Banks are financial institutions that are engaged principally in the business of money lending and money borrowing. The customer base of the banking sector is very large and there is also a substantial risk involved in lending money.
While the bank always has the option of taking legal action on the defaulting borrowers, it is not always economically feasible to do so. The bank sometimes decides to just cut its losses, clean up its balance sheet and keep the business moving towards better avenues. This is where an Asset Reconstruction Company (ABC) comes in.
Overview of an Asset Reconstruction Company (ARC)
An asset reconstruction company’s primary goal is to manage and to make profitable those assets which have been underperforming or become formally classified as NPA’s belonging to companies who have been unable to generate sufficient, timely revenue to service their outstanding obligations. One of the downsides is the potential loss of income that can be suffered in trying to resolve crises in distressed debt where companies are in danger of bankruptcy/insolvency. Nonetheless, ARC’s, when managed properly, have a significant possibility of profit if they can relieve the company under financial stress and manage to pass over the acquisition of the assets to other more worthy candidates. ARC’s charge a management fee or commission for their services from the distressed company/individual.
Asset Reconstruction Company
An asset reconstruction company is a special type of financial institution that buys the debtors of the bank at a mutually agreed value and attempts to recover the debts or associated securities by itself.
The asset reconstruction companies or ARCs are registered under the RBI and regulated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002).
The ARCs take over a portion of the debts of the bank that qualify to be recognised as Non-Performing Assets. Thus ARCs are engaged in the business of asset reconstruction or securitisation or both.
All the rights that were held by the lender (the bank) in respect of the debt would be transferred to the ARC. The required funds to purchase such such debts can be raised from Qualified Buyers
Asset Reconstruction
It is the acquisition of any right or interest of any bank or financial institution in loans, advances granted, debentures, bonds, guarantees or any other credit facility extended by banks for the purpose of its realisation. Such loans, advances, bonds, guarantees and other credit facilities are together known by a term – ‘financial assistance’.
Securitisation
It is the acquisition of financial assets either by way of issuing security receipts to Qualified Buyers or any other means. Such security receipts would represent an undivided interest in the financial assets.
Qualified Buyers
Qualified Buyers include Financial Institutions, Insurance companies, Banks, State Financial Corporations, State Industrial Development Corporations, trustee or ARCs registered under SARFAESI and Asset Management Companies registered under SEBI that invest on behalf of mutual funds, pension funds, FIIs, etc. The Qualified Buyers (QBs) are the only persons from whom the ARC can raise funds.
Asset Reconstruction Company (ARC) in India
In India, the problem of recovery from NPAs was recognized in 1997 by the Government of India. In India, the Government recognizes the problem of recovery from NPAs The Narasimhan Committee Report mentioned that an important aspect of the continuing reform process was to reduce the high level of NPAs as a means of banking sector reform. With the combination of policy and institutional development, new NPAs in the future could afford it at lower. However, the huge backlog of existing NPAs continued to hound the banking sector, and this impinged severely on the banks’ performance and any ensuing hopes of their profitability. The Report envisaged the creation of an “Asset Recovery Fund” to take the NPAs off the lender’s books at a discount.
Accordingly, Asset Reconstruction Company (Securitization Company / Reconstruction Company) is a company registered under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SRFAESI) Act, 2002. It is regulated by the Reserve Bank of India as a Non-Banking Financial Company (u/s 45I (f) (iii) of RBI Act, 1934).
RBI has exempted ARCs from the compliances under section 45-IA, 45-IB, and 45-IC of the Reserve Bank Act, 1934. ARC functions like an AMC within the guidelines issued by RBI.
ARC has been set up to provide a focused approach to Non-Performing Loans resolution issue by:-
(a) Isolating Non-Performing Loans (NPLs) from the Financial System (FS), (b) Freeing the financial system to focus on their core activities and (c) Facilitating the development of the market for distressed assets.
Process of Asset Reconstruction by ABC?
The main intention of acquiring debts / NPAs is to ultimately realise the debts owed by them. However, the process is not a simple one. The ARCs have the following options in this regard:
- Change or takeover of the management of the business of the borrower.
- Sale or lease of such business.
- Rescheduling the payment of debts – offering alternative schemes, arrangements for the payment of the same.
- Enforcing the security interest offered in accordance with the law.
- Taking possession of the assets offered as security.
- Converting a portion of the debt into shares.
How an Asset Reconstruction Company (ARC) actually works?
The ARC transfers the acquired assets to one or more trusts (set up u/s 7(1) and 7(2) of SRFAESI Act, 2002) at the price at which the financial assets were acquired from the originator. Asset Reconstruction Companies have seen an increase in their client base during the recession, with many companies experiencing financial difficulties and having distressed assets in their possession. Banks see that many of their loans turn non-performing and require restructuring in Toto. ARCs have the opportunity to relieve these companies, resell their assets, and make the most of them, with the trusts they turn to buy them off and bearing the risks concomitant with them. These ARCs will have an obligation to help companies in times of stress rejuvenate the activities of non-performing assets. Some companies that have not been working for a while can continue their operations by virtue of a transaction made by these companies. The trusts themselves issue Security Receipts to Qualified Institutional Buyers [as defined u/s 2(u) of SRFAESI Act, 2002]. The trusteeship of such trusts shall vest with the ARC. ARC receives a management fee from the trusts. Any upside in between acquired price and the realized price will be shared with the beneficiary of the trusts and ARC. Likewise, any downside in between acquired price and the realized price will be borne by the beneficiary of the trusts.