Committee To Review Working of ARCs

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The RBI has set up a committee headed by Sudarshan Sen to undertake a comprehensive review of the working of asset reconstruction companies (ARCs) in the financial sector ecosystem.

About

• The committee will recommend suitable measures for enabling them to meet the growing requirements.
• Terms of reference: To review the existing legal and regulatory framework applicable to ARCs and recommend measures to improve efficacy of ARCs.
  • To review the role of ARCs in the resolution of stressed assets, including under the Insolvency and Bankruptcy Code (IBC), and give suggestions for improving liquidity in and trading of security receipts.

Asset Reconstruction Company (ARC)

• It is a company which buys the bad loans (Non-Performing Assets (NPAs)) of banks or any other financial institution, to let them clear their books and resume lending.
  • Another name of Asset Reconstruction Company (ARC) is Bad Bank.
• The concept was pioneered at the Pittsburgh-headquartered Mellon Bank in 1988 and has been successfully implemented in many western European countries post the 2007 financial crises like Ireland, Sweden, France etc.

The Asset Reconstruction Companies or ARCs are registered under the RBI.

• It will help in clearing the balance sheets of banks so that rather than going after the defaulters by wasting their time and effort, banks can sell the bad assets to the ARCs at a mutually agreed value.

Background

• Economic survey 2016-17: Proposed the idea of setting up a Public Sector Asset Rehabilitation Agency to tackle the growing menace of NPAs, which had started affecting the economy of the country.
• In June 2018, a committee was set up by the then Finance minister to study the suitability of transferring the NPAs to a bad bank or an ARC.
• Budget 2021-22: The finance minister has announced the setting up of a bad bank to take over the bad loans of commercial banks in India.

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.

Advantages of ARCs

• Free up resources: Banks have to set aside a part of their operating revenue to cover up for the potential doubtful advances.  ARCs can take over the bad loans of the bank, thereby freeing up the bank from the provisioning requirements.
• Specialisation: ARC would be specialised in maximising the recovery out of a bad loan, as this would be its primary task. In contrast, banks are not in the business of recovery, therefore, their capability to resolve the loans is minimal.
• Economic slowdown: Reports have pointed to a potential increase in stressed assets due to economic slowdown in India. Combined with the COVID-induced lockdown, this may create a situation in which the NPAs might increase to an unsustainable limit.
  • To resolve such a situation, it is pertinent to be proactive and try to work out a solution which can be optimised to reverse the effects of slowdown in the country.
• Improved sentiment: Industry needs to come out of the crisis it is facing if India is serious about its stated goal of a $5 trillion economy. This requires a bullish sentiment in the economy. ARC can provide such an impetus to the industry by freeing up the books of banks.
• Lesser need for recapitalisation of banks: The present method of recapitalization can have only partial success due to limitations of Indian financial capabilities. Further, it will not clear up the bad assets but would only give some more life to projects.

Issues associated

• Shifting the problem: ARC is expected to take over the debts of commercial banks under itself. However, to what extent it will be successful in resolving the NPA crisis is not clear.
  • This is because almost all of the remedies which are available in the market have been tried by the existing commercial banks. Therefore, the ARC can only be expected to aggregate, but not resolve the problem.
• Haircut for the banks: When the bad loans are being taken over by ARCs, the banks are expected to transfer such a loan at a discount to its original value.
  • In such a scenario, the value of discount might prove to be controversial as both the entities, i.e. commercial banks as well as the ARC, are being financed by the exchequer and are subject to public scrutiny. Also, banks have been cautious of taking big hair cuts because of the scrutiny from the 3 Cs (CBI, CVC and CAG).
• Losses for the banks: Similar to the last point, the haircuts taken by the banks would reflect on its profit and loss account and affect its profitability. This might raise questions on both the management of the bank as well as its decision making regarding both earlier and future haircuts.
• Fear of unethical practices: Since there would be pressure on the bad bank to perform, it is possible that the employees might turn towards unethical practices to boost recovery out of a bad loan.
  • This has been a continuing problem earlier as there have been reports of harassment of the banks’ clients, who were unable to pay their dues.
• This concept may not be relevant for India since much of the assets backing the banks’ loans are viable or can be made viable. E.g. a large chunk of projects stalled due to extraneous factors like problems in land acquisition or environmental clearance.

Way Forward

• Firm steps required to address the crisis: Government has emphasized on the ‘4R strategy’ to yield results in the resolution of NPA crisis. It constitutes Recognition of NPAs, Resolution of bad loans and recovery of value from the assets, Recapitalisation of the banks by the government and Reforms in the banking sector.
• Asset Quality Review: While the spike in NPAs was a result of RBI-mandated Asset Quality Review, it is to be understood that the process was a mere recognition of the extent of the problem facing the financial sector of India.
• The proposed National Infrastructure and Investment Fund (NIIF), operating with private partners, will provide both equity and new credit to stress infra projects going through the SDR mechanism.

Source: TH