Let bad assets move to ARCs, to enable banks to focus on credit growth and core banking
Hari Hara Mishra | November 8, 2021
An RBI appointed committee to review the working of Asset Reconstruction Companies (ARCs) recently submitted a report containing a set of 42 recommendations. The recommendations have been made to ensure the flow of NPAs to ARCs gather speed and momentum, so that bankers can focus on core banking activities like lending, leaving stressed asset management to specialised regulated institutional framework like ARCs.
A few of these are discussed below, which have potential to deepen and broad-base the distressed loan sales market substantially. The enabling suggestions can be clubbed in three categories:
1. Introduction of new players into distressed debt space
2. Factors facilitating / forcing banks to sell NPAs
3. Factors facilitating ARCs with greater capacity to acquire
ARCs raise funds from investors for investment through Security Receipts (SRs), a typical promissory note type instrument issued by ARCs in lieu of cash and accepted by seller banks of the Non-Performing Assets (NPAs). The investors eligible to invest in these instruments are banks, Financial institutions, Foreign Portfolio Investors (FPIs), and some other specified entities like NBFCs, HFCs with a threshold level of asset size. Now the report recommends inclusion of several entities like High Net-worth Individuals (HNIs) (investment> ₹1 crore), corporates (Net worth>₹10 crore), all NBFCs, HFCs, Trusts, Family office, Distressed asset fund, pension funds etc. This change will greatly facilitate ARCs raise resources, while making a separate asset class, viz. Security Receipts, being made available in the market for investment and trading.
Apart from banks extending credit facilities, there are many other players in the broader financial system like Mutual Funds and AIFs who have exposure to various debts. But so far only banks, FIs, NBFCs could sell their loans to ARCs. For a comprehensive solution of distressed debt, the report suggests inclusion of AMCs, AIFs, FPIs as eligible entities to sale credit facilities to ARC.
So far, generally ARC sale used to be the last resort by banks after exploring all other means of resolution. In the process, the demographic composition of NPAs sold was ageing with minimal chance of a turnaround and ARCs did not have much choice other than asset sale, settlement etc, and there was not much of turnaround and reconstruction. The committee acknowledges the systemic importance NPA sale to ARC, and that too at an early date, so that lenders can focus on their core business. The committee has made recommendations as below which will have significant impact:
• For all NPAs above ₹100 crore, the resolution must include evaluation of sale to ARC
• For all NPAs above 2 years, with no active resolution, reason for not selling to ARC to be recorded
• Allowing early sale of NPAs, even less than 60 days. It can be sold on date of default itself
• Amortisation of loss on sale of NPAs over a period of 2 years
• If 66% lenders agree to ARC sale, offer will be binding on all others, else they have to make 100% provision on total loan
• Relaxation in provisioning norms for banks for loans sold by banks, if 51% of SRs held by non-lenders
• All financial entities (not only banks) to prepare a list of NPAs to be sold at beginning of year and circulate it to all ARCs.
• Fraud accounts (now estimated around ₹4 trillion ) permitted to be sold
The acquisition capabilities of ARCs will go up, as its margin/ contribution to acquire is now proposed at only 2.5% against 15% now, if they are able to co-opt a SR investor and give cash exit to seller banks. For other cases, it will be only 15% of lenders’ investment or 2.5%, whichever is higher. ARCs’ scope of functioning and empowerment also are proposed to be enhanced as follows:
• Permitted to float AIF as supporting platform for resolution
• SARFAESI right available for debts acquired from even those which were not having the power as assignor
• If ARC acquires 66% debt, 2-year moratorium on even Govt dues
• ARCs can become resolution applicant under IBC, subject to capping it at the level of SRs acquired in its usual Non-IBC acquisitions
• Can buy equity from banks
• Can acquire loans to domestic borrowers by overseas regulated entities
The Committee has made a host of other recommendations including standardisation of process and documents, online trading platform etc. One Important recommendation is fixation of reserve price, which will be done at a higher level, that has the power to write off the amount. So far, one of the bottlenecks was valuation expectation mismatch between banks and ARCs. Hopefully, with application of mind at higher management, price fixation will be more realistic. Incidentally, all assets above ₹500 crore will now have two valuers.
The focus of ARCs now will be market making an investor class of HNIs, Corporates etc with risk capital and appetite to invest in distressed papers. The challenge lies in convincing the attractiveness of business proposition from a risk-reward perspective.
Incidentally, very rightly, the RBI Committee recommends for disclosure of 10 years performance track record of ARCs in the offer document to be issued to the investors.
Mishra is a policy analyst and columnist.
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