This RBI circular could mean fewer ARCs to resolve toxic assets

In October 2022, RBI raised the minimum mandated net owned funds of asset reconstruction companies (ARCs) to ₹300 crore, from ₹100 crore at present. The regulator offered a glidepath to reach ₹300 crore by 31 March 2026, with the target for March 2024 being set at ₹200 crore. Industry executives and external experts said this could prove detrimental for smaller ARCs that lack the ability to meet the NOF norms.

Net owned funds is similar to net worth which is defined as the difference between what a company owns and its liabilities.

Lenders sell stressed loans to ARCs at a discount, either in exchange for cash or a mix of cash and security receipts. These receipts are redeemable as and when the ARC recovers the specific loan. That apart, ARCs charge an asset management fee of 1.5-2% of the asset every year.

There were 27 ARCs registered with RBI as on 30 September, showed data from the regulator. Of the 27 ARCs, 11 did not meet the ₹200 crore net owned funds requirement, as per FY23 annual reports analysed in a recent note by industry lobby body Assocham and rating agency Crisil. The data showed that while seven ARCs had net owned funds (NOF) between ₹200-300 crore, the remaining nine were over ₹300 crore. The ARC industry has little choice since RBI had in the 2022 directive specifically said that non-compliance could lead to prohibition on incremental business till the company reaches the mandated level of net-owned funds.

“The impact of amendments can be seen on various fronts, ranging from a strategic change in the way ARCs acquire debt from original lenders to likely consolidation in the industry because of the higher minimum NOF requirement," said the Assocham-Crisil report cited above.

According to two senior ARC officials, the industry could have fewer players as many might not be able to meet the NOF requirements. Both spoke on condition of anonymity, unwilling to comment on the businesses of their industry peers. However, one of these officials said that there are several ARCs that are doing little businesses, with the top five ARCs cornering the majority of the business. The person said that as per industry estimates Edelweiss ARC, Arcil, JM Financial ARC, Phoenix ARC, and Assets Care & Reconstruction Enterprise (ACRE) comprise over 70-80% of the system assets under management (AUM).

“The number of ARCs will decline not just because of the NOF criteria as some that were not at that level in FY23 might manage to meet it by the deadline," said one of the ARC chiefs cited above. He added that a couple of ARCs are already looking for buyers as there is not enough business available for everyone in the market.

In fact, the Small Industries Development Bank of India (Sidbi) is trying, for the second time, to exit its subsidiary India SME Asset Reconstruction Company (ISARC), its chairman S Ramann said in an interview.

Industry executives said the improvement of banking sector asset quality has also made it difficult for ARCs. Fewer the bad loans, the worse it is for a sector that has its business model based on availability of such toxic assets. Banking system bad debt has reduced to 3.2% of outstanding loans as on 30 September, from 5% in September 2022.

Corporates have also cleaned up their act and banks have been able to resolve some large stressed loans over the years, thanks to India’s insolvency legislation and more prudent underwriting decisions. Still, retail NPAs are on the table. ARC industry executives said they need feet on the street to be able to recover from these borrowers, something that not many can boast of.

“ARCs trying to resolve stressed retail loans should look at outsourcing it to external agencies who have the required manpower to handle such small cases," said Pallav Mohapatra, chief executive, ARCIL. “However, they need to keep in mind that these agencies are bound by the fair practice code and follow RBI guidelines prescribed for recovery agents."

Others said ARCs can deliver better value if lenders sell stressed assets early instead of holding on to them for long, affecting recoveries.

ARCs have been focussing on restructuring viable cases, for value maximisation and contribution to the economy at large, according to RK Bansal, chairman of the Association of ARCs in India. “The rate of turnaround is higher if NPAs are sold to ARCs early, instead of after exhausting all means of resolution by the sellers, by which time there may be substantial erosion in value," Bansal was quoted as saying in the Assocham-Crisil note.