News Analysis

Why bad-loan sales to ARCs have been flat for 3 years

Radhika Merwin BL Research Bureau | Updated on December 09, 2019 Published on December 09, 2019

RBI barring ARCs from buying loans from lenders sponsoring them may slow sales further

The regulatory clampdown has impacted the sale of bad loans to Asset Reconstruction Companies (ARCs) over the past three to four years. The RBI’s diktat last Friday can hurt sales in the near-term further.

Between 2016-17 and 2018-19, security receipts (SRs) issued by ARCs (essentially the price paid for acquiring the bad loans) have been in the range of ₹17,000-18,000 crore. While this is a vast improvement from weak sales of ₹9,800 crore in 2015-16, it is still lower than the peak levels of 2013-14 and 2014-15, when value of SRs issued were about ₹20,000-22,000 crore.


In a bid to improve transparency in the sale of bad loans to ARCs and ensure ‘true sale’ of assets, the RBI disallowed ARCs from buying bad loans bilaterally from banks or financial institutions that are the sponsors of the ARC. It also barred ARCs from buying assets from lenders that have lent to them, subscribed to the fund or are part of the same group as the ARC. They can, however, participate in auctions of the assets, provided these are conducted in a transparent manner, on an arm’s length basis, with pricing determined by market forces.

“The RBI’s directive importantly seeks to bring in more transparency in the sale of loans by NBFCs (a few being sponsors of ARCs or part of the same group), which has been gaining traction recently,” says Siby Antony, Chairman, Edelweiss ARC, and Chairman of Association of ARC of India.

ARCs usually buy banks’ bad loans, by paying a portion as cash up front, and issue security receipts (SRs) for the balance, which can be redeemed when the stressed assets are recovered. Depending on the expectation of the recovery in each case, banks and ARCs arrive at a price at which the loans are offloaded to ARCs.


Reasons for the slackness

Until August 2014, sale of loans used to happen at the 5:95 structure — implying a 5 per cent upfront cash payment and the balance 95 per cent being paid to the bank against the SR. This had led to a sudden rush by banks to sell bad loans. From about ₹2,000 crore in 2012-13, sale of bad loans (SRs issued) spiked to about ₹20,000 crore in 2013-14.

Wary of the unrealistic pricing that the 5:95 set-up had triggered, the RBI introduced the 15:85 structure, increasing the upfront cash payment to be made by ARCs to 15 per cent. This impacted the sale of loans, which slumped in 2015-16, because of the sudden threefold jump in the upfront payment and capital scarcity of ARCs.

While sales picked up after the sharp fall in FY16, they still remains tepid compared to the sharp rise in bad loans over the past three years. Bad loans in the banking sector have galloped from about ₹6 lakh crore in 2015-16 to around ₹10 lakh crore in 2018-19.

Aside from lack of consensus on the pricing, capital constraints faced by ARCs are one of the key reasons for the slackness. Currently while there are a total of 28 ARCs, the top three alone constitute 72 per cent of the total market share (in terms of assets under management).


In a bid to offer some respite to ARCs on the capital front, the 2016-17 Budget had made amendments in the SARFAESI Act 2002 to enable the sponsor of an ARC to hold up to 100 per cent from the earlier 49 per cent. Also, the Budget had provided for 100 per cent FDI in ARCs through the automatic route, against the earlier threshold of 74 per cent.

But these measures have not seemed to help much. As of March 2019, the total assets under management (AUM) of ARCs is about ₹98,000 crore. Of this, Edelweiss ARC (47 per cent), JM Financial ARC (14 per cent) and ARCIL (12 per cent) constitute the chunk, while the market share of most other players is still in low single digits.

According to Siby Antony, while many challenges remain, many foreign funds are keen on investing in India and some have tied up with the ARCs of Edelweiss, Kotak (Phoenix), JM Financial, etc.

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

Published on December 09, 2019
This article is closed for comments.
Please Email the Editor