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What is regulatory framework for Asset Reconstruction Companies (ARCs)?

Reserve Bank of India (RBI) has recently amended the regulatory framework for Asset Reconstruction Companies (ARCs).

What are Asset Reconstruction Companies (ARCs)?

Asset Reconstruction Companies (ARCs) acquire the non-performing assets (NPAs) from banks or financial institutions along with the underlying securities mortgaged and / or hypothecated by the borrowers to the lenders. The ARCs then try and manage or resolve these NPAs acquired from banks or financial institutions. 

What is the basis for amendment in regulatory framework of ARC?

In April 2021, Reserve Bank of India (RBI) had constituted a Committee (Chairman: Shri Sudarshan Sen, former Executive Director, RBI) to undertake a comprehensive review of the working of ARCs in the financial sector ecosystem and recommend suitable measures for enabling such entities to meet the growing requirements of the financial sector. 

Based on the Committee’s recommendations and feedback from the stakeholders, the regulatory framework for ARCs has been amended by RBI.

What is the deadline for complying with the Guidelines?

ARCs are required to comply with the guidelines within 6 months from the date of the guidelines (October 11, 2022).

What are Minimum Net Owned Fund (NOF) requirements for ARCs?

Current Minimum NOF Existing ARCs New ARCs
By March 31, 2024 By March 31, 2026
₹100 crore ₹200 crore ₹300 crore ₹300 crore

Which loans can be transferred to ARCs?

Stressed loans which are in default in the books of the transferors are permitted to be transferred to ARCs.

What are the measures to enhance governance of ARCs?

  • The Chair of the Board shall be an independent director.
  • The quorum for the Board meetings shall be 1/3rd of the total strength of the Board or 3 directors, whichever is higher. Further, at least half of the directors attending the meetings of the Board shall be independent directors.
  • Tenure of Managing Director (MD) / Chief Executive Officer (CEO) or Whole -time Directors (WTDs) shall not be for more than 5 years at a time and the individual shall be eligible for re-appointment. However, the post of the MD / CEO or WTD shall not be held by the same incumbent for more than 15 years continuously. Thereafter, the individual shall be eligible for re-appointment as MD / CEO or WTD in the same ARC, after a minimum gap of 3 years. During this 3-year cooling period, the individual shall not be appointed or associated with the ARC in any capacity, either directly or indirectly. 
  • No person shall continue as MD / CEO or WTD beyond the age of 70 years. 
  • The performance of MD / CEO and WTD shall be reviewed by the Board annually.

Which committees shall be constituted by ARCs?

ARCs shall constitute the following committees of the Board –

Audit Committee

  • shall comprise of non-executive directors only. 
  • shall meet at least once in a quarter with a quorum of 3 members.
  • shall ensure that accounting of management fee / incentives / expenses is in compliance with the applicable regulations.

Nomination and Remuneration Committee – shall ensure 'fit and proper' status of proposed / existing directors and sponsors.

When is prior approval of RBI required?

ARCs are required to obtain prior approval of RBI for –

  • Change in shareholding on account of transfer of shares. 
  • Change in the sponsors of an ARC due to fresh issuance of shares.
  • Appointment / re-appointment of a director or MD / CEO.  

Which additional disclosures are to be made by ARCs?

The following additional disclosures are to be made by ARCs in the offer document –

  • Summary of financial information of the ARC for last 5 years or since commencement of business of the ARC, whichever is shorter.
  • Track record of returns generated for all Security Receipt (SR) investors on the schemes floated in the last 8 years.
  • Track record of recovery rating migration and engagement with rating agency of schemes floated in the last 8 years.

What are the requirements regarding credit rating?

  • ARCs shall mandatorily obtain recovery rating of the SRs from Credit Rating Agencies (CRAs) and disclose the assumptions and rationale behind such rating to SR holders.
  • ARCs shall retain a CRA for at least 6 rating cycles (of half year each). If a CRA is changed mid-way through these 6 rating cycles, the ARC shall disclose the reason for such change.

What are instructions on settlement of dues payable by borrowers under One-time Settlement?

  • Settlement of dues with the borrower shall be done only after the proposal is examined by an Independent Advisory Committee (IAC). 
  • The Board of Directors including at least 3 independent directors shall deliberate on the recommendations of IAC.
  • Settlement with the borrower should be done only after all possible steps to recover the dues have been taken and there are no further prospects of recovering the debt.
  • The Net Present Value (NPV) of the settlement amount should generally be not less than the realizable value of securities. If there is a significant variation between the valuation of securities recorded at the time of acquisition of financial assets and the realisable value assessed at the time of entering into a settlement, reasons thereof shall be duly recorded.
  • The settlement amount should preferably be paid in lump sum. In cases where the borrower is unable to pay the entire amount in lump sum, IAC shall make specific recommendations about minimum upfront lump-sum payment and maximum repayment period.

What are other guidelines for ARCs?

  • In addition to the avenues already permitted, ARCs are now permitted to deploy the available surplus funds in short-term instruments viz., money market mutual funds, certificates of deposit and corporate bonds / commercial papers which have a short-term rating equivalent to the long-term rating of AA- or above by an eligible CRA, up to 10% of the NOF of the ARC.
  • ARCs shall, by transferring funds, invest in the SRs at a minimum of either 15% of the transferors’ investment in the SRs or 2.5% of the total SRs issued, whichever is higher, of each class of SRs issued by them under each scheme on an ongoing basis till the redemption of all the SRs issued under such scheme.
  • ARCs (with minimum NOF of ₹1,000 crore) are now permitted to undertake the activities, which are not specifically allowed under the SARFAESI Act, as a Resolution Applicant (RA) under IBC. 


References

Reserve Bank of India. (2022, October 11). 'Review of Regulatory Framework for Asset Reconstruction Companies (ARCs)'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12399&Mode=0


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