Tag: IBC

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.