What are Asset Reconstruction Companies (ARCs)?

About Asset Reconstruction Companies (ARCs):

• An ARC is a specialized financial institution that purchases the bad debts of a bank at a mutually agreed value and attempts to recover those debts or associated securities by itself.
• ARCs help banks clean up their balance sheets by acquiring financial assets from banks and financial institutions through auctions or bilateral negotiations.
• 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).
• They function under the supervision and control of the RBI.
• As per the RBI, ARC performs the functions namely Acquisition of financial assets, Change or takeover of Management or Sale or Lease of Business of the Borrower, Rescheduling of Debts, Enforcement of Security Interest and Settlement of dues payable by the borrower.
• ARCs take over a portion of the bank's debts, which qualify as Non-Performing Assets (NPAs). Therefore, ARCs are involved in the business of asset reconstruction, securitisation, or both.
• All the rights previously held by the lender (the bank) in regard to the debt are transferred to the ARC.
• The required funds to purchase such debts can be raised from 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 are the only persons from whom the ARC can raise funds.
  • ARCs are prohibited from raising money by way of deposit.
• To commence the business of securitisation or asset reconstruction, an ARC is required to have a minimum net owned fund (NOF) of Rs 300 crore and thereafter, on an ongoing basis.
• They are also mandated to maintain a capital adequacy ratio of a minimum of 15% of its total risk-weighted assets.

News Rules issued by the RBI:

• The revised framework by the RBI mandates that ARCs adopt a more structured approach to settle dues while ensuring transparency and accountability in their operations.
• As per the new guidelines, every ARC must establish a Board-approved policy  that governs the settlement of borrower dues.
  • The policy is required to address critical aspects such as eligibility criteria for one-time settlements, permissible sacrifices based on exposure categories, and methodologies to determine the realisable value of securities.
• For borrowers with outstanding dues exceeding Rs 1 crore, settlementscan only proceed after a thorough evaluation by an Independent Advisory Committee (IAC).
  • This committee has to comprise experts with technical, financial, or legal expertise, who will assess the borrower’s financial position, projected earnings, and recovery prospects before making recommendations to the ARC.
  • Further, the Board of Directors, including at least two independent directors, must deliberate on the IAC’s recommendations and evaluate alternative recovery options.
  • The Board’s decision, along with the rationale, must be meticulously documented in meeting minutes.
• For dues of Rs 1 crore or below, ARCs can process settlements based on criteria defined in the Board-approved policy.
• However, officials involved in acquiring the financial asset cannot participate in the approval of the settlement to prevent conflicts of interest.
• Additionally, the Board must review quarterly reports detailing trends and recovery timelines for these accounts.
• The revised framework emphasised on robust reporting requirements, including periodic analysis of accounts settled through compromise. 
  • This analysis has to include details such as trends in settled accounts, categorisation of fraud and wilful default cases, and recovery timelines.
• Settlements involving borrowers classified as wilful defaulters or frauds will follow the same stringent procedures applicable to high-value accounts, irrespective of the settlement amount. 
• ARCs are also required to ensure that settlements comply with existing laws and obtain consent decrees from judicial authorities when recovery proceedings are already underway.

Q1: What is the difference between asset reconstruction and securitisation?

Asset Reconstruction refers to the acquisition of any right or interest of a bank or financial institution in loans, advances, debentures, bonds, guarantees, or any other credit facility extended by banks for the purpose of recovering the funds. These loans, advances, bonds, guarantees, and other credit facilities are collectively referred to as 'financial assistance.' Securitization, on the other hand, means the acquisition of financial assets through the issuance of security receipts to Qualified Buyers or other means. These security receipts represent an undivided interest in the financial assets.

Source: BS