Capital suggestion

In December 2011, a key advisory group on asset reconstruction companies (ARC) sector reforms, appointed by the government, had recommended, among others, thus: “Since ARC industry is capital intensive, and the existing investors lack adequate resources to fund the expansions, ARCs may be allowed to tap capital market. This will also increase public scrutiny and higher disclosures.”

The advisory group also suggested that ARCs may be allowed to raise equity from market in public issue of shares.

This has assumed critical importance particularly after August 2014, when the Reserve Bank has raised mandatory investment in securities receipts issued by an ARC from 5 per cent to 15 per cent. Also, non-performing assets (NPA) in the banking system have been rising at a menacing pace. From a gross NPA level of ₹1.4 lakh crore in 2011-12, this is estimated now at ₹3.4 lakh crore as of March 2015.

On the one hand, gross NPAs have risen nearly three times, and on the other hand, there has been a three-fold rise in mandatory investment required by ARCs.

As per a recent study by rating agency Crisil released on May 12, 2015, gross NPAs in the banking system is projected to rise to ₹4 lakh crore. The ARCs with an estimated capital base of ₹4,000 crore only stand helplessly and grossly inadequate in terms of financial muscle to rise to the occasion.

This necessitates the ARCs to build up their capital base substantially for an effective participatory role in NPA sales. In fact, ARCs have been setup to acquire NPAs of banks or financial institutions with the objective of focused management and optimal recovery, thereby relieving banks and financial institutions of the burden of NPAs and allowing the banks to focus on core activities.

In the Indian context, ARCs have been permitted to float Trusts for resolution of the NPAs acquired and funding is through issuance of security receipts which are akin to pass-through certificates with underlying cash flow from the NPAs acquired.

However, in the absence of third party investor money, the bank that sells NPAs doubles up as investor in security receipts — which is estimated around ₹53,000 crore, of which a substantial portion is invested by the selling banks themselves.

In effect, there is no effective risk mitigation at the bank; credit risk being only substituted by another risk — investment risk. For a real clean up of the system, fresh money should come in.

A meaningful and plausible solution is to decontrol ARCs by permitting them unrestricted access to capital market for equity and delinking investment in security receipts from only a select group of qualified institutional buyers (QIBs) and throwing it open for all institutional players in debt trading.

Further, provision like no sponsor being able to hold in excess of 50 per cent equity should be dispensed with, to enable promoters to bring in additional equity without dependence on another set of investors.

The author is President of UV ARC Ltd, Delhi. The views are personal

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