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Indian Economy

Asset Reconstruction Company

  • 04 Feb 2021
  • 6 min read

Why in News

In the Budget 2021-22, Asset Reconstruction Company (ARC) have been proposed to be set up by state-owned and private sector banks, and there will be no equity contribution from the government.

  • The ARC, which will have an Asset Management Company (AMC) to manage and sell bad assets, will look to resolve stressed assets of Rs. 2-2.5 lakh crore that remain unresolved in around 70 large accounts.
  • This is being considered as the government's version of a bad bank.

Key Points

  • About the Asset Reconstruction Company (ARC):
    • Objective:
      • It is a specialized financial institution that buys the Non Performing Assets (NPAs) from banks and financial institutions so that they can clean up their balance sheets.
      • This helps banks to concentrate in normal banking activities. Banks rather than going after the defaulters by wasting their time and effort, can sell the bad assets to the ARCs at a mutually agreed value.
    • Legal Basis:
      • The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up of ARCs in India.
      • The SARFAESI Act helps reconstruction of bad assets without the intervention of courts. Since then, a large number of ARCs were formed and were registered with the Reserve Bank of India (RBI) which has got the power to regulate the ARCs.
    • Capital Needs for ARCs:
      • As per amendment made in the SARFAESI Act in 2016, an ARC should have a minimum net owned fund of Rs. 2 crore.
      • The RBI raised this amount to Rs. 100 crore in 2017. The ARCs also have to maintain a capital adequacy ratio of 15% of its risk weighted assets.
        • Risk-weighted assets are used to determine the minimum amount of capital that must be held by banks and other financial institutions in order to reduce the risk of insolvency.
  • About the new ARC:
    • Need:
      • Of the existing ARCs, only 3-4 are adequately capitalised, while the more-than-dozen remaining are thinly capitalised — necessitating the need to set up a new structure to resolve stressed assets urgently.
      • In a report released by Reserve Bank of India (RBI), it was said that banks' gross non-performing assets may rise to 13.5% by September 2021, from 7.5% in September 2020 under the baseline scenario.
    • Functioning:
      • The transfer of stressed assets to the ARC will happen at net book value, which is the value of assets minus provisioning done by banks against these assets. This could enable the banks to alleviate its losses from NPAs - a part of stressed assets.
      • The bank will get 15% cash and 85% security receipts against bad debt that will be sold to the ARC.
        • Security Receipts (SR) are issued by ARCs, when Non-Performing Assets (NPAs) of commercial banks (CB) or financial institutions (FI) are acquired by the ARCs for the purpose of recovery.
        • As per extant instructions, investment in SRs is restricted to the Qualified Institutional Buyers (QIBs), as defined by SARFAESI Act 2002.
    • Support by Central Government:
      • While the government will not provide any direct equity support to the ARC, it may provide sovereign guarantee that could be needed to meet regulatory requirements.
  • Expected Benefits:
    • This structure will reduce the load of stressed assets on the bank balance sheet and look to resolve these bad debt in a market-led way.
    • With most banks expected to be on board this company, the resolution is expected to be faster.
  • Other Proposed Reforms:
    • Development Financial Institution:
      • The government could subsume India Infrastructure Finance Company Limited (IIFCL) into the proposed Development Financial institution (DFI), which is being set up to enable long-term infra funding worth Rs. 5 lakh crore in 3 years.
      • The National Bank for Financing Infrastructure and Development (NaBFID), the proposed DFI, will anchor the National Infrastructure Pipeline (NIP).
      • The Reserve Bank of India will regulate the proposed DFI, which will be fully owned by the government in initial years.
    • Privatisation:
      • With regard to the privatisation of two state-owned banks and one insurer, the companies will be identified by a government-defined process.
      • NITI Aayog will do the first round for selecting, then it will go to the core group of secretaries on disinvestment and, thereafter, it will be examined by the alternate mechanism.
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