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Asset Reconstruction Companies (ARCs)
An Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from banks and financial institutions so that the latter can clean up their balance sheets. So, ARCs are in the business of buying bad loans from banks. ARC is a company registered under the companies Act and registered with Reserve Bank of India under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.
SARFAESI Act provides the legal basis of setting up an Asset Reconstruction Company (ARC) in India. ARCs are regulated by RBI as a Non-Banking Financial Company (NBFC) under RBI Act, 1934. They function under the supervision and control of the Reserve Bank of India (RBI). 100% Foreign Direct Investment (FDI) in Asset Restructuring Companies under the Automatic route.
The Asset Reconstruction Companies (ARCs) through SARFAESI Act, “enables the secured creditors to realise the long-term assets, manage problems of liquidity, asset liability mismatch and recovery of their dues stuck in the non-performing assets, by exercising the powers under section 13(4), without the intervention of the Court or Tribunal, to take possession of the securities and sell them by adopting the measures for recovery or reconstruction as per the provisions of the act.” As per RBI, ARC performs the functions namely Acquisition of financial assets, Change or takeover of Management or Sale or Lease of Business of the Borrower, Rescheduling of Debts, Enforcement of Security Interest and Settlement of dues payable by the borrower.
For legal purposes, these entities are considered to be banking entities. Therefore the laws that apply to banking companies also apply to Asset Reconstruction Companies. Also, they are subject to the same regulation as banks are. Therefore they are also governed by the same regulators as banks are i.e. banking ombudsmen.
From the above paragraph, we can understand the functions of ARC as follows:
Acquisition of financial assets
Change or takeover of Management / Sale or Lease of Business of the Borrower
Rescheduling of Debts
Enforcement of Security Interest
Settlement of dues payable by the borrower
The origin of ARCs is normally credited to a 1991 report on financial sector reforms by a panel chaired by former RBI Governor M.Narasimham. Accounting policies of the banking system until the 1990s didn’t include any norms for setting aside funds against bad loans. RBI released its first set of norms to classify bad loans or non-performing assets in October 1990. It led to a pile of bad loans in most public sector banks and development financial institutions was unearthed. The Narasimhan Panel recommended the establishment of an asset reconstruction fund or asset reconstruction company to flush bad loans out of the system.
The Board for Industrial and financial Reconstruction, set up as a part of the Department of Financial Services of the Ministry of Finance, in January 1987. Its objective was to determine the sickness of industrial companies and to assist in reviving them. BIFR showed little success in tackling industrial sickness. That and delays in winding-up procedures led to the establishment of debt recovery tribunals (DRTs). The objective was a speedy recovery of money from defaulters who had borrowed from banks and financial institutions. But DRTs, too, could not speed up the recovery procedures in most cases as they lacked sufficient judicial experience. This resulted in a lot of pending cases. Hence, ARCs were set up to enable faster recovery without the intervention of the court.
As of May 31, 2021, there are 28 Asset Reconstruction Companies that have been registered under the Reserve Bank of India. The first off the block, Asset Reconstruction Company (India) Ltd. or Arcil was set up in 2002 by four banks: SBI, ICICI Bank, Punjab National Bank and IDBI Bank. While Arcil has worked on Rs.78, 000 crore of debt over the years, the action now has shifted to the promoter-led ARCs that mushroomed later. Lenders have decided to initially transfer 22 bad loan accounts of ₹89,000 crore to the proposed National Asset Reconstruction Company Limited (NARCL), aiding the cleanup of their balance sheets. The aggregate amount of bad loans likely to be transferred in trenches will be ₹2 trillion.
In the Budget 2021-2022, Asset Reconstruction Company has been proposed to be set up by State owned and Private Sector banks, and there will be no equity contribution from the government. While the Central government will not provide any direct equity support to the ARC, it may provide the sovereign guarantee that could be needed to meet regulatory requirements.
The ARC, which will have an Asset Management Company (AMC) to manage and sell bad assets, will look to resolve stressed assets of Rs.2-5 lakh crores that remain unresolved in around 70 large accounts. This is being considered as the government’s version of a Bad bank. This function of ARC helps banks to concentrate in normal banking activities rather than going after the defaulters by wasting their time and effort.
As per amendment made in SARFAESI Act in 2016, an ARC should have a minimum net owned fun Rs.2 crore. The RBI raised this amount to Rs.100 crore in 2017. The ARCs also have to maintain a capital adequacy ratio of 15% of its risk weighted assets. These assets are used to determine the minimum amount of capital that must be held by banks and other financial institutions in order to reduce the risk of insolvency.
Of the existing ARCs, only 3 to 4 are adequately capitalized, while the more than dozen remaining are thinly capitalized- necessitating the need to set up a new structure to resolve stressed assets urgently. In a report released by RBI it was said that banks gross non-performing assets my raise to 13.5% by September 2021, from 7.5% in September 2020 under the baseline scenario.
The transfer of stressed assets to ARC will happen at net book value, which is the value of assets minus the provisioning done by banks against these assets. This could enable the banks to alleviate its losses from NPAs. The bank will get 15% cash and 85% security receipts against bad debt that will be sold to ARC.
RECOVERY MECHANISM OF NPA BY ARCs
The loan amount taken by a client by providing mortgaged asset will be converted into NPA if the borrower fails to repay it and it is due for 90 days or more. Now the bank has the option either to recover the loan itself or sale that NPA to an ARC. ARC will raise the necessary funds through a subscription instrument floated by the trust. This instrument is known as Security Receipt (SR) and this will be issued to qualified institutional buyers. The banks or financial institutions (FIs), who desire to transfer their bad assets to ARCs, invite intending ARCs to express their interest which will show their willingness to acquire the financial assets of the Banks/FIs. The seller Banks/FIs detail out their terms and conditions of sale of financial assets which are to be accepted by intending ARCs. Before giving the price bid by the intending ARCs, due diligence is to be taken. The ARCs would give indicative offer to seller bank or FI. On receipt of acceptance from seller, they execute assignment of debt with seller bank/FI so that SC/RC may take further steps for resolution of acquired NPAs. The non-fund based facilities are generally not taken over since these are obligations. Until and unless these are crystallized as liabilities, these are not taken over. In case these facilities are crystallized as liability ARCs also take over them. The assets will be taken over either on sale basis or agency basis after applying certain discount. The discount will be worked out in consultation with banks/FIs and it is based on various factors like security value, promoters profile, the current status of the assets (whether running or idle), age, product market, etc. The whole process is to be done in a transparent manner and on mutually agreed terms. In case of consortium or multiple banking, if 75 per cent of the lenders by value agree then the remaining banks/FIs will be obliged to accept the offer by the ARC. The borrower does not have the right to oppose the transfer of assets to ARCs, if the board of the respective banks/FI has agreed for such transfer. Any dispute between the ARCs and Banks/FIs shall be resolved only through arbitrator and no one can approach the courts. Almost all the State Governments have rationalized the rates of stamp duty for assignment of debts and registration charges to smoothen the process for acquisition of financial assets by the ARCs.
The RBI has set up the Sudarshan Sen Committee to review the working of Asset Restructuring Companies comprehensively. It will recommend suitable measures for enabling them to meet the growing requirements. The committee shall submit its report in 3 months’ time.
ARCs have more than 2 decades of experience in the resolution of stressed assets in India. We should leverage this capacity to the fullest. By tweaking some regulations, ARCs can become a potent solution to the growing crisis of the NPAs.