In December 2002 when the Parliament of India enacted the Securitisation Act 2002 (THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT), 2002), it paved the way for asset reconstruction business in India. Before the enactment of the Securitisation Act, of 2002, banks and financial institutions had no option but to enforce their security interests through the court process, which was extremely time-consuming.
Asset Reconstruction Companies in India
After the implementation of the act, many asset reconstruction companies (ARCs) were formed. The Asset Reconstruction Company of India Ltd (ARCIL) was the first one and pioneered the building business of asset reconstruction in India. It was promoted by ICICI Bank, IDBI Bank, and SBI. Over the past many years, ARCIL has launched NPA resolution initiatives by working with the banking system and also launched a subsidiary ARMS to handle retail NPA cases. Presently there are about fourteen Asset Reconstruction Company of India Ltd (ARCIL) in the country. Prominent among them are ARCIL, ASREC, India SME Asset Reconstruction Company Limited (ISARC), Pegasus Assets Reconstruction Pvt. Ltd., Reliance Asset Reconstruction Company Ltd, etc.
The Securitisation Act mainly provides for the following:
1) Enforcement of Security Interests by secured creditors;
2) Transfer of Non-Performing Loans to asset reconstruction companies (ARCs), which can then take measures for recovery as prescribed under the Securitisation Act, 2002;
3) A legal framework for securitization of assets.
Functioning of ARCs and a model flow of transactions in the Asset reconstruction industry
The trust acquires NPAs from banks/FIs by formulating different trusts for the financial assets taken over. NPA is acquired from banks/FIs at fair value based on an assessment of the realizable amount and time to resolution. This of course at times goes through even the bidding process. The maximum life of the trust as prescribed by the regulations is five years. The trust is set up as a pass-through certificate (PTC) entity for Income tax purposes.
1) Accordingly, the trusts issue securities receipts (SR) to the investors which are usually Qualified Institutional Bodies (QIBs) or the seller bank itself. So in case the seller bank is buying the SR in the Trusts, its status changes from lender of the loan to that of investor in the SR. SR represents undivided rights, titles, and interests in the trust fund. After acquiring the NPA, the trust becomes the legal owner and the security holders its immediate beneficiaries. The Securitisation Act prescribes that an ARC has to make a minimum of certain investment in the trust.
2) The Trust redeems the investment to the SR holders out of the money realized from the borrowers. The Asset Reconstruction Company of India Ltd (ARCIL) facilitates the whole work.
The NPAs acquired are held in an asset-specific or portfolio trust scheme. In the portfolio approach, due to the small size of the aggregate debt the ARC makes a portfolio of the loan assets from different banks and FIs. Whereas when the size of the aggregate debt of a bank/FI is large, the trust takes asset asset-specific approach.
Advantages of Asset Reconstruction Industry-
- As the cash realization activity from defaulting borrowers is a lengthy and cumbersome procedure, relieving banks of the burden of NPAs enables banks to focus better on managing the core business including new business opportunities.
- The transfer helps restore depositor and investor confidence by ensuring the lender’s financial health. The banks use it as a method to hive off the bad loans from their balance sheet. ARCs are meant to maximize recovery value while minimizing costs.
- ARCs considered experts in managing and handling NPA cases help in building industry expertise in loan resolution and restructuring management, besides serving as a catalyst for important legal reforms in bankruptcy procedures and loan collection.
- Asset Reconstruction Company of India Ltd (ARCIL) plays an important role in developing capital markets through secondary asset instruments.
Issues that concern the industry
The Asset Reconstruction industry is in its nascent stage in India and many issues concern the industry. Prominent among them are-
3) NPA valuation- The valuation of NPA remains a concern with many parameters affecting its results. There is always a difference of opinion on recovery period, method of valuation (whether value as going concern or not), and data collection. Bridging the valuation gap and creating confidence will be important for the growth of the sector
4) Flexibility in controlling the structure of an ARC- India has taken an approach with ARCs either owned by the private parties or the bank (i.e. not by the government). However, there are restrictions on a controlling stake by a single party and minimum investment in the Asset Reconstruction Company of India Ltd (ARCIL). A relaxation of this norm would encourage more private entities to have a presence in this sector bringing more depth to this sector. This will bring specialists into the game and the sector will be more competitive and transparent. There is also a possibility to create the structure for handling retail NPA with lower capital requirements.
5) Reduction and standardization of registration fee and stamp duty- The duties should be rationalized and simplified to reduce the transaction cost and make the procedure smoother.
6) Life of trust set up by ARC for asset resolution-the maximum life prescribed by the law for trust is five years. There should be flexibility for extending the life of the trust if the resolution is ongoing or appears to be likely in the foreseeable future.
7) Lengthy recovery process legal procedures are known to concern those who are dealing with Indian laws. The regulator should frame some laws to speed up the recovery procedure to encourage more churning in the sector.
8) Accounting policies- As this sector is relatively new in India; the accounting treatment of important issues differs from company to company. ICAI should come forward and prescribe some guidance that will bring comparability and transparency to this sector.
The growth of the Asset reconstruction sector is important for the Indian Economy. Some kind of fiscal incentives should be provided to fuel the growth of the industry. Also as the total NPA in the Indian banks is reducing the ARCs should look forward to other avenues of business like business turnaround management and debt restructuring. There should be a mechanism to review to working of ARC which should work to increase the transparency in the sector. As more and more private players enter into this sector, this space is really exciting and can become a multi-billion dollar business in itself. Considering the current size of NPA Rs. 1725 billion, the problem is big and requires a focussed approach to solve.
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