ARC industry will need to reinvent itself

The RBI unveiled new regulations in October 2022, which enhanced governance standards and permitted ARCs to act as resolution applicants under the IBC's ambit

Asset reconstruction companies (ARCs) have their genesis in the Sarfaesi Act, 2002, and corresponding Reserve Bank of India (RBI) guidelines in 2003, starting as an agency dedicated to resolving bad loans. The model was changed with the stipulation of a minimum investment of 5 per cent, which turned it into a low-capital-investment model. While ARCs geared up to raise capital to meet this stipulation, the minimum investment was tripled to 15 per cent in August 2014. This impacted the economics and raised question marks about their ability to raise funds.

However, ARCs and lenders slowly worked out appropriate pricing for sale of assets and their recovery, and redemption of security receipts (SRs) improved substantially under the 15:85 structure. ARCs invested over Rs 43,000 crore until FY22 to acquire assets at a pricing of over Rs 2 trillion. Of this, lenders have already realised 50 per cent of their SR holdings. Under the 15:85 structure, over 80 per cent of SR redemption can be expected — unlike the 5:95 route, where the pricing was high.

ARCs were dealt another blow when the RBI withdrew the provisioning benefit to lenders on sale of assets to ARCs under the SR structure. This impacted their business, particularly from state-run banks, which started looking for sales under the 100 per cent cash structure.

ARCs can be effective agents in resolution of stressed assets, if a few basic enablers can be set in motion. This mainly relates to availability of reasonable medium-term funding and making the current option acceptable to lenders with revival of provisioning benefits or valuation on a fair-value basis under IndAS.

With pricing under the cash basis being substantially lower due to investors’ return expectations, there weren’t many transactions. Cash-starved ARCs with limited access to qualified buyers could not make higher purchases. These transactions are happening through distressed funds where yield expectations of overseas investors are high.

In July 2021, the National Asset Reconstruction Company (NARCL) was set up as a solution to the perceived inefficiency of ARCs to resolve larger volumes of non-performing assets. While NARCL functions under the 15:85 structure with conditional guarantee support from the government for 85 per cent of the value, their offers are also put under Swiss Challenge to other ARCs, which is not a real level playing field, as other ARCs have to bid fully in cash.

ARCs’ cash constraint will continue to hinder them in participating in these transactions. While the transactions under NARCL at this juncture appear to be muted, they could play an active role going forward, considering that they would be an effective agency, particularly to warehouse large-value assets in which the potential can be realised a few years down the line.

Just as the ARCs were settling down, the RBI unveiled new regulations in October 2022, which have enhanced corporate governance standards, freed up capital requirements for all cash transactions, and permitted ARCs to act as resolution applicants under the Insolvency and Bankruptcy Code framework. However, the settlement process to be followed — which includes a review of settlements by an independent advisory committee and board approval — has impacted business.

Considering that ARCs have assets of all sizes and structures — from unsecured credit card dues to very large corporate assets — the generic stipulation will need a review, because the current framework would delay settlements. ARCs have made representations to the RBI, and hope to get a positive response. 

In the interim, the recent discussion paper on securitisation of stressed assets has raised certain concerns about the ARCs’ potential for sustained growth. The industry will have to again reinvent itself to be an effective and active player. With 2.5 per cent investment in cash deals and the possibility of being a resolution manager, if permitted under the SSAF, ARCs can again start looking at the agency model and don that role as well.

The writer is managing director and chief executive officer, Edelweiss Asset Reconstruction Company