Poor in Africa Change
and Asia: A Start-Up Perspective Note 12: New Ways for Cities to Tackle Climate Change
Note 33: Creating Markets in Turkey’s Power Sector Note 11: How Business Can Insure Against Climate
Risks
FEBRUARY 2017
Note 10: How New Data Tools Can Assess Climate
Note 32: Private Provision of Education: Risks
Opportunities for Emerging Markets
Note 9: Innovative Insurance to Manage Climate Risks
Note 31: Improving Emerging Markets Healthcare
Through Private Provision MAY 2016
Note 6: Global Productivity Slowdown and The Role of
JANUARY 2017
Technology Adoption in Emerging Markets
Note 30: Masala Bond Program—Nurturing A Local
Currency Bond Market APRIL 2016
Note 29: Toward a Framework for Assessing Private Note 5: Infrastructure Financing Trends
vs. Public Investment in Infrastructure Note 4: Infrastructure Finance—Colombia and FDN
Note 28: The Importance of Local Capital Markets for Note 3: Blending Public and Private Finance
Financing Development
Note 2: Case Study—Bayport Financial Services
DECEMBER 2016 Note 1: Supporting Local Bond Market Development
Note 27: How Banks Can Seize Opportunities in
Climate and Green Investment

NOVEMBER 2016
Note 24: De-Risking by Banks in Emerging Markets—
Effects and Responses for Trade
Note 23: Energy Storage—Business Solutions for
Emerging Markets
Note 22: Mitigating the Effects of De-Risking in
Emerging Markets to Preserve Remittance Flows

76
About IFC and the

IFC’s Distressed Asset Recovery Program (DARP) focuses on the acquisition and resolution of distressed assets, the
refinancing and rollover risk of viable entities, and restructurings of small and medium enterprises (SMEs). DARP is a
critical and effective tool for reducing the effects of poverty in emerging markets by preventing the loss of assets (mainly
family homes and productive assets) and access to formal credit, while helping to preserve jobs. DARP has allowed banks
to offload $30 billion in non-performing loans (NPLs) and is facilitating the normalization of obligations of more than
18 million households and SMEs. At the same time, it is introducing and supporting best resolution practices. Access to
finance and credit helps drive economic growth. Yet when banks have unresolved NPLs on their books, the flow of credit
stalls, and so does growth. With the growth of credit globally, effective ways of resolving distressed assets is increasingly
critical. The ability to quickly dispose of problem assets is even more necessary during financial crises. As distressed assets
are cleared from a financial system, economic recovery can pick up pace and lending and job creation can resume. Since
2007, IFC has committed over $7.3 billion globally through DARP, of which $2.7 billion comes from IFC’s own account
and $4.6 billion from third-party investors. DARP enables IFC to rapidly and successfully introduce non-performing
asset resolution capabilities across the markets in which we work. IFC continues to build the infrastructure needed for
distressed assets globally, serving as a catalyst for the development of secondary distressed assets markets. Please see
our short video on IFC’s Distressed Asset Recovery Program here: https://www.ifc.org/wps/wcm/connect/ Industry_
EXT_Content/IFC_External_Corporate_Site/Industries/Financial+Markets/Retail+Finance/DARP/.
IFC
2121 Pennsylvania Avenue, N.W.
Washington, D.C. 20433 U.S.A.

ifc.org/ThoughtLeadership

OCTOBER 2019