Challenges and Strategic Adjustments for ARCs

Asset Reconstruction Companies (ARCs) are facing a slowdown in growth, primarily due to a reduction in Non-Performing Assets (NPAs), which have fallen to a 12-year low of 2.8% as of March 2024. According to Crisil, assets under management (AUM) by ARCs are expected to contract by 7-10% in 2024-25, following a stagnant performance in 2023-24.

Concerns of Asset Reconstruction Companies (ARCs)

Low Business Potential

1. Decrease in new non-performing corporate assets has led ARCs to target smaller, less profitable retail loans.
2. Despite this focus, there has not been a significant increase in retail NPAs, limiting opportunities for ARCs.

Increased Investment Mandate

1. RBI's directive in October 2022 requires ARCs to invest at least 15% of bank investments in security receipts or 2.5% of total security receipts issued, whichever is higher.
2. This has placed additional constraints on ARCs' capital usage, with many struggling to meet the new ₹300 crore minimum net owned funds requirement.

Net Owned Funds Requirements

1. The RBI raised the minimum net owned funds requirement for ARCs from ₹100 crore to ₹300 crore in October 2022 to ensure robust balance sheets.
2. Many ARCs are struggling to meet this requirement, leading to potential mergers or exits.

Competition from NARCL

1. The state-owned National Asset Reconstruction Company Ltd (NARCL) offers security receipts guaranteed by the government, making them more attractive to financial institutions.
2. This creates significant competition for private ARCs.

Regulatory Challenges

1. ARCs must now obtain approval from an independent advisory committee for all settlement proposals, leading to delays.
2. Increased RBI scrutiny, including the banning of Edelweiss ARC from new loans for bypassing regulations, has impacted major ARCs.
3. Trust deficit between the RBI and ARCs, with concerns about transactions potentially helping defaulting promoters regain control of assets, violating Section 29A of the IBC.

What are ARCs?

1. Definition: An asset reconstruction company (ARC) buys distressed debts from banks at an agreed value and attempts to recover the debts or associated securities.
2. Background: ARCs were introduced by the Narsimham Committee – II (1998) and established under the SARFAESI Act, 2002.
3. Current Status: 27 ARCs are registered with the RBI, including prominent ones like NARCL, Edelweiss ARC, and Arcil.
4. Registration and Regulation: ARCs must be registered under the Companies Act, 2013 and with the RBI under the SARFAESI Act.
5. Funding: ARCs raise funds from Qualified Buyers (QBs) including insurance companies, banks, and asset management companies.

Working of ARCs

Asset Reconstruction

1. Acquiring rights in distressed loans or credit facilities for recovery.
2. Buying distressed loans at a discount, redeemable within eight years.

Securitisation

1. Acquiring financial assets by issuing security receipts to Qualified Buyers.

Non-Performing Asset (NPA)

1. Definition: A loan classified as NPA when payments are overdue for 90 days; for agriculture, if overdue for two cropping seasons.
2. Categories:
   1. Sub-standard Assets: Non-performing for ≤12 months.
   2. Doubtful Assets: Non-performing for >12 months.
   3. Loss Assets: Uncollectible and needing to be written off.

Recent Changes in ARCs Regulations by RBI

1. Strengthening Governance Structure: Chair and at least half of the board must be independent directors.
2. Enhancing Transparency: Disclosure of track record of returns and collaboration with rating agencies for schemes launched in the past eight years.
3. Revised Investment Requirements: ARCs must invest at least 15% of the transferor’s investment or 2.5% of total receipts issued, whichever is higher.

Measures to Address Challenges Faced by ARCs

1. Diversification of Asset Portfolios: Explore sectors beyond traditional corporate and retail loans, such as infrastructure and MSMEs.
2. Improving Regulatory Transparency and Collaboration: Work closely with the RBI and other regulatory bodies for transparent operations and compliance.
3. Enhancing Efficiency in Settlements: Use technology, such as AI-driven analytics, to speed up settlement processes.
4. Adopting Strategic Competition with NARCL: Offer specialized solutions or focus on faster recovery mechanisms to differentiate from NARCL.

Conclusion

Asset Reconstruction Companies (ARCs) are facing multiple challenges, including a reduced pool of non-performing assets, increased regulatory requirements, and competition from the state-owned NARCL. Addressing these challenges requires diversification, improved regulatory collaboration, and enhanced operational efficiency.

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