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NPA resolution mechanism and role of ARCs
The alarming rise of Non-Performing Assets (NPAs) both in public and private sector banks have been a subject of major concern since the last decade. Due to the adverse impact of the Covid-19 pandemic, the problem of NPAs is bound to further exacerbate in India. KV Kamath Committee’s report dated 7 September 2020 on ‘Resolution Framework for Covid-19 related Stress’ has noted that after the arrival of Covid-19 in India, corporate sector debt worth Rs. 15.52 lakh crore has come under stress whereas another Rs. 22.20 lakh crore was already under stress prior to the pandemic. Further, the Reserve Bank of India (RBI) in its bi-annual ‘Financial Stability Report’ published in January 2021 has suggested that the banks’ gross NPAs may rise to 13.5% by September 2021 from 7.5% in September 2020 under the baseline scenario. Against this backdrop, this article analyses the role Asset Reconstruction Companies (ARCs) play in the NPAs resolution in India.
ASSET RECONSTRUCTION COMPANY (ARC)
ARC is a company registered with RBI under section 3 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) for the purpose of carrying on the business of ‘asset reconstruction’ or ‘securitisation’ of stressed assets including NPAs. As stated by RBI in a discussion paper dated 17 December 2013 ‘Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy’, ARCs are construed as a supportive system for stressed asset management with greater emphasis on asset reconstruction rather than asset stripping.
ARCs engage in ‘asset reconstruction’ by acquiring the right or interest of any bank or financial institution (FIs) in loans, advances, debentures, bonds, guarantees or any other credit facility (financial assets) for the purpose of their realization. Further, ARCs carry on ‘securitisation’ by acquiring financial assets from banks or financial institutions by raising funds from Qualified Buyers by issue of security receipts representing undivided interest in such financial assets. Hence, ARCs take over the NPAs of commercial banks, manage them and finally recover the money over a period of time, thereby helping banks in clearing their balance sheets and resolving NPAs.
NPA RECOVERY MECHANISM BY ARCs
NPA is simply a loan or advance for which the principal or interest payment remains overdue for a period of 90 days. The NPA recovery mechanism of ARCs consists of three stages, which are elucidated below:
1. Acquisition of Assets: ARCs generally acquire NPAs from banks and FIs either through bilateral deals or auctions. As stipulated by RBI guidelines dated 6 December 2019 on ‘Acquisition of financial assets by Asset Reconstruction Companies from sponsors and lenders’, bilateral deals of ARCs with sponsor banks or FIs are prohibited. However, no such restrictions exist for auctions conducted by the banks and FIs as the process is fair and transparent. Pursuant to the acquisition of the assets, ARCs formulate schemes for inviting subscription to security receipts (SRs) by Qualified Institutional Buyers (QIBs) through one or more trusts set up exclusively for the purpose under section 7 of SARFAESI Act.
The NPAs acquired from banks or FIs are held in asset-specific schemes when the size of aggregate debt is large whereas in portfolio-specific schemes when the size of acquired debt is small. It is pertinent to note that ARCs are allowed to acquire debts either through cash alone or a mix of cash and SRs. Furthermore, according to regulatory guidelines, ARCs are mandated to invest a minimum of 15 percent of the SRs under each scheme on an ongoing basis till the redemption of all SRs.
2. Resolution of Assets: After the acquisition of assets, the next stage is the resolution of these assets and a plan for the same is prepared by ARCs within six months from the date of acquisition. The resolution methods of ARCs can be divided into following five categories: (a) rescheduling of payment of debt; (b) enforcement of security interest; (c) settlement of dues of borrower; (d) taking possession of assets; and (e) by sale of business.
3. Recovery and Redemption of Security Receipts (SRs): The last stage following resolution of assets is recovery of debt and work on the redemption of SRs. ARCs are allowed a period of five years to redeem the SRs. However, the period can be extended up to eight years subject to the approval of their Boards. The performance of ARCs is evaluated through the recovery of SRs. As per regulatory guidelines, ARCs are required to disclose the Net value Assets of SRs issued by them which are used for valuation of the SRs by investors.
To conclude, ARCs have been an integral part of the institutional infrastructure for NPAs resolution in India. Despite the enactment of Insolvency and Bankruptcy Code, 2016 (IBC) that streamlined the insolvency resolution process for corporate and individuals along with protecting the interest of secured and unsecured creditors, ARCs still remain one of the prominent channels of NPA resolution for banks. RBI’s report dated 26 April 2021 ‘ARCs in India: A Study of their Business Operations and Role in NPA Resolution’ highlights that in 2019-20, the amount recovered as per cent of the amount involved under IBC was 45.5 per cent, followed by 26.7 per cent for ARCs.
Further, since the introduction of Insolvency and Bankruptcy Code, 2016, ARCs share in the total amount involved across all channels of recovery has ranged between 25 percent and 35 percent. Furthermore, ARCs still account for about 30 percent of the total amount recovered through various channels of recovery by banks. The Union Budget 2021-22, considering the same, has also proposed setting up an Asset Reconstruction Company Limited and Asset Management Company, funded by state-owned and private sector banks, to consolidate and take over the existing stressed debt for their effective resolution. This is a welcome step, which will help in further strengthening the NPA resolution mechanism in India.