Retail and MSME asset buying to drive ARC business in FY24: India Ratings

Expected credit loss model for banks; PCA for NBFCs levers to asset sale

The acquisition of stressed loans in the retail and MSMEs segments will drive the business of asset reconstruction companies (ARCs) in FY24 in the backdrop of planned implementation of Expected Credit Loss (ECL) framework.

The application of the Prompt Corrective Action (PCA) framework for non-banking finance companies (NBFCs) may also lead to a rise in asset sale, according to India Ratings (Ind-Ra).

Because of the expected muted stress addition in large-ticket corporate assets, the ARC sector's AUM growth would be heavily reliant on small-ticket retail and MSME non-performing assets (NPAs).

Ind-Ra has assigned a stable rating outlook to asset reconstruction companies (ARCs) for FY24.

With rising inflation and interest rates, MSME and retail borrowers could face margin pressure, leading to a build-up in delinquencies which could drive acquisitions for the sector.

In past, NBFCs’ migration to Indian Accounting Standards led to a rise in provisions for unsecured lenders for stage 1 and stage 2 assets. There could be a similar trend playing out for banks with a larger unsecured book. This could lead to early asset sale to ARCs in the retail and MSME segment, post the adoption of the proposed expected credit loss framework for banks, agency said in a statement.

Also, bringing finance companies under PCA regime may mean rise in asset sales, largely in the segments of unsecured personal and business loan and used vehicle loans, it added.

The top few players constitute a significant share of the total industry. As a consequence, the small players will have to build equity to drive acquisitions as well as to meet the higher equity capital requirement as per the revised regulations.

While trend of improving profitability will continue, a conservative leverage strategy would be key for a sustainable business model, given the volatile nature of their cash flows, agency pointed out.