What are Asset Reconstruction

Companies (ARCs)?
tojo jose
July 11, 2017

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.

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.

Resolution Strategies that can be followed by ARCs

while restructuring the assets

The guidelines on recovery of money from the resolution process

by the ARCs say that regaining the value through restructuring
should be done within five years from the date of acquisition of
the assets. SARFAESI Act stipulates various measures that can
be undertaken by ARCs for asset reconstruction. These include:

a) taking over or changing the management of the business of

the borrower,

b) the sale or lease of the business of the borrower

c) entering into settlements and

d) restructuring or rescheduling of debt.

e) enforcement of security interest

 The last step of ‘enforcement of security interest’ means ARCs can
take possession/sell/lease the supported asset like land, building
etc.

ARCs and the secured creditors cannot enforce the security

interest under SRFAESI unless at least 75% by value of the
secured creditors agree to the exercise of this right.

Besides restructuring, the ARCs can perform certain other

functions as well. They are permitted to act as a manager of
collateral assets taken over by the lenders by receiving a fee.
Similarly, they can also function as a receiver, if appointed by any
Court or DRT.

Performance of ARCs

During the early period of 2008 – 13 where reconstruction

business was in infancy stage, the conversion of NPAs was slow.
According to an ASSOCHAM report, the average recovery rate for
ARCs in India is around 30% of the principal and the average time
taken is between four to five years.

During 2013-14, because of multiple positive factors, the

reconstruction business was booming as ARCs bought large
quantity of bad assets from banks.

But after 2014, the performance of ARCs in settling the NPAs

became below par. Especially in the recent periods, ARCs became
underperformers in the context of the present rising tide of bad
assets. This has caused steep rise in NPAs in the banking sector.

The declining asset reconstruction activity was started from the

second half of 2014, when the RBI has raised certain norms for
securitization business. RBI released a comprehensive
‘Framework for Revitalizing Distressed Assets in the Economy’. It
suggested a corrective action plan to fight NPAs. Later, the RBI
raised the cash payment to banks from 5% to 15%. Similarly, the
it removed special asset classification benefits to asset
restructuring from April 1, 2015 to align with international norms.
As a result of these, the asset reconstruction business witnessed a
slow-down.

At present, there are 19 ARCs in India. But collectively, their

capital base is also insufficient to tackle the country’s nearly Rs 8
lakh crores NPAs. The main problems in the sector are: low capital
base of ARCs, low funds with the ARCS, valuation mismatch of
bad assets between banks and ARCs etc.

Several steps were taken by the RBI and the government to bring
life into the asset reconstruction activities. In one such step, the
Government raised FDI in the sector to 100%. Similarly, the ARCs
may get a vital role for asset restructuring under the new
Insolvency and Bankruptcy Code. In 2016, the RBI has amended
the SARFAESI Act to give make the ARCs more efficient.