ARCs must be strengthened if they are to be effective

| Updated on December 15, 2019

Despite numerous regulatory interventions and growing evidence of the relevance of asset reconstruction companies, there is much ground to cover in India’s distressed assets space

Asset reconstruction companies (ARCs), that were formed under the SARFAESI Act to help banks manage and recover bad loans, have sprung back into focus after the RBI’s recent directive and the Supreme Court ruling in the Essar Steel case. While the former ensures more transparency in the sale of bad loans by banks to ARCs, the latter highlights how ARCs can help ease banks’ burden. The RBI’s recent notification — disallowing ARCs from buying bad loans bilaterally from banks or financial institutions which are the sponsors of/lenders to the ARC, or part of the same group — is imperative to ensure that there is ‘true sale’ of assets. Given that banks stopped recording assets sold to ARCs as bad loans in their books, it is important that banks do not use the ARC tool to evergreen their balance sheets. At the same time, the successful resolution of Essar Steel brings to light the importance of having an efficient ARC structure in place.

But despite numerous regulatory interventions over the past few years and the growing evidence of the relevance of ARCs, there is much ground to cover in India’s distressed assets space. Sale of bad loans to ARCs had slumped significantly in FY16 after the RBI increased the upfront payment three-fold to 15 per cent, to ensure more skin in the game for ARCs. While the sale has picked up since then, it remains tepid. Banks, on their part, have been reluctant to offload their NPAs at low price. However, after the successful resolution of Essar, banks may start to offload more loans to ARCs. There may also be better consensus on the pricing of loans, given the reasonable track record of recovery under the IBC. But there are several other challenges.

Being a capital-intensive business, ARCs have not been able to take on bad loans from banks at an aggressive pace. The issue of insufficient capital only became more pronounced after the RBI’s directive on higher down payment (15 per cent) in August 2014. While there have been several measures undertaken by the government to ease the flow of capital, they have not made a significant impact. Despite there being 28 ARCs currently in existence, just the top three still command over 70 per cent of the market. Sometime back, the idea of quarantining stressed power sector accounts into a national asset management company was finding favour in many quarters. Instead, strengthening existing ARCs that have been in operation for over a decade would go a long way in tackling highly stressed capital-intensive assets. Above all, the biggest challenge in drawing capital into the distressed asset space in India up until now has been the undue delays in the recovery process. Ironing out the chinks in the IBC process and hastening recovery will be critical to kindle investor interest and help capital flow into the India’s distressed asset sector.

Published on December 15, 2019

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