Function of Asset Reconstruction Companies & RBI Regulation for ARC

Shreya Patel

13 Jul, 2023

The prominent problem in the country right now is the alarming volume of Non-Performing Assets with the banking system. Several attempts were made to tackle NPAs. A serious such step was the creation of dedicated institutions called Asset Reconstruction Companies or ARCs that purchase bad assets or NPAs from banks at a negotiable price and helps banks to clean up their balance sheets.

Performance of the ARCs is under evaluation in the context of the mounting NPAs. At the same time, the new Insolvency and Bankruptcy Act will give a critical role to the ARCs in settling the bad assets through the insolvency process.

Assets reconstruction companies are recognized by RBI as NBFC whose main objective is to handle NPA of the banks. The Role of AFC is very vital in terms of re-organization of the bank debt. RBI is very stringent while giving permission to ARC.

What are ARCs?

An Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from banks and financial institutions and cleans up their balance sheets. In other words, ARCs are in the business of buying bad loans from banks.

ARCs clean up the balance sheets of banks when the latter sells these to the ARCs. Which helps banks to concentrate on 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.

SARFAESI Act 2002- The Origin of ARCs

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up ARCs in India. Section 2 (1) of the Act explains the meaning of Asset Securitization. Similarly, ARCs are also elaborated under Section 3 of the Act.

The SARFAESI Act provide service for reconstructing bad assets without the intervention of courts. Since then, a large number of ARCs were formed and were registered with the RBI which has got the power to regulate the ARCs.

Role of Asset Reconstruction Company

• Acquisition of financial assets (as defined u/s 2(L) of SRFAESI Act, 2002)
• Change or takeover of Management / Sale or Lease of Business of the Borrower
• Rescheduling of Debts
• Enforcement of Security Interest (as per section 13(4) of SRFAESI Act, 2002)
• Settlement of dues payable by the borrower

RBI Guidelines for Securitisation and Asset Reconstruction Companies

• The Reserve Bank of India (RBI) brought into force guidelines relating to securitization and Asset Reconstruction Companies (ARCs). Under various provisions of the SARFAESI Act, the RBI has issued the 2003 Guidelines and Directions.
• The exception to the scope of the Directions is that most of the operative part of the Directions apply to a direct acquisition of assets by a SARC, but does not apply only if such assets are held as a trustee for a trust. The SARC has to settle a trust, be a trustee to such trust, and acquire assets as a trustee to fall outside the discipline of the Directions.
• SCs/RCs shall become members of JLF as described on ‘Framework for Revitalised Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP)and shall be a part of the process with reference to such stressed assets.
• SCs/RCs shall obtain prior approval of Reserve Bank when transfers result in substantial change.

Registration of Company under Securitisation Act

• Every Securitisation Company or Reconstruction Company shall apply for registration in the specified application form.
• The company shall obtain a certificate of registration from the Bank as provided under Section 3 of the Act.
• Such Company can undertake both securitization and asset reconstruction activities after obtaining the certificate.
• The company shall commence business within six months from the date of grant of Certificate of Registration by the Bank. Provided on special circumstances extension up to 12 months can be granted.
• NBFC registered as SC / RC registered with the Bank under Section 3 of the SARFAESI Act, 2002 are exempted from the provisions of sections 45 -IA, 45-IB, and 45-IC of RBI Act, 1934.

What are the Permissible Business Activities?

A Securitisation Company or Reconstruction Company,

• Shall commence/undertake only the securitization and asset reconstruction activities.
• Shall not raise monies by way of deposit.
• The company carries business other than allowed activities would result in cancellation of registration.

What is the Limit of Net Owned Fund Requirement?

Net Owned Fund of every Securitisation Company or Reconstruction Company shall not be less than Rs. 2 crore or such other higher amount as the Reserve Bank.

Any SC/RC carrying on business shall have a minimum Net Owned Fund not less than fifteen percent (15%) of the total financial assets acquired or to be acquired by the SC / RC on an aggregate basis, or Rs.100 crore, whichever is less. The minimum NOF shall be maintained on an ongoing basis.

What is the Capital Adequacy Requirement?

All Securitisation Company or Reconstruction Company (SC/RC) shall maintain a capital adequacy ratio on an ongoing basis, which shall not be less than fifteen percent of its total risk-weighted assets. The risk-weighted assets shall be calculated as the weighted aggregate of on-balance sheet and off-balance sheet items as specified.

How SC/RC Deploy the Funds

• An SC/RC, as a promoter and for the purpose of establishing a joint venture, invests in the equity share capital of an SC/RC formed for the purpose of asset reconstruction.
• SC/RC may deploy any surplus funds available with it, in terms of a policy framed in this regard by its Board of Directors, only in Government securities and deposits with Small Industries Development Bank of India, National Bank for Agriculture, scheduled commercial banks and Rural Development or such other entity as may be specified by the Bank from time to time.
• No SC/RC shall invest in land or building, Provided that the restriction shall not apply to the investment by SC/RC in land and buildings for its own use up to 10% of its owned fund.

Regulatory Reporting

• Every SC/RC is required to submit a quarterly statement, viz. SCRC 1 & SCRC 2 to the Bank within 15 days of the close of the quarter
• Every SC/RC is required to furnish to the Bank a copy of the audited balance sheet along with the directors’ / auditors’ report within one month from the date of Annual General Meeting (AGM) in which the audited accounts of SC/RC are adopted.
• The operations and activities of such companies may be subjected to periodic audit and checks by internal/external agencies.

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