What is the issue ?
- The Union Finance Ministry has setup a committee under the Chairmanship of Sunil Mehta, non-executive chairman of Punjab National bank .
- The committee will examine the possibility of setting up an asset reconstruction company or an asset management company to fast track resolution of stressed assets.
What is an Asset Reconstruction Company ?
- 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. Or in other words, ARCs are in the business of buying bad loans from banks.
- ARCs clean up the balance sheets of banks when the latter sells these to the ARCs. This helps banks to concentrate in normal banking activities. Banks rather than going after the defaulters by wasting their time and effort, can sell the bad assets to the ARCs at a mutually agreed value.
SARFAESI Act 2002– origin of ARCs
- The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002; enacted in December 2002 provides the legal basis for the setting up ARCs in India.
- The SARFAESI Act helps reconstruction of bad assets without the intervention of courts. Since then, large number of ARCs were formed and were registered with the RBI which has got the power to regulate the ARCs.
Capital needs for ARCs
- As per amendment made on the SARFAESI Act in 2016, an ARC should have a minimum net owned fund of Rs 2 crore. The RBI plans to raise this amount to Rs 100 crore by end March 2019.
- Similarly, the ARCs have to maintain a capital adequacy ratio of 15% of its risk weighted assets.
How ARCs get funding to buy bad assets from banks?
- Regarding funds, an ARC may issue bonds and debentures for meeting its funding requirements. But the chief and perhaps the unique source of funds for the ARCs is the issue of Security Receipts.
- As per the SARFAESI Act, Security Receipts is a receipt or other security, issued by a reconstruction company (or a securitization company in that case) to any Qualified Institutional Buyers (QIBs) for a particular scheme. The Security Receipt gives the holder (QIB) a right, title or interest in the financial asset that is bought by the ARC. These SRs issued by ARCs are backed by impaired assets.
Rules for the acquisition of assets and its valuation by ARCs
- NPAs shall be acquired at a ‘fair price’ in an arm’s length principle by the ARCs. They have to value the acquired bad assets in an objective manner and use uniform process for assets that have same features.
- SARFAESI Act permits ARCs to acquire financial assets through an agreement banks. Banks and FIs may receive bonds/ debentures in exchange for NPAs transferred to the ARCs. A part of the value can be paid in the form of Security Receipts (SRs). Latest regulations instruct that ARCs should give 15% of the value of assets in cash.
- Bond or debentures can have a maximum maturity of six years and should have a rate of interest at least 1.5% above the RBI’s ‘bank rate’. While dealing with bad assets, ARCs should follow CAR regulations.
Resolution Strategies that can be followed by ARCs while restructuring the assets
- The guidelines on recovery of money from the resolution process by the ARCs say that regaining the value through restructuring should be done within five years from the date of acquisition of the assets.
- SARFAESI Act stipulates various measures that can be undertaken by ARCs for asset reconstruction. These include:
a) taking over or changing the management of the business of the borrower,
b) the sale or lease of the business of the borrower
c) entering into settlements and
d) restructuring or rescheduling of debt.
e) enforcement of security interest
The last step of ‘enforcement of security interest’ means ARCs can take possession/sell/lease the supported asset like land, building etc.
ARCs and the secured creditors cannot enforce the security interest under SRFAESI unless at least 75% by value of the secured creditors agree to the exercise of this right.
Besides restructuring, the ARCs can perform certain other functions as well. They are permitted to act as a manager of collateral assets taken over by the lenders by receiving a fee. Similarly, they