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Asset Reconstruction Companies (ARCs)

Reserve Bank of India (RBI) has issued directions on 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.

To whom shall the directions be applicable?

The directions shall apply to every ARC registered with RBI under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (the Act).

What are the guidelines on registration of ARCs?

  • Before commencement of the business of securitisation or asset reconstruction, an ARC shall obtain a certificate of registration (CoR) from RBI as per Section 3 of the Act.
  • An ARC shall commence business within 6 months from the date of grant of CoR. RBI may grant extension up to 12 months from the date of grant of CoR on receipt of the application from the ARC.
  • Provisions of Section 45-IA, 45-IB and 45-IC of RBI Act, 1934 shall not apply to an ARC registered with RBI under Section 3 of the Act.

What is the Net owned fund (NOF) requirement for ARCs?

  • To commence the business of securitisation or asset reconstruction, an ARC shall have a minimum net owned fund (NOF) of ₹300 crore and shall maintain it on an ongoing basis.
  • ARCs existing as on October 11, 2022 have been provided the following glide path –

Minimum required NOF
On October 11, 2022 By March 31, 2024 By March 31, 2026
₹100 crore ₹200 crore ₹300 crore

Which activities can be undertaken by ARCs?

  • An ARC shall commence / undertake only securitisation and asset reconstruction activities and functions provided in the Act.
  • ARCs (with minimum NOF of ₹1,000 crore) have been permitted to undertake those activities as Resolution Applicants under Insolvency and Bankruptcy Code, 2016 (IBC) which are not specifically allowed under the Act. 
  • An ARC may, as a sponsor and for the purpose of establishing a joint venture, invest in the equity share capital of another ARC.
  • An ARC may deploy its funds for restructuring of acquired loan account with the sole purpose of realizing its dues.
  • An ARC may deploy any surplus funds available with it in –
    • Government securities and deposits with scheduled commercial banks, Small Industries Development Bank of India (SIDBI) and National Bank for Agriculture and Rural Development (NABARD).
    • 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 credit rating agency (CRA), subject to a cap of 10% of the NOF of the ARC on maximum investment in such short-term instruments.
  • No ARC shall invest in land or building. However, this restriction shall not apply to –
    • Investment by the ARC in land and building for its own use up to 10% of its owned funds.
    • Land and building acquired by the ARC in satisfaction of claims in ordinary course of its business of reconstruction of assets. Such land and building shall be disposed of within 5 years from the date of such acquisition.
  • An ARC shall not raise monies by way of deposit.

What are the guidelines on acquisition of financial assets by ARCs?

  • Every ARC shall frame 'financial asset acquisition policy' within 90 days of grant of the CoR. 
  • Before bidding for the stressed assets, ARCs may seek adequate time, of at least 2 weeks, from the auctioning banks to conduct a meaningful due diligence of the account by verifying the underlying assets.
  • All the financial assets due from a single debtor to various banks / financial institutions and financial assets having linkages to the same collateral, may be considered for acquisition to ensure relatively faster and easy realisation.
  • Both fund and non-fund based financial assets may be included in the list of assets for acquisition.
  • Assets classified as special mentioned accounts (SMAs) in the books of the originator may also be acquired.
  • An ARC can sell financial asset to another ARC subject to the following conditions –
    • The transaction is settled on cash basis.
    • The selling ARC shall utilize the proceeds so received for the redemption of underlying security receipts (SRs).
    • The date of redemption of underlying SRs and total period of realisation shall not extend beyond 8 years from the date of acquisition of the financial asset by the first ARC.
  • ARCs shall not acquire financial assets from the following on a bilateral basis, whatever may be the consideration –
    • A bank / financial institution which is the sponsor of the ARC.
    • A bank / financial institution which is either a lender to the ARC or a subscriber to the fund raised by the ARC for its operations.
    • An entity in the group to which the ARC belongs.
  • However, they may participate in the auctions of the financial assets provided such auctions are conducted in a transparent manner, on arm’s length basis and the prices are determined by the market forces.

What are the guidelines on realisation of financial assets?

  • The ARC shall formulate the policy for realisation of financial assets under which the period for realisation shall not exceed 5 years from the date of acquisition of the financial asset concerned.
  • The Board of the ARC may increase the period for realisation of financial assets so that the total period for realisation shall not exceed 8 years from the date of acquisition of the financial asset concerned.

What are the measures of asset reconstruction and enforcement of security?

  • An ARC may effect change in or takeover of the management of the business of the borrower for the purpose of realisation of its dues from the borrower, where –
    • The amount due to it from the borrower is not less than 25% of the total assets owned by the borrower.
    • The borrower is financed by more than one secured creditor (including ARC), secured creditors (including ARCs) holding not less than 60% of the outstanding SRs agree to such action.
  • The ARC shall give a notice of 60 days to the borrower indicating its intention to effect change in or takeover of the management of the business of the borrower and calling for objections. The objections submitted by the borrower shall be initially considered by the Independent Advisory Committee (IAC) and thereafter the objections along with the recommendations of the IAC shall be submitted to the Board of the ARC. The Board shall pass a reasoned order within 30 days from the date of expiry of the notice period.
  • An ARC may reschedule the debts due from the borrowers.
  • The ARCs shall obtain, for the purpose of enforcement of security interest, the consent of secured creditors (including ARCs) holding not less than 60% of the amount outstanding to a borrower.
  • Settlement of dues with the borrower shall be done only after the proposal is examined by the IAC and all possible steps to recover the dues have been taken but there are no further prospects of recovering the debt.
  • An ARC may convert the debt into equity of the borrower entity.

What are the guidelines on securitisation?

  • ARCs shall, by transferring funds, invest in the SRs (issued by the trusts floated by the ARC), 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.
  • Every ARC shall mandatorily obtain initial rating / grading of SRs from a SEBI registered CRA within 6 months from the date of acquisition of assets and shall get the rating / grading of SRs reviewed from the CRA as on June 30, and December 31 every year.
  • The rating shall be assigned on a specifically developed rating scale called ‘recovery rating (RR) scale’. The rating / grading should be based on ‘recovery risk’ as against ‘default’ i.e., how much more can be recovered instead of timely payment.
  • 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.
  • ARCs with acquired assets in excess of ₹500 crore can float the fund under a scheme which envisages the utilization of part of funds raised from Qualified Buyers (QBs), for restructuring of financial assets acquired out of such funds up to 25% of the funds raised under the scheme.

What is the required capital adequacy ratio for ARCs?

Every ARC shall maintain, on an ongoing basis, a capital adequacy ratio of minimum 15% of its total risk weighted assets.

What are the asset classification norms for ARCs?

Every ARC shall classify the assets held in its own books into following categories –

  • Standard assets
  • NPAs

Which assets are classified as NPAs in the books of ARCs?

NPA in the books of ARCs means an asset in respect of which –

  • Interest or principal (or instalment thereof) is overdue for a period of 180 days or more from the date of acquisition or the due date as per contract between the borrower and the originator, whichever is later.
  • Interest or principal (or instalment thereof) is overdue for a period of 180 days or more from the date fixed for receipt thereof in the plan formulated for realisation of the assets.
  • Interest or principal (or instalment thereof) is overdue on expiry of the planning period, where no plan is formulated for realisation of the assets. (Planning period means a period up to 6 months allowed for formulating a plan for realisation of financial assets acquired for the purpose of reconstruction).
  • Any other receivable, if it is overdue for a period of 180 days or more in the books of the ARC.

The Board of Directors of an ARC may, on default by the borrower, classify an asset as an NPA even earlier than the period mentioned above (for facilitating enforcement).

How shall NPAs be classified?

The NPAs shall be classified as –

NPA Category Conditions
Sub-standard asset The asset remained NPA for up to 12 months.
Doubtful asset The asset remained sub-standard asset for more than 12 months.
Loss asset The asset is non-performing for more than 36 months.
The asset is adversely affected by a potential threat of non-recoverability due to either erosion in the value of security or non-availability of security.
The asset has been identified as a loss asset by the ARC or its internal or external auditor.
The financial asset including SRs is not realized within the total time frame specified in the plan for realisation formulated by the ARC and the ARC or the trust concerned continues to hold those assets.

  • Assets acquired by the ARC for the purpose of asset reconstruction may be treated as standard assets during the planning period.
  • Where the terms of agreement regarding interest and / or principal relating to a standard asset have been renegotiated / rescheduled by an ARC (otherwise than during planning period), the asset concerned shall be classified as sub-standard asset with effect from the date of renegotiation / rescheduling or continue to remain as a sub-standard or doubtful asset as the case be. The asset may be upgraded as a standard asset only after satisfactory performance for 12 months as per the renegotiated / rescheduled terms.

What are the provisioning requirements?

Every ARC shall make provisions against NPAs, as under –

Asset category Provisioning required
Sub-standard assets A general provision of 10% of the outstanding amount.
Doubtful assets 100% provision to the extent the asset is not covered by the estimated realisable value of security.
In addition to the above, 50% of the remaining outstanding amount.
Loss assets The entire asset shall be written off.
(If, for any reason, the asset is retained in the books, 100% thereof shall be provided for).

What are the guidelines on governance and conduct?

  • Prior approval of RBI is required for appointment / re-appointment of a Director or Managing Director (MD) / Chief Executive Officer (CEO).
  • No person shall continue as MD / CEO or WTD beyond the age of 70 years. 
  • Tenure of MD / CEO or WTD shall not be 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-years cooling period, the individual shall not be appointed or associated with the ARC in any capacity, either directly or indirectly.
  • All ARCs shall constitute the following committees of the Board –
    • Audit Committee
    • Nomination and Remuneration Committee
  • ARCs shall obtain prior approval of RBI for transfers that result in substantial change in management namely –
    • Any transfer or fresh issuance of shares resulting in a new sponsor.
    • Any transfer or fresh issuance of shares resulting in cessation of an existing sponsor.
    • An aggregate transfer of 10% or more of the total paid up share capital of the ARC by a sponsor during the period of 5 years commencing from the date of the CoR.
  • Any management fee / incentives charged towards the asset reconstruction or securitisation activity shall come only from the recovery effected from the underlying financial assets.
  • If – (i) Management fee recognised during the planning period remains unrealised beyond 180 days from the date of expiry of the planning period (ii) Management fee recognised after the planning period remains unrealised beyond 180 days of such recognition (iii) Any unrealised management fee, irrespective of the period for which it has remained unrealised, where the Net Asset Value (NAV) of the SRs has fallen below 50% of the face value, then – (i) Unrealised management fees should be reversed (ii) ARCs preparing their financial statements as per IndAS, shall reduce the amount of unrealised management fees from their NOF while calculating the capital adequacy ratio and the amount available for payment of dividend.


References

Reserve Bank of India. (2024, April 24). 'Master Direction – Reserve Bank of India (Asset Reconstruction Companies) Directions, 2024'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12669&Mode=0


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