[Shreya and Sruti are students at National Law University Odisha.]
An asset reconstruction company (ARC) plays a pivotal role in the realm of debt management and financial recovery. They have gained prominence for their ability to acquire and restructure non-performing assets (NPA) from banks and financial institutions, with the promise of revitalizing these dormant resources. While ARCs are actively working towards revival of stressed assets, often this revival is limited to monetary profits and not actual revival, because not all assets undergo transformation that leads to revival.
Currently, with the complex market situation, it is evident that work of ARCs will have to pass through various hurdles and complexities. While there’s no one right path towards asset recovery, relying solely on ARCs as a solution to bad loans might be troublesome.
The Position and Success of ARCs
The data and statistics released by various ARCs prove they are doing quite well in their personal capacity. For instance, the newly constructed National Asset Reconstruction Company Limited (NARCL) has acquired bad debt amounting to INR INR 21,000 crores in the fourth quarter of FY23.
Asset Reconstruction Company (India) Limited (ARCIL) was the first ever ARC established in 2002. In the last fiscal year, it has marked a 67% increase in net profits due to increase in loan acquisitions and recovery of bad debts. Reliance Asset Reconstruction Company Limited (RARCL) projected a profit after tax of INR 22.13 crores in its recent annual report of 2021-22, while maintaining a portfolio of INR 2,230 crores.
But how exactly do these ARCs revive the increasing bad loans and assets?
The Sen Committee’s Review Report
Apart from the setting up of NARCL in 2021, the Reserve Bank of India (RBI) set up the Sudarshan Sen Committee to review the working of ARCs and provide their suggestions to improve their performance. They focused on reviewing existing legal framework and business models of ARCs while recommending measures which would improve their functioning and governance.
One of the key findings was that ARCs rarely exercised their power to change or take over the management of business as provided under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI Act). Their methods of reconstruction would not lead to revival of the business but only the recovery of debts.
The committee came out with a total of 42 recommendations. One of the recommendations which would ease the working of ARCs was to implement a “consolidated set of Master Directions” which would bring all rules applicable to ARCs in one place. Furthermore, the committee recommended the expansion of the scope of the SARFAESI Act to include any entities as notified by RBI that can provide their assets to the ARCs for reconstruction. This would not only provide such entities with some relief in revival of bad debts but help advance the business of ARCs.
While the committee made strong points, these recommendations are yet to be implemented. The Indian Banks’ Association has recently, at RBI’s request, formed a 5-member working group containing representation from the lender institutions and ARCs for implementing these recommendations. IBA is also expected to provide a model process for the lenders to conduct uniform and transparent auctions for ARCs as per the committee’s recommendations.
The 2023 RBI Direction
In another attempt to strengthen ARCs, RBI updated the guidelines contained in the Asset Reconstruction Companies (Reserve Bank) Guidelines and Directions 2023. One of the significant revisions includes setting up a minimum limit in investment in security receipts (SR) issued by the trusts floated by the ARCs.
The formula set by RBI is that when ARCs are coming into operation, they should invest in at least 15% of the total amount that has been invested by an entity, be it an individual or a financial institution. As an alternative formula, ARCs must invest in a minimum of 2.5% of the total value of the SRs, which are ARC-issued under each of the schemes. Also, the ARCs need to continue with this investment till all the SRs under the scheme are fully redeemed.
Further, the surplus funds left by the ARCs can be deployed in short-term instruments such as corporate bonds, mutual funds etc., as these have short-term ratings, where conditions to do the above include maximum investment being capped at 10% of the net-owned fund (NOF) of the ARC, and this shall be approved by the Board. This NOF for ARCs has been increased from a minimum of INR 100 crores to INR 300 crores, and this should be on an ongoing basis.
Asset Reconstruction vis-à-vis Insolvency Law
Despite the fact that we have the Insolvency and Bankruptcy Code 2016 (IBC) in place, the banks place a greater faith on ARCs and accordingly the banks sell a huge number of their bad loans. According to these banks, ARCs are a better option as they believe that they will consolidate the bad loans and help manage the capital.
Under Section 29A of the IBC, an ARC as a financial entity has been enabled to apply as a resolution applicant. Additionally, as stated in Section 10(2) of the SARFAESI Act, ARCs are not allowed to carry on any types of activities or business other than securitization and asset reconstruction without prior approval of RBI. However, RBI has now decided that the ARCs will be allowed to carry on above excluded activities specified in the SARFAESI Act, under Section 10(2) of the Act.
The objective behind this move by RBI was that it will pump up the amount of bidding of that asset, which will be more than the earlier liquidation value, which will affect the lenders drastically. Also, through this move, ARCs can submit their resolution plans where they will seek insolvency resolution. However, there has been mentioned a condition as well, where the above allowance will be given to that ARC which has a minimum NOF of INR 1,000 crore and should be approved by the Board.
However, in the case of Superna Dhawan v. Bharti Defence and Infrastructure Limited, NCLAT took a different view unlike those who thought that the October 2022 RBI notification will be a welcome move. The NCLAT was of the view that practically the resolution applicant should work towards revitalizing the activities of the corporate debtor rather than decreasing it. The focus should be towards insolvency resolution more than adding value after selling the asset and therefore the goal of IBC is defeated with this move of the government.
Are ARCs Living up to Their Name?
Recently in the year 2022, RBI released a report named "Report on Trend and Progress of Banking in India 2021-22", where it was stated that 3.2% of gross NPAs were sold to ARCs for the FY 2021-22, which has actually reduced as compared to data released two years earlier and before COVID happened. RBI also said that all the financial assets which were securitized by these ARCs decreased during this period as the cost of acquiring these stress loans were rising heavily.
So the above report of RBI shows that ARCs are losing upon its objective of resolution of loans as there is a boom in bad loans and also because of the regulatory changes that have occurred. Even the 2022 directive released by RBI was aimed at bringing a reformation to the ARCs but it has been found that there is no recovery process of NPAs as most of them happen through settlements.
So, it can be inferred from this article that ARCs do not have enough funds in order to fulfill the requirement of NPAs. Secondly, it can also be inferred that there is no proper settlement of valuation between the ARC and the seller in this already existing debt market of India. Furthermore, SRs belong to the same bank which further adds to the distressing situation.
Way Forward
There is no doubt that dealing with an increasing amount of NPAs is a hurdle for banks and financial institutions and ARCs are working towards lifting this burden, but not up to their full potential. ARCs have the scope of not just reviving assets but also reviving businesses which would contribute towards a more permanent resolution instead of a temporary fix in the bad debts situation. There is an absence of a regulatory framework, when it comes to structuring the whole process regarding resolving the NPAs by the ARCs. A way forward would be for RBI to take part in the process of resolution of NPAs by contributing equity to ARCs. This will add further to the capital of the company.
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