NBFC

Provisions for a penalty on ARC for non-compliance

Financial Institutions called Asset Reconstruction Companies (“ARCs”) reconstruct and securitise bad assets held by banks and other financial institutions. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”) governs them. Apart from securitisation, reconstruction, and statutorily permitted tasks, the ARCs are required by the SARFAESI plan to obtain the Reserve Bank of India’s (“RBI“) prior approval before performing any other duty. We discuss provisions for a penalty on ARC for non-compliance.

The Reserve Bank of India, which regulates the asset reconstruction company has the authority to impose penalties for non-compliance with regulatory requirements. Penal provisions are mentioned in the SARFAESI Act of 2002. Let us discuss them in detail.

Asset Reconstruction Company

The term “asset reconstruction” refers to the acquisition by any [asset reconstruction business] of any bank’s or financial institution’s right or interest in any financial assistance in order to realise that financial assistance; 

Section 2 (ba) of the SARFRASI Act defines the asset reconstruction company as an organisation that has registered with the Reserve Bank under Section 3 in order to engage in the business of asset reconstruction, securitisation, or both are referred to as an “asset reconstruction company”;

They are specialised financial organisations that purchase the bank’s debtors at a predetermined price and work to collect the debtor’s obligations or associated securities. Asset Reconstruction Companies classify the debtor they take over as non-performing assets, sometimes known as bad assets. It aids banks or financial institutions in cleaning up their balance sheets, allowing them to concentrate on their standard banking operations. The ARCs acquire all of the rights and interests that the bank previously held towards such a debtor. As a result, an ARC engages in both asset reconstruction and securitisation. 

 Net Owned Fund

Net Owned Fund (NOF) for Asset Reconstruction Companies must be at a minimum of Rs. 300 crores on an ongoing basis which is effective from October 11, 2022. Because of this, any Asset Reconstruction Companies that receives a certificate of registration on or after October 11, 2022, cannot start a securitisation or asset reconstruction operation without a minimum NOF of Rs. 300 crores. For ARCs that were in existence as of October 11, 2022, the following glide path is offered to help them reach the minimal necessary NOF of Rs. 300 crores:

The non-complying Asset Reconstruction Companies will be subject to supervisory action in the event of non-compliance at any of the aforementioned stages, including a limitation on engaging in incremental business until it reaches the necessary minimum NOF applicable at that time.

Minimum required Net Owned Fund on October 11, 2022	By March 31, 2024	By March 31, 2026
Rs. 100 crore	Rs. 200 crore	Rs. 300 crore

Regulatory Authorities of Asset Reconstruction Company

• The Companies Act of 2013 requires the asset reconstruction company to be formed like all other businesses.
• The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 is where the idea for asset reconstruction companies first emerged legally.
• The Reserve Bank of India has jurisdiction over the majority of financial institutions in the banking sector, including private banks, non-banking financial institutions, payment banks, and small financing banks. Asset reconstruction companies are tightly entwined with the lending side of banking. Therefore, the RBI has the authority to regulate them as well. 

How an Asset Reconstruction Company actually works?

At a price paid to purchase the financial assets from the originator, the ARC transfers the acquired assets to one or more trusts (created in accordance with Sections 7(1) and 7(2) of the SRFAESI Act, 2002).

Since many businesses are struggling financially and have distressed assets in their control during the crisis, asset reconstruction companies have seen an increase in their client base. Banks notice that a significant portion of their loans become non-performing and need restructuring. With the trusts they use to buy them off and assume the risks associated with them, ARCs have the potential to free these firms, resell their assets, and make the most of them.

These ARCs will have a duty to assist businesses in reviving the operations of non-performing assets during times of hardship. Due to a transaction performed by these companies, several businesses that haven’t been active in a while can resume operations. To Qualified Institutional Buyers [as defined in Section 2(u) of the SARFAESI Act, 2002], the trusts themselves issue Security Receipts. The ARC shall administer such trusts as trustees. The trusts pay ARC a fee for managing their assets. The trust beneficiaries and ARC will split any gains that exist between the bought price and the realised price. Likewise, the beneficiary of the trusts will be responsible for covering any losses that occur between the acquired price and the realised price.

Penalty on ARC for Non-Compliance

The penalty imposition on asset reconstruction companies for non-compliance was given under section 30 A of the SARFAESI Act, 2002 which is discussed below: 

• The adjudicating authority may, by order, impose on any asset reconstruction company or person in default a penalty not exceeding Rs. 1 crore or twice the amount involved in such default or failure, where such amount is quantifiable, whichever is more, and where such default or failure is a continuing one, a further penalty which may extend to Rs. 1 lakh for every day will be imposed. 
• Adjudicating authority refers to the Reserve Bank officer or committee of officers that the Central Board of Reserve Bank has designated as such from time to time by notification; 
• Person in default refers to the asset reconstruction company or any other person that has violated the Reserve Bank guidelines¹ in any way, as well as any person in charge of that company or that other person, as the case may be. 
• The adjudicating authority shall issue a notice on the asset reconstruction company or the person in default for the purpose of imposition of a penalty, requiring such company or person to show cause, the reason for doing so and why the amount specified in the notice issued should not be imposed as a penalty and providing such person with a reasonable opportunity to be heard. 
• Any penalty imposed under this section must be paid within thirty days of the day of the notification.
• The adjudicating authority shall cancel the asset reconstruction company’s registration if it does not pay the fine within the specified time frame. However, the asset reconstruction company must be given a chance to be heard before the registration is cancelled. 
• No complaint about any failure for which a penalty has been assessed and recovered by the Reserve Bank under this section may be brought against any person who is in default in any court. 
• No action for the imposition of a penalty against a person in default under this section shall be taken when any complaint has been brought against that person in the court with jurisdiction. 

Conclusion

In order to address ARC non-compliance, the RBI may impose additional regulatory actions as considered necessary. It is vital to remember that the RBI determines the particular fines by their authorities and enforcement actions for ARC non-Compliance, which can alter as regulations and policies change. In order to avoid fines and enforcement proceedings, asset reconstruction companies are expected to follow regulatory standards, maintain a compliance framework, and provide efficient governance and risk management practices.

Read our Article: Asset Reconstruction Company (ARC) in India

1. https://www.rbi.org.in/Scripts/DraftNotificationsGuildelines.aspx