Banks are financial institutions primarily engaged in the business of lending and borrowing money. The banking sector has a wide customer base, and lending money entails a considerable amount of risk. While the bank always has the option of pursuing legal action against defaulting borrowers, doing so is not always financially feasible. The bank may choose to simply cut its losses, clean up its balance sheet, and keep the business moving in the right direction. This is where a company specializing in asset reconstruction can help.
Meaning of Asset Reconstruction Company
An asset reconstruction company is a type of financial institution that buys a bank’s debtors at a mutually agreed-upon price and tries to recover the debts or associated securities. The RBI registers asset reconstruction companies, or ARCs, and the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 regulates them (SARFAESI Act, 2002). The ARCs take over a portion of the bank’s debts that meet the criteria for being classified as Non-Performing Assets.
As a result, ARCs are involved in asset reconstruction, securitization, or both. All of the lender’s rights to the debt would be transferred to the ARC. Qualified Buyers can provide the funds needed to purchase such debts.
Asset Reconstruction Company (ARC) is proposed in Budget 2021-22 to be established by state-owned and private-sector banks, with no government equity contribution. The ARC, which will have an Asset Management Company (AMC) to manage and sell bad assets, will try to resolve stressed assets worth Rs. 2-2.5 lakh crore in around 70 large accounts. The government’s version of a bad bank is being considered.
SARFAESI Act, 2002: Origin of ARCs
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, which was enacted in December 2002, establish the legal framework for ARCs in India. The definition of Asset Securitization is defined in Section 2 (1) of the Act. Similarly, ARCs are similarly elaborated under Section 3 of the Act. The SARFAESI Act allows for the restoration of bad assets without the need for court interference. Since then, a large number of ARCs have been formed and registered with the RBI, which has regulatory authority over them.
Performance of ARCs
- The conversion of NPAs was slow during the early years of the reconstruction industry, from 2008 to 2013, when the industry was still in its infancy. According to an ASSOCHAM survey, the average recovery rate for ARCs in India is about 30% of the principal, with a time frame of four to five years on average.
- The reconstruction industry boomed in 2013-14, due to a variety of positive factors, as ARCs acquired vast quantities of bad assets from banks
- However, after 2014, ARCs’ success in resolving NPAs declined. In the sense of the current rising sea of bad assets, ARCs have become underperformers, especially in recent periods. This has resulted in a major increase in nonperforming assets (NPAs) in the banking sector.
Since the RBI increased certain securitization market norms in the second half of 2014, asset reconstruction activity has been declining. The Reserve Bank of India (RBI) has published a detailed ‘Framework for Revitalizing Distressed Assets in the Economy.’ To tackle NPAs, it proposed a corrective action plan. The Reserve Bank of India later increased the cash payment to banks from 5% to 15%. To comply with international standards, it also eliminated special asset classification advantages to asset restructuring as of April 1, 2015. As a result of these factors, the asset reconstruction industry has slowed.
In India, there are actually 19 ARCs. However, their combined capital base is inadequate to counter the country’s nearly Rs 8 lakh crores in nonperforming assets. The key issues in the industry are ARCs’ low capital base, their lack of funds, and the value mismatch of bad assets between banks and ARCs, among others.
The RBI and the government have taken several steps to resurrect asset restoration efforts. The government took one such measure by rising FDI in the sector to 100 percent. Similarly, under the new Insolvency and Bankruptcy Code, ARCs can play an important role in asset restructuring. The RBI amended the SARFAESI Act in 2016 to increase the performance of ARCs.
How ARCs get funding to buy bad assets from banks?
In terms of financing, an ARC will issue bonds and debentures to meet its needs. The problem of Security Receipts, however, is the main and likely special source of funds for the ARCs. Security Receipts are receipts or other securities issued by a reconstruction company (or a securitization company in that case) to any Eligible Institutional Buyers (QIBs) for a specific scheme, as specified by the SARFAESI Act. The holder (QIB) of a Security Receipt has a right, title, or interest in the financial asset purchased by the ARC. These ARC-issued SRs are backed by non-performing assets.
Role of Asset Reconstruction Company
- Acquisition of financial assets (as defined u/s 2(L) of SRFAESI Act, 2002)
- Change or takeover of Management / Sale or Lease of Business of the Borrower
- Rescheduling of Debts
- Enforcement of Security Interest (as per section 13(4) of SRFAESI Act, 2002)
- Settlement of dues payable by the borrower
Objects of Assets Reconstruction Company
ARCs purchase non-performing assets from a range of lenders to expedite the corporate restructuring process. The key aim is to acquire and efficiently liquidate non-performing assets, to clean up the books by reducing non-performing assets, to spend less time dealing with non-performing customers, and to assign special legislative powers to fewer Asset Reconstruction Firms rather than to each bank.
The rapid growth of bad debts/non-performing assets has long been a stumbling block to the Indian economy’s healthy development. Asset Reconstruction Companies were developed as specialist agencies to assist in the securitization and asset reconstruction of non-performing assets, allowing for the fastest resolution and the return of liquidity to the economy.
Capital needs for ARCs
According to a 2016 amendment to the SARFAESI Act, an ARC must have a minimum net owned fund of Rs 2 crore. By the end of March 2019, the RBI expects to increase this amount to Rs 100 crore. ARCs, on the other hand, must preserve a capital adequacy ratio of 15% of risk weighted assets.
Registration of Assets Reconstruction Company
- No asset reconstruction company may begin or continue its business of securitisation or asset reconstruction without:
- obtaining a certificate of registration granted under this section; and
- having a net owned fund of at least two crore rupees, or any other higher sum as the Reserve Bank can determine by notification;
The Reserve Bank can designate different amounts of owned fund for different groups or classes of asset reconstruction companies by notification.
- Any asset reconstruction company must apply to the Reserve Bank for registration.
Functions of ARC in India
ARCs in India are regulated and supervised by the Reserve Bank of India. The business of ARCs is to securitize and reconstruct financial properties. They strictly follow the SARFAESI Act and Reserve Bank of India guidelines. ARCs buy bad debts/NPA accounts from banks and financial institutions and try to settle them as soon as possible using remedies available under Indian law.
How will the ARC carry out the process of asset reconstruction?
The primary aim of collecting debts / non-performing assets (NPAs) is to gradually recover the debts owed to them. However, the technique is not straightforward. In this regard, the ARCs have the following choices:
- Modification or acquisition of the borrower’s company management
- Selling or lease of the borrower’s business
- Rescheduling debt payments – offering alternative plans, provisions for payment
- Taking ownership of the properties provided as insurance
- Transforming a portion of the debt into securities
- Implementing the security interest offered in compliance with the law
ARCs have been shown to be the most powerful recovery channel for NPAs, according to many economists. During FY2014, there was a large increase in the selling of stressed assets to ARCs. Indian banks sold nonperforming assets to ARCs at a mutually agreed price in order to clear NPAs. According to RBI figures, Indian banks sold $2.8 billion in stressed loans in FY2014, up from $0.2 billion in FY2013. Prior to the RBI’s shift in ARC investment guidelines in the first quarter of FY2015, banks sold more than $2.5 billion to ARCs.
Since then, the number of transactions has decreased substantially, according to media reports, and more than 1,000 nonperforming assets (NPAs) with a gross principal due of $4 billion have been auctioned by various banks. Just $0.3 to 0.5 billion was successfully sold to ARCs out of this amount. There was another estimate that ARCs will acquire NPAs worth Rs 12,000-14,000 crore in 2015-16, but Indian banks have yet to provide any additional details on ARCs’ acquisition of NPAs.