RBI now allows ARCs to hold more than 26% shares

By Mayank Agarwal ( finserv@vinodkothari.com )

Introduction

The ever-increasing volume of Non-Performing Assets has paralyzed the Indian banking sector, with the gross NPA figures reported to be around Rs. 8.4 lakh crores at the end of September 2017.[1] Forming around 12% of the total banking advances, the distressed Indian banking situation should have provided the Indian Asset Reconstruction Companies (ARCs) with a vast share of market to cater to and thus yield impressive results. However, the past few years have resulted in the contrary, with the Indian ARCs failing to live up to its expectations.

ARCs- The picture so far

Since its inception in the year 2002, the ARCs have had to face rough waters in the India ecosystem due to inefficient laws and tardy procedures and better alternatives already present with the banks. With 19 registered operators as on 31st March, 2016[2] in the country, the industry, despite being in existence for over a decade, is yet to establish a strong foothold. An insignificant capital employed of Rs. 5,757 crore and miniscule Assets-under-Management (AUM) of about Rs. 50,000 crores during the year 2016[3] compared to the huge NPA figure highlights just how under-utilized the ARCs have been. Most notably, during the 1st half of FY17-18, Banks sold only about 20% of the Rs. 30,000 crore worth of assets they had put up for sale to ARCs.[4] Flawed valuation methods resulting in huge bid-ask spread, time-consuming recovery and turnaround processes, and better value through reporting cases to National Company Law Tribunal (NCLT) and are some of the key reasons why business volumes of ARCs have failed to keep pace with the steep rise in NPAs.

The flourishing ARC industry in India took a major brunt when the minimum investment in Security Receipts (SRs) was increased from 5% to 15%[5], thus slimming down the margins and leading to various players bowing out of the market. The decision to increase the minimum Net Owned Funds (NOF) from Rs. 2 crores to Rs.100 crores added further insult to the injury. However, raising FDI in the sector to 100% acted as a fillip as it injected liquidity into the dry Indian ARC market.

Relaxation in shareholding

On 23rd November, 2017 the Reserve Bank of India (RBI) issued a notification[6] eliminating the 26% post conversion of debt into equity limit on the ARCs. The notification did away with such limit and granted freedom to the ARCs by increasing the extent of shareholding post conversion to be in accordance with the permissible FDI limit for the specified sector.

This relaxation is applicable only for those ARCs which comply with the following conditions:

  • Minimum Net Owned Funds (NOF) of Rs. 100 crores;
  • Independent Directors constitute at least half of the Board of Directors;
  • The ARC shall frame policy on debt to equity conversion with the approval of its Board of Directors and may delegate powers to a Committee comprising majority of independent directors for taking decisions on proposals of debt to equity conversion;
  • Valuation of such equity shares must be done at least once a month.

The notification further says, “The ARC shall explore the possibility of preparing a panel of sector-specific management firms/ individuals having expertise in running firms/ companies which could be considered for managing the companies.”

The amendment is sure to incentivize the ARCs as it allows them to acquire greater control over the sick units and vesting it with greater authority to turn around the fortunes of the stressed asset. The consideration for a sector-specific panel further strengthens the operations of the ARC as it would allow for greater specialization in the management of that company and thus result in better returns.

Conclusion

The government has recognized the need to clean-up Indian Banking sector that has been clogged with surmounting stressed assets. The implementation of Insolvency and Bankruptcy Code (IBC), carrying out Asset Quality Review (AQR) and the decision to recapitalize the banks by injecting funds have been implemented along the same lines. The June Financial Stability Report issued by RBI warns that the banking systems’ gross bad loan ratio will increase to 10.2% of the total advances by banks in March 2018 from this year’s 9.6%. Although there remains a huge market for the ARCs to exploit, time seems to be running out as banks are resorting to other economic and time-efficient alternatives. The notification is a welcome move and is expected to revitalize the lagged operations of the Indian ARCs by allowing them to exercise greater control.


[1] https://economictimes.indiatimes.com/markets/stocks/news/bad-loan-recovery-in-q2-falls-as-sales-to-arcs-dip/articleshow/61762932.cms

[2] https://rbidocs.rbi.org.in/rdocs/content/pdfs/LSCRCRBI07092016.pdf

[3] http://www.moneylife.in/article/asset-reconstruction-companies-in-india-at-an-inflection-point/48200.html

[4] http://www.moneycontrol.com/news/business/economy/banks-sell-only-20-of-bad-loan-assets-to-arcs-as-they-bet-on-better-value-from-insolvency-courts-2437813.html

[5] http://arcindia.co.in/pages/doccuments/rbiguidelinePDF/rbiguideline_13082014_07_44_07.pdf

[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11177&Mode=0

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