Tag: ARCs

RBI Committee, BFSI News, ET BFSI

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Multiple factors have led to sub-optimal performance of the asset reconstruction companies (ARCs) in the country, said the Reserve Bank Of India (RBI) Committee.

The ARC framework was designed to allow originators to focus on their core function of lending, by removing sticky stressed financial assets from their books.

It was also designed to help borrowers revive their businesses, which protects the viable and productive assets of the economy and often ensures a better return to banks and financial institutions (FIs).

Accordingly, the Committee constituted to “Review the working of ARCs said multiple factors behind the sub-optimal performance of the sector such as vintage NPAs being passed on to ARCs, lack of debt aggregation, non-availability of additional funding for stressed borrowers, difficulty in raising of funds by the ARCs on their balance sheet, among others.”

“Also, ARCs have lacked focus on both recovery and acquiring necessary skill sets for holistic resolution of distressed borrowers.”

The RBI Committee cited data which showed that the performance of the ARCs has been lacklustre, both in terms of ensuring recovery and revival of businesses.

“Banks and other investors could recover only about 14.29 per cent of the amount owed by borrowers in respect of stressed assets sold to ARCs during the FY 2004-2013 period.”

“Similarly, data shows that approximately 80 per cent of the recovery made by ARCs has come through deployment of measures of reconstruction that do not necessarily lead to revival of businesses.”

Considering the challenges impacting the performance of the ARC sector, the Committee recommended sale of stressed assets by lenders at an earlier stage to allow for optimal recovery by ARCs.

“In this respect, the Committee highlights the need for regulatory clarification on sale of all categories of special mention accounts (SMAs) to ARCs.”

“Further, as a measure to incentivise lenders to sell their financial assets to ARCs at an early stage of stress, the committee recommends a dispensation to lenders, on an ongoing basis, to amortise the loss on sale, if any, over a period of two years.”

Besides, it called for a higher threshold of investment in SRs by lenders below which provisioning on SRs held by them may be done on the basis of Net Asset Value (NAV) declared by the ARC instead of the IRACP norms.

In addition, the Committee among other measures, recommended the creation of an online platform for sale of stressed assets.

“Infrastructure created by the Secondary Loan Market Association (SLMA) may be utilised for this purpose.”

–IANS

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As India’s bad bank knocks, ARCs seek relaxations from RBI, BFSI News, ET BFSI

Banking & Finance

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With the bad bank on the anvil, asset reconstruction companies have sought relaxation of the pricing structure for the purchase of bad loans, funding from banks, and clarity on participating in insolvency cases as a resolution applicant. These are among the suggestions made by ARCs to the committee formed by the Reserve Bank of India in April.

Usually, sales take place either on a full-cash basis or under the 15:85 structure, where 15% is paid as upfront cash and the remaining in the form of security receipts.

ARCs have sought a reduction in the minimum investment requirement to 2.5% from 15% in cases where cash is fully paid upfront.

The cash proportion of 15% has pushed the ARCs to raise their returns through securitisation and asset reconstruction.

Unless the ARC recovers 130% of the acquisition value, it will not make its return. Even at 100%, an ARC will make a loss because the management fee of 1-2% doesn’t make any ARR for ARC. Recovery should be over 130% so that 100% of security rights will be redeemed.

Also read: What are NARCL and IDRCL? How do they work and what is the plan?

Also, in September 2016, the Reserve Bank of India introduced new regulatory guidelines regarding provisioning. From April 2018 banks have to sell at 90% cash and 10% SRs. If a bank holds more than 10% SR, it had to continue provisioning for the loan which is not even on their books. So there is no incentive for them to transfer to ARCs. Now no banks transfer on 15:85 and all deals are in cash.

Bank funding

Asset reconstruction companies have asked RBI to allow bank funding for them on the lines of provided to non-banking finance companies. They have also sought doing away with dual-provisioning norms, a move which will benefit banks the most.

ARCs have suggested that bank provisioning needs to be solely based on the rating agency-determined net asset value of the security receipts.

From April 2018, banks have had to make provisions for stressed assets that are sold, assuming they remain on the books. This is applicable in cases where security receipts make up for more than 10% in the sale of non-performing assets.

Banks also have to make mark-to-market provisions in cases where the rating of security receipts is downgraded. Security receipts are valued on net asset values, linked to recovery ratings, which is an assessment of probable recovery from an underlying non-performing asset by rating agencies.

With banks not having to go for dual provisioning, they sell NPAs on a 15:85 structure, making more NPAs available for ARCs.

Currently, outstanding security receipts are estimated to be around Rs 1.1 lakh crore.

The RBI committee

In April this year, the RBI has formed a six-member panel under the chairmanship of Sudarshan Sen, former RBI executive director, to examine the role of asset reconstruction companies (ARCs) in stressed debt resolution, including under the Insolvency & Bankruptcy Code (IBC), 2016 and review their business model.

The committee is reviewing the legal and regulatory framework of ARCs and recommend measures to improve their efficacy. It will submit its report within three months from the date of its first meeting. As of January, the number of ARCs registered with the RBI stood at 28.



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RBI allows banks to sell ‘fraud loans’ to ARCs

Banking & Finance

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The Reserve Bank of India on Friday allowed loan exposures classified as fraud to be transferred to Asset Reconstruction Companies (ARCs). This comes in the wake of banks reporting frauds aggregating ₹3.95-lakh crore between FY19 and FY21.

Stressed loans, which are in default for more than 60 days or classified as non-performing assets (NPA), can be transferred to ARCs. This shall include loan exposures classified as fraud as on the date of transfer.

Issuing the guidelines for transfer of loan exposure, including stressed loans, the central bank said the transfer of such loans to an ARC, however, does not absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds.

Until now, when an account is declared fraud, banks had to set aside 100 per cent of the outstanding loan as provision. Under the new rules, banks can hope to recover a part of the loan. For ARCs, this will allow them to buy debt cheaper than regular loan accounts.

Swiss Challenge method

The RBI also said the transfer of stressed loans above ₹100 crore negotiated on a bilateral basis between lenders and permitted acquirers, including ARCs, must necessarily be followed by an auction through the Swiss Challenge method. Under the Swiss Challenge auction, the price bilaterally negotiated for the sale of a stressed asset becomes the floor price for inviting counter-proposals from other interested buyers.

Loan transfers are usually resorted to by lending institutions for multiple reasons ranging from liquidity management, rebalancing of exposure or strategic sales. “A robust secondary market in loans can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity,” the RBI said in a circular to lenders.

New guidelines

Under the new guidelines, loans can be transferred only after a minimum holding period (MHP) of three months in case of loans with tenor up to 2 years, and six months fior those with tenor of more than 2 years. In case of loans where the security does not exist or cannot be registered, the MHP shall be calculated from the date of first repayment of the loan.

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Understanding future of revamped ARCs in India’s future trillion dollar economy, BFSI News, ET BFSI

Banking & Finance

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Asset Reconstruction Companies were established with the role of providing specialized expertise in management and recovery of non-performing assets (NPA). Ideally, this would allow financial institutions to focus more on optimizing lending instead of difficult recoveries. The high number of NPAs on the balance sheet of Indian banks in the last three years is not fresh news. ARCs are important interventionists and crisis managers who can play a major role in the insolvency and turnaround framework of India. But they are presently like the unetched character of a Bollywood potboiler without the proper chance to shine because the script fails them.

A committee has been set up by RBI to undertake a comprehensive review of and recommend the working of ARCs to meet the growing requirements of the financial sector on April 19, 2021, under the chairmanship of Shri Sudarshan Sen, former Executive Director, RBI. The role of ARCs in relation to NPAs needs to be re-thought allowing legroom for a disruptive role. Just like the Insolvency and Bankruptcy Code led to behavioural change in loan repayments, it is necessary that the market behaviour of banks and ARCs is compulsorily modified for them to think out of the box and allow risk diversification. Some of our recommendations are discussed below.

Objective Valuation of Financial Assets: The price bid by ARCs for NPAs does not reflect the true recoverable value of financial assets generally. Acquisition of assets is known to happen at acutely discounted rates which may not be aligned with the bank’s recoverable value let alone the market value of the financial asset had it not been distressed. There is a need for objective guidelines for the valuation of financial assets and prohibition on acquisitions and sales at overtly discounted values.

Concentration limit on retention of security receipts by banks: After acquiring an NPA, the ARC issues security receipts (SR) redeemable on the resolution of NPA. This mechanism is supposed to create risk spread, allow a diverse class of investors and make NPA a tradeable asset. But 80-90% of the SR are held again by financial institutions. Effectually, NPAs never leave the balance sheet of financial institutions but just re-enter through the backdoor. Financial institutions continue to heavily invest in SR despite substantial disincentives in holding SRs above 50%. It is important to create concentration limits on SR holding of financial institutions creating a compulsion to market SR to a more diverse category of investors.

Separate Regulatory Department and Class of Professionals: Some of the least supervised and audited (regulatory) classes of regulated entities in India include ARCs and credit rating agencies. Although the function of ARCs is distinctly different from banks and NBFCs, they presently come under the same regulatory and supervisory department of RBI which is already understaffed and overworked. It is important to acknowledge ARCs and even NBFC-Factors as a separate class of regulated entities from banks, cooperative banks and NBFCs. The ARC sector also needs specialized professionals to provide thought leadership and out of box thinking on NPA management, asset turnaround, investment banking, and valuation just like insolvency professionals.

Third-party funding of dispute resolution and securitization process: Most of the times banks have to take up litigation or arbitration for enforcement of security interest. Such dispute resolution is part of the NPA resolution process and maybe a high cost for the bank. To allow banks to increase their liquidity when required, ARCs should be allowed to act as third-party funders of the cost of litigation or arbitration in lieu of part or whole of a financial asset as a success fee. This form of funding is already well established in other financially mature jurisdictions like United Kingdom, Singapore, Hong Kong, and the USA.

While revitalizing the ARC industry it is important that enough thought is given to creating mechanisms and processes that allow proper shifting and allocation of risks and responsibilities. Unless the risk of NPA actually does not move out of the balance sheet of banks and there is enough regulatory freedom for ARCs for resolution of stressed assets through innovative and out of box structures, the mechanism for NPA resolution is fraught to be dependent on government rescue which is not feasible in the long run for the economy and the industry.

The blog has been authored by Ajaya Kumar Sahoo, COO, Find friends & Independent Director at PC Financial
Services and Kritika Krishnamurthy, Partner BFSI at AK and Partners

DISCLAIMER: The views expressed are solely of the author and ETBFSI.com does not necessarily subscribe to it. ETBFSI.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.



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RBI may tweak rules to reduce ARCs’ cash outgo when buying stressed assets

Banking & Finance

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The Reserve Bank of India may tweak the ‘skin in the game’ criteria for Asset Reconstruction Companies (ARCs) in cases where they link-up with an investor to buy stressed assets from lenders on 100 per cent cash basis.

The central bank is examining the possibility of lowering an ARC’s contribution to acquire a stressed asset on all-cash basis from 15 per cent of the acquisition price to 2.5 per cent to 5 per cent.

The reason for this is that there are investors willing to bring in a chunk of money (95-97.5 per cent of the acquisition price) for buying stressed assets.

Given banks’ preference to sell their stressed assets on all-cash basis, the lowering of the ‘skin in the game’ requirement will alleviate ARC’s capital constraints and encourage them to step up purchase of bad loans. This, in turn, will help banks clean up their books. In cases where ARCs acquire stressed assets through a mix of cash and stressed assets, they are required to invest a minimum of 15 per cent of the security receipts. Hari Hara Mishra, Director, UV ARC, observed that in three years from 2018 to 2020, the cash component of purchase consideration paid by ARCs to seller banks and financial institutions went up three times from 28 per cent to 87 per cent.

“There is a long-felt need to reduce minimum contribution by ARCs in 100 per cent cash transactions from existing 15 per cent to 2.5 per cent in line with guidelines as applicable to Alternative Investment Funds (AIFs),” he said.

Reducing stress in sector

Mishra emphasised that this would enable ARCs to arrange more funds and absorb more non-performing assets, thereby reducing stress in the financial sector.

Pallav Mohapatra, MD & CEO, ARCIL, said: “What we want is that when an ARC, along with an investor, acquires a stressed asset on a 100 per cent cash basis from a bank, in such cases the regulator should, I think, reduce the 15 per cent requirement of contribution by ARCs. This can be reduced to 5 per cent.”

Mohapatra underscored that investors are proactive when it comes to seeking regular updates on resolution of stressed assets and recovery. Hence, ARCs will be on their toes despite lower skin in the game.

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NARCL may prompt existing ARCs to reorient their business: ARCIL Chief

Banking & Finance

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The National Asset Reconstruction Company Ltd, (NARCL), which is slated to become the mother of all Asset Reconstruction Companies (ARCs), will prompt existing ARCs to change their business orientation and start focussing on buying the stressed retail and MSME assets, according to Pallav Mohapatra, MD & CEO, Asset Reconstruction Company (India) Ltd (ARCIL).

He emphasised that ARCs have a huge business opportunity to buy stressed assets aggregating about ₹1 lakh crore in the retail and micro, small and medium enterprise (MSME) segments.

Stressed assets with principal outstanding of ₹500 crore and above, aggregating about ₹2 lakh crore, are expected to be transferred by lenders to NARCL.

In an interaction with BusinessLine, Mohapatra, who was MD & CEO of Central Bank of India before taking the reins at ARCIL in March 2021, emphasised that there is enough scope for existing ARCs (28 at the last count) to buy stressed assets below ₹500 crore from Banks.

Excerpts

Will the setting up of NARCL, does not diminish the business prospects of existing ARCs?

NARCL’s mandate is basically to acquire stressed assets where the total exposure of the banking sector is more than ₹500 crore.

But I feel there is enough scope for getting the business (buying stressed assets) below ₹500 crore. As of today, most of the ARCs were playing in the big-ticket corporate stressed assets.

Now I feel they will change their orientation and start focusing on stressed retail and MSME assets where the size will increase in the backdrop of the Covid-19 pandemic. It (increase in size) will not be there in the case of corporates to a reasonably large extent. This is because, to a great extent, things have been sorted out. There will be a few cases but not as many as it used to be earlier. So, if the ARCs equip themselves with infrastructure, technology, and human resources skills to handle the stressed retail and MSME assets, that is going to be a very huge business opportunity for ARCs.

How big will the business opportunity be?

The business opportunity will be sufficiently large. The opportunity will be bigger than the total existing Assets Under Management (estimated at about ₹60,000 crore) of all the ARCs put together. This particular pool (of stressed retail and MSME assets) could be about ₹1 lakh crore.

Given that sale of stressed assets by banks to ARCs has been declining in the last couple of years, will ARCIL change tack?

We want to focus more on resolution and recovery of non-performing assets and earn income after some time rather than focusing on earning income from fees or some other structure.

If you look at the Profit & Loss accounts of ARCs, normally there are three channels of income — management fee income (for managing the acquired assets), interest income (arising from restructuring) and when ARCs can recover more than the face value of the Security Receipts, they get an upside income.

Our focus is to basically increase the proportion of the upside income. This will have beneficial effects — one is there will be a better churning of the capital in ARCs; second, they will also be earning income, with the upside income going straightaway to P&L; and third is it will be good for the economy as such because there will be recovery and resolution.

So, instead of focusing on earning management fees, which will cover our capital investment, we are looking at earning income, as far as possible, by doing resolution and recovery.

Banks want to sell stressed assets on all cash basis but capital could be constraint for ARCs. How do you deal with this situation?

Banks want all-cash deals because of the non-redemption of SRs. If they know that ARCs are going to redeem the SRs as well as give them upside income, why will they not sell their stressed assets for a mix of cash and SRs?

From the capital and availability of funds point of view, ARCIL doesn’t have a problem. Even if there is a funding gap, we always try to get some investor. If we are doing a 100 per cent cash deal with a bank, we try to pay 100 per cent to the bank. But when it comes to our capital deployment, we try to make it 15 per cent or a maximum of 20-25 per cent, and we always get an investor who will put the money. Now, the advantage of this is that since the investor is putting in 75-85 per cent of the money, they will be very keen on resolution of the assets. The investors will not be keen that the ARC is earning the management fees they have to pay for. They will have regular interaction with the ARC because they want a return on their money. And investors are keen to work with those ARCs that have a very fair, open and transparent business model.

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Allow us to sell bad loans back to defaulting promoters, ARCs tell RBI, BFSI News, ET BFSI

Banking & Finance

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As the government gears up to roll out National Asset Reconstruction company or bad bank, next month, asset reconstruction companies (ARCs) have sought more leeway from the banking regulator.

They have asked the RBI to let them sell assets of defaulting promoters back to them and want corporates and high net worth individuals to be allowed to invest in troubled loans through the securities issued by ARCs.

Level-playing field

Responding to the RBI’s call for suggestions to overhaul their structure in the country, it has said that special regulatory dispensation/benefit if any given to proposed ARC should apply to all existing ARCs and level playing field from the regulatory perspective be given to all existing ARCs.

ARCs were allowed to sell bad loans back to defaulting promoters under the SARFAESI Act. However, it was disallowed under the IBC clause, which has hampered the ARCs.

ARCs have asked for this minimum investment to be brought down to 2.5% in cases where the bank selling the bad loan is not the investor. Other suggestions include a request to be classified as non-banking financial companies, which will enable ARCs to borrow from banks.

Bad bank

National Asset Reconstruction Company Ltd (NARCL), the name coined for the bad bank announced in the Budget 2021-22, is expected to be operational in June.Bad bank refers to a financial institution that takes over bad assets of lenders and undertakes resolution.

The new entity is being created in collaboration with both public and private sector banks.

NARCL will take over identified bad loans of lenders. The lead bank with offer in hand of NARCL will go for a ‘Swiss Challenge’, where other asset reconstruction players will be invited to better the offer made by a chosen bidder for finding higher valuation of an NPA on sale.

The company will pick up those assets that are 100 per cent provided for by the lenders, he added.

Finance Minister Nirmala Sitharaman in Budget 2021-22 announced that the high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books.

“An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt,” she had said in the Budget speech. It will then manage and dispose of the assets to alternate investment funds and other potential investors for eventual value realisation, she added.

Last year, IBA had made a proposal for creation of a bad bank for swift resolution of non-performing assets (NPAs). The government accepted the proposal and decided to go for asset reconstruction company (ARC) and asset management company (AMC) model for this.

Mehta further said NARCL will pay up to 15 per cent of the agreed value for the loans in cash and the remaining 85 per cent would be government-guaranteed security receipts.

The government guarantee would be invoked if there is loss against the threshold value, he added.



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Monitor ARCs for ‘circuitous movement of funds’ with banks, says RBI paper, BFSI News, ET BFSI

Banking & Finance

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The Reserve Bank of India has flagged risks of excessive reliance on banks by the ARC industry.

An RBI paper, published in the central bank’s monthly bulletin for April, said banks supply non performing assets (NPAs) to the ARCs, hold shareholding in these entities and also lend to them, which makes it necessary to monitor if there is a “circuitous movement of funds between banks and these institutions (ARCs)”.

“Considering that banks are not just the major shareholders of and lenders to ARCs but also sellers of NPAs to ARCs, it may be necessary to monitor if there is a circuitous movement of funds between banks and these institutions. A movement of this kind can have implications for the genuine sale of NPAs and the overall growth of the ARC industry,” the article titled ‘ARCs in India: A Study of their Business Operations and Role in NPA Resolution’ said.

ARC versus IBC

It advocated for a strong a strong asset reconstruction sector, which complements the Insolvency & Bankruptcy Code mechanism, to better deal with non-performing assets and ensure higher recovery and resolution. Asset reconstruction companies recovered 29.7% of dues in 2019-20, while for IBC, this number was much higher at 45.5%, it said. Highlighting that there has been a declining trend in recovery over the years, the article said that even post IBC, their recovery amounts to 25-35% of dues, and they also account for 30% of total amount recovered through all channels.

Bad bank

The RBI article sees a greater role for asset reconstruction companies, including the bad bank announced in the budget.

“Going forward, the introduction of a new asset reconstruction company for addressing the NPAs of public sector banks may also shape the operations of the existing ARCs,” the RBI paper said. It added that there is a definite scope for the entry of a “well-capitalised and well-designed entity” in the Indian ARC industry and such a body will strengthen the asset resolution mechanism further.

It cited global experiences to lay down the necessary features of the new ARC announced by the government.

The paper advocated that the new ARC or the bad bank should have a narrow mandate such as resolving NPAs with clearly defined goals, a sunset clause defining their lifespan, supportive legal infrastructure involving bankruptcy and private property laws, backing of a strong political will to recognise problem loans, and a commercial focus including in governance, transparency, and disclosure requirements.

Capital constraints

The paper highlights the capital constraints of the ARC indsutry saying it has had an impact on the ability of their to ensure resolution and recovery. In terms of capital base of the industry, 62% was held by the top three asset recast companies and 67% for top five, which the authors argue shows how the business remains highly concentrated. As per the article, of the total assets under management, about 62% and 76% were held by the top three and top five asset reconstruction companies in March 2020, respectively.

Security receipts

About 42 per cent of the outstanding SRs (security receipts) as on March 2020 were more than five years of age and would have to be redeemed over the next four years to avoid write-offs,” the paper said, pointing out at the difficulties being faced by the current set of ARCs in resolving the stress.

While resolving a case, ARCs pay a minor portion in cash to the selling bank while the rest is SRs to be paid over a time.

Security receipts are issued as an instrument to enable offloading of stressed assets, and to encourage recovery and resolution of dues.

It said due to capital constraints, there was a high dependence on bank funding for such asset reconstruction companies, with banks selling bad loans continuing to hold security receipts, despite regulatory disincentives. In March 2020, just two asset reconstruction companies held about 62% of the total security receipts issued. The paper said that banks holding such a large volume of security receipts limits secondary trading and effectively market-based price discovery.



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RBI article calls for monitoring movement of funds between banks and ARCs

Banking & Finance

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It may be necessary to monitor if there is a circuitous movement of funds between banks and Asset Reconstruction Companies (ARCs), according to an article in the Reserve Bank of India’s latest monthly bulletin.

This observation comes in the backdrop of banks being not just major shareholders of and lenders to ARCs but also sellers of non-performing assets (NPAs) to them, it added.

Attracting ‘new money’ will be a challenge for the ARC

A movement of this kind can have implications for the genuine sale of NPAs and the overall growth of the ARC industry, said RBI officials Amarnath Yadav and Pallavi Chavan from the Department of Supervision, in the article.

The authors emphasised that given the private character of ARCs, they have tended to rely heavily on borrowings, particularly from banks, as a major source of their funds.

The article underscored that the capital base of ARCs is made up largely by domestic sources, particularly banks and financial institutions, with foreign sources remaining weak.

Being private sector entities, the key shareholders of ARCs are banks (29 per cent) and other financial institutions (37 per cent).

RBI set up 6-member panel to review working of ARCs

In order to boost their capital base, ARCs were allowed to accept 100 per cent of foreign direct investment (FDI) through the automatic route in 2016.

Notwithstanding the liberalisation relating to FDI, foreign entities account for a small portion (10 per cent) of the total capital of ARCs, the authors said.

Highly concentrated business

Although the number of ARCs has increased over time, their business has remained highly concentrated.

The authors assessed that of the total assets under management (AUM), about 62 per cent and 76 per cent was held by the top three and top five ARCs in March 2020, respectively.

Furthermore, in terms of the capital base of the industry, 62 per cent was held by the top three ARCs; the corresponding share was 67 per cent for the top five ARCs.

When it comes to acquisition of assets by ARCs, over time, although the average acquisition ratio (acquisition cost to book value of assets) has gradually risen, it remains in the range of 30-35 per cent, the article said.

There is a wide variation in the acquisition ratio also across sectors, it added.

Iron and steel, and power sectors are the two sectors having a relatively high concentration in acquired assets, as they are also ridden with NPAs. The acquisition ratio in these two sectors has been much lower (roughly about 45 per cent).

By contrast, hospitality (acquisition ratio: about 85 per cent) and real estate (about 70 per cent) account for a smaller share in total assets acquired, but their acquisition ratio has been relatively high.

Limited trading of SRs

Going by the resolution methods, ARCs prefer the method of rescheduling of the payment obligations (32 per cent as of March 2020) over other methods — enforcement of security interest (26.6 per cent); settlement of dues of borrower (26 per cent); by sale of business (13.9 per cent); and taking possession of assets (1.5 per cent).

The authors said banks continue to hold close to 70 per cent of the total Security Receipts (SRs) despite a change in the regulation disincentivising them from holding SRs above a specific threshold.

The authors observed that dominance of selling banks in holding SRs has often been described as a reason for limited secondary trading of SRs, despite the regulatory push to incentivise listing and trading of these instruments.

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RBI paper, BFSI News, ET BFSI

Banking & Finance

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Introduction of a bad bank may help “shape the operations” of the existing asset reconstruction companies (ARCs), an RBI paper said on Monday, noting that a sizable bulk of assets bought by such entities have not been resolved for a long time. The paper, published in the central bank’s monthly bulletin for April, also flagged risks of an excessive reliance on banks by the ARC industry.

It said banks supply non performing assets (NPAs) to the ARCs, hold shareholding in these entities and also lend to them, which makes it necessary to monitor if there is a “circuitous movement of funds between banks and these institutions (ARCs)”.

In her Budget speech for FY22, Finance Minister Nirmala Sitharaman had declared that a new ARC will be created to hold the sour assets of the state-run lenders and resolve such assets professionally.

“About 42 per cent of the outstanding SRs (security receipts) as on March 2020 were more than five years of age and would have to be redeemed over the next four years to avoid write-offs,” the paper said, pointing out at the difficulties being faced by the current set of ARCs in resolving the stress.

While resolving a case, ARCs pay a minor portion in cash to the selling bank while the rest is SRs to be paid over a time.

“Going forward, the introduction of a new asset reconstruction company for addressing the NPAs of public sector banks may also shape the operations of the existing ARCs,” the RBI paper said.

It added that there is a definite scope for the entry of a “well-capitalised and well-designed entity” in the Indian ARC industry and such a body will strengthen the asset resolution mechanism further.

It cited global experiences to lay down the necessary features of the new ARC announced by the government.

It advocated that the new ARC or the bad bank should have a narrow mandate such as resolving NPAs with clearly defined goals, a sunset clause defining their lifespan, supportive legal infrastructure involving bankruptcy and private property laws, backing of a strong political will to recognise problem loans, and a commercial focus including in governance, transparency, and disclosure requirements.

The paper said while proactive asset recognition is important for a correct assessment of the health of the banking system, it needs to be followed by effective asset resolution and recovery by banks.

The absence of an effective resolution and recovery mechanism can discourage recognition of NPAs by banks in the first place. The lack of recourse to timely recovery can also deteriorate the economic value of assets adding to the losses incurred by banks over time, it said.

The regulatory changes by the Reserve Bank have been broadly geared towards strengthening the ARC industry, ensuring genuine sale of NPAs by banks, enhancing the involvement of ARCs in the process of resolution and deepening the market for SRs, it said.

However, it noted that there has been a concentration in the industry in terms of AUM and SRs issued, and net owned funds.

Secondly, despite the regulatory push to broaden, and thereby enhance, the capital base of these companies, they have remained reliant primarily on domestic sources of capital, particularly banks.



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