REPORT ON

ASSET RECONSTRUCTION COMPANIES

AND ITS CHALLENGES IN INDIA

PGDM BATCH 2018-20

SUBMITTED BY: SUBMITED TO:

Dr. Mayank Kumar

Ketan Bhardwaj (BM-018144)

Khushbu Bisht (BM-018146)

Kirti Singh (BM-018147)

Kritanshu Rathi (BM-018149)

Kumar Srijai (BM-018151)
Mahender Tewatia (BM-018153)
What are Asset Reconstruction Companies (ARCs)?

The leading problem in the country right now is alarming volume of Non-
Performing Assets with the banking system. Several attempts were made to
tackle NPAs. A serious such step was the creation of dedicated institutions
called Asset Reconstruction Companies or ARCs that purchases bad assets or
NPAs from banks at a negotiable price and helps banks to clean up their balance
sheets (by removing the NPAs). Performance of the ARCs are under evaluation
in the context of the mounting NPAs. At the same time, the new Insolvency and
Bankruptcy Act will give a critical role to the ARCs in settling the bad assets
through the insolvency process.

What are ARCs?

An Asset Reconstruction Company is a specialized financial institution that

buys the NPAs or bad assets from banks and financial institutions so that the
latter can clean up their balance sheets. Or in other words, ARCs are in the
business of buying bad loans from banks.

ARCs clean up the balance sheets of banks when the latter sells these to the
ARCs. This helps banks to concentrate in normal banking activities. Banks
rather than going after the defaulters by wasting their time and effort, can sell
the bad assets to the ARCs at a mutually agreed value.

SARFAESI Act 2002– origin of ARCs

The Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest (SARFAESI) Act, 2002; enacted in December 2002 provides
the legal basis for the setting up ARCs in India. Section 2 (1) of the Act
explains the meaning of Asset Securitization. Similarly, ARCs are also
elaborated under Section 3 of the of the Act.
The SARFAESI Act helps reconstruction of bad assets without the intervention
of courts. Since then, large number of ARCs were formed and were registered
with the RBI which has got the power to regulate the ARCs.

Capital needs for ARCs

As per amendment made on the SARFAESI Act in 2016, an ARC should have a
minimum net owned fund of Rs 2 crore. The RBI plans to raise this amount to
Rs 100 crore by end March 2019. Similarly, the ARCs have to maintain a
capital adequacy ratio of 15% of its risk weighted assets.

How ARCs get funding to buy bad assets from banks?

Regarding funds, an ARC may issue bonds and debentures for meeting its
funding requirements. But the chief and perhaps the unique source of funds for
the ARCs is the issue of Security Receipts. As per the SARFAESI Act, Security
Receipts is a receipt or other security, issued by a reconstruction company (or a
securitization company in that case) to any Qualified Institutional Buyers
(QIBs) for a particular scheme. The Security Receipt gives the holder (QIB) a
right, title or interest in the financial asset that is bought by the ARC. These SRs
issued by ARCs are backed by impaired assets.

Working of the ARC

The working of the ARC can be summarized by the following diagram:

The business of asset reconstruction or securitisation may be commenced only
after obtaining a registration certificate under Section 3 of the SARFAESI Act,
2002. The main requirement in this regard is that the ‘net owned funds’ as
prescribed in the RBI Act should be Rs. 100 crore or more.

How will the ARC carry out the process of asset reconstruction?

The main intention of acquiring debts / NPAs is to ultimately realise the debts
owed by them. However the process is not a simple one. The ARCs have the
following options in this regard:

 Change or takeover of the management of the business of the borrower

 Sale or lease of such business
 Rescheduling the payment of debts – offering alternative schemes,
arrangements for the payment of the same.
 Enforcing the security interest offered in accordance with the law
 Taking possession of the assets offered as security
 Converting a portion of the debt into shares

What type of debts can the ARC take over?

The ARC can take over only secured debts which have been classified as a non-
performing asset (NPA). In case debentures / bonds remain unpaid, the
beneficiary of the securities is required to give a notice of 90 days before it
qualifies to be taken over.

How ARC’s get funding to buy bad assets from banks?

Regarding funds,

1. An ARC may issue bonds and debentures for meeting its funding
requirements.

2. Issue of Security Receipts- As per the SARFAESI Act, Security Receipts is a

receipt or other security, issued by a reconstruction company to any Qualified
Institutional Buyers (QIBs) for a particular scheme. The Security Receipt gives
the holder (QIB) a right, title or interest in the financial asset that is bought by
the ARC. These SRs issued by ARCs are backed by impaired assets.

Rules for the acquisition of assets and its valuation by ARCs

NPAs shall be acquired at a ‘fair price’ in an arm’s length principle by the

ARCs. They have to value the acquired bad assets in an objective manner and
use uniform process for assets that have same features.

SARFAESI Act permits ARCs to acquire financial assets through an agreement

banks. Banks and FIs may receive bonds/ debentures in exchange for NPAs
transferred to the ARCs. A part of the value can be paid in the form of Security
Receipts (SRs). Latest regulations instruct that ARCs should give 15% of the
value of assets in cash.

Bond or debentures can have a maximum maturity of six years and should have
a rate of interest at least 1.5% above the RBI’s ‘bank rate’. While dealing with
bad assets, ARCs should follow CAR regulations.
News Related to ARCs

1.Banks warm up to block sale of bad loans to ARCs

In the first quarter of this year, banks off-loaded Rs 30,000 crore of outstanding
loans that are classified as stressed loans. Banks have sold nearly four bad
accounts to asset reconstruction companies (ARCs) as a consortium, a move
that is aimed at fetching them a better value and quicker resolution.
State Bank of India, the lead bank for Hotel Leelaventure and Bharati Shipyard,
was the driving force behind the decision to sell loans to a single ARC and all
lenders agreed to sell the loans at the price accepted by SBI, banking executives
familiar with the matter said.

2. Avenue India joins as new sponsor shareholder of ARCIL

Asset Reconstruction Company (India) Ltd (Arcil) on Friday announced

Avenue India Resurgence Pte. Ltd. as its new sponsor shareholder, following
the completion of secondary purchase from a few existing shareholders."A
representative of Avenue is expected to join the board of Arcil post regulatory
approvals. It is expected that some further shares might be acquired by Avenue,
likely to close shortly with a couple of other shareholders. Post those tranches,
Avenue is expected to achieve minority interest in the company," Arcil said in a
statement.Avenue India Resurgence Pte. Ltd. is an arm of the New York-
headquartered global investment firm, Avenue Capital Group.

3. NY based Avenue capital picks up 27% stake in ARCIL

New York-based $10-billion distressed fund manager Avenue Capita has picked
up a 27 per cent in Asset Reconstruction Co of India (Arcil), India’s oldest
stressed asset aggregator, a sign foreign investors have a buoyant outlook for
the sector.
Avenue Capital’s stake purchase from six shareholders gives Arcil a much-
needed shot of liquidity as it scouts for distressed assets in a market rebooted by
the new Insolvency and Bankruptcy Code (IBC).
Lathe Investment, an arm of the government of Singapore, IDFC Bank, First
Rand Bank, Karur Vysya Bank, and Quiveo Enterprises, a subsidiary of UK-
based Ashmore Group, have all exited Arcil.

“Avenue has been investing in distressed assets in India since 2005 and they can
now help us raise funds. We plan to raise Rs 1,500 crore in the next six months
and Ashmore can help us raise funds. The new bankruptcy framework has
helped quicken the resolution process and increased opportunities in the
distressed space,” said Arcil CEO, Vinayak Bahuguna.
4. Reliance ARC to double total AUM to Rs.4000 cr in three years.

Reliance Asset Reconstruction Company, a part of Reliance Capital, intends to

double its total Assets Under Management (AUM) to ₹4,000 crore within the
next three years. The Anil Ambani company is also close to acquiring a stressed
credit card portfolio in the next couple of months. To double its AUM, Reliance
ARC is banking on bad loans in the retail sector, while some select assets in the
wholesale space would be a windfall. In the retail segment, the company is
active in MSMEs and retail loan portfolios. “The non-performing assets (NPAs)
in the MSME sector is growing and in our business, we are more skewed
towards secured debt, as only 25 per cent of our portfolio is unsecured. If we get
some stressed assets in wholesale, we’ll grow faster. However, pricing is the
key and it needs to be return on equity (RoE) accretive,” Ravindra Rao, ED and
CEO at Reliance ARC told Business Line.

5. ARCIL’s new online tool to help investors track

Plans to raise ₹1,000 cr via AIF route in FY19

In a bid to attract investments in the bad loans space, Asset Reconstruction
Company (India) (Arcil) is developing an online asset management system that
will help investors track the performance of their investments in instruments
such as security receipts.

6. ARCs banned from buying own group assets

The Reserve Bank of India (RBI) on Friday prohibited (ARCs) from buying
assets on a bilateral basis from its own group or parent bank.

The central bank said ARCs could not buy financial assets from a bank or
financial institution which was the sponsor, or “ a lender or a subscriber to the
fund, if any, raised by the ARC for its operations”

7. RBI tightens norms for ARCs to acquire financial assets

RBI stops asset reconstruction companies from buying assets from sponsor
banks or financial institutions via bilateral deals. An ARC shall not acquire
assets in a bilateral deal from a bank or financial institution, which is either a
lender to the ARC or a subscriber to the fund, if any, raised by the ARC for its
operationsAccording to the new rules, ARCs cannot acquire financial assets
from a bank or financial institution, which is the sponsor of the ARC, on a
bilateral basis. RBI also stopped ARCs to buy financial assets from a bank or
financial institution, which is either a lender to the ARC or a subscriber to the
fund raised by the ARC for its operations and an entity in the group to which the
ARC belongs.

Challenges faced by Assets Reconstruction Company: Report by Crisil

The total assets under management (AUM) of bad loan aggregators in India has
crossed Rs 1 lakh crore in fiscal ended March 2019 but the pace of growth has
eased as asset reconstruction companies’ (ARCs) face challenges due to higher
cash portion in acquisition of bad loans.
As per a report by thr rating agency Crisil the growth in ARC assets has fallen
to 7% in fiscal year 2019 from 25% a year ago mainly as the redemption rate for
security receipts (SRs) has improved. SRs are issued to banks pending recovery
from a bad account. These SRs are then en-cashed after the loan is recovered.
Crisil rates ARCs accounting for around 75% of overall industry AUM. The
rating agency estimates that redemption of SRs increased to around 15% in
fiscal 2019.
Higher provisioning requirements for banks has also increased cash settlement
by banks. New RBI norms effective from April 2017 said that if SRs make
more than 50% of the value of the asset under consideration, banks have to
continue to provide for these loans as if the loans continue in the books of the
bank, increasing provisioning requirements for banks and making it less
lucrative to put fresh stock of bad loans on the block. This has pushed banks
towards cash settlements. Cash as a portion of total acquisition cost for the
fiscal 2019 was around 90%, up from 28% last fiscal.
“With selling banks unwilling to invest more than 10% in most cases, the
business model for ARCs has become more capital intensive, with a need to
either put in their own funds, or bring in other investors. In such a scenario,
quicker recoveries by ARCs becomes even more critical as it helps free the
capital deployed by them to make way for newer acquisitions and also attract
new and repeat investors,” said Krishnan Sitaraman, senior director, Crisil
Ratings.
In 2016, ownership norms were also eased, allowing foreign investors to take
100% stake in ARCs. This together with a functioning bankruptcy law has led
to an increase in foreign fund interest in the bad loan market in India. Crisil said
ARCs’ ability to tap this Rs 9.4 lakh crore opportunity and grow sustainably
will hinge on their ability to collaborate with other investors and accelerate their
pace of recoveries.
Such foreign funds and investors picked up 59% of the SRs in fiscal 2019
according to Crisil’s estimates up from 8% in fiscal 2018 and from about 1% in
fiscal 2017. “ARCs have been able to rope in external investors to subscribe to
the SRs. In fact, in fiscal 2019, for Crisil-rated ARCs, foreign banks, stressed
assets funds and global pension funds, subscribed to around 60% of total SRs
issued. Two years ago, this was negligible,” said Subha Sri Narayanan, director,
Crisil.