News Analysis

Bankruptcy code can help capital-starved ARCs generate better returns

Radhika Merwin BL Research Bureau | Updated on January 09, 2018




Recoveries by ARCs have remained at a low 20%

Effective implementation of the Insolvency and Bankruptcy Code (IBC) can provide a leg-up to asset reconstruction companies (ARCs), that essentially step into the banks/lenders’ shoes to recover bad loans.

According to a report published by Crisil, released at the Assocham’s national conference on IBC recently, recovery rate for ARCs has been low at 20 per cent, with resolution taking more than five years. A quick resolution under IBC can help ARCs churn their capital better and improve returns.

Low recovery

According to the RBI and Crisil estimates, redemption ratio — security receipts (SRs) redeemed by SRs issued — which was a high 40-50 per cent between June 2011 and 2013, has fallen to 20 per cent as of June 2015 and June 2017.

Instead of taking cash payment upfront, banks have sold bad loans to ARCs through the SR route. This essentially implies that banks are willing to accept delayed payment, in the form of SRs, which are redeemed once the amount is recovered by the ARC.

The higher recovery in the earlier periods is on a very low base, as bad loan sales only started to gain meaningful traction from 2013-14 onwards. The data point to note thus, is the poor recovery in the last two years, which has not been up to expectations.

Smaller accounts (debt up to ₹100 crore) have had a better recovery rate with sale of assets/settlement being the most preferred route, according to Crisil. With reconstruction being the preferred resolution route for larger accounts, delay in legal proceeding have impacted recoveries.

ARCs were originally set up under the Sarfaesi Act to enable faster recoveries without the intervention of the court. But in practice, judicial intervention and the inefficacy of the Debt Recovery Tribunals (DRTs) have prevented ARCs from expediting recoveries.

Recent rulings by various courts, in particular, the Gujarat High Court verdict in the Essar Steel case, has upheld the powers of the National Company Law Tribunal (NCLT) as the insolvency court. Many believe that a time-bound resolution (180 days with 90 days extension), this time around will help in quicker resolution. This should help ARCs churn their capital better.

The IBC can also rekindle investor interest, and help draw more capital flows into the ARC industry.

Capital starved

After a lacklustre beginning, banks started aggressively offloading their bad loans to ARCs in 2013-14. This was thanks to deals done through the SR route.

In 2012-13, just about ₹10,000 crore of bad loans were sold to ARCs. This rose sharply to around ₹50,000 in 2013-14 and 2014-15.

But the RBI tweaking the rules for upfront payment brought the spurt in sales to an abrupt halt. In August 2014, the RBI increased the upfront payment to be made by ARCs from 5 per cent to 15 per cent. In 2015-16 and 2016-17, asset sales to ARCs fell to about ₹20,000 crore levels.

The issue of insufficient capital has became more pronounced after the RBI’s directive on higher down-payment. Being a capital-intensive business, insufficient capital has impeded the growth of ARCs.

The 21-odd ARCs in the country have an aggregate capital of just around ₹4,000 crore to tackle the ₹8 lakh crore of bad loans in the system.

The tardy legal and recovery process, up until now, has made matters worse for these capital-starved ARCs.

Published on August 07, 2017

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