The latest buzz in the finance sector arises from the announcement made during the Budget 2021-22. Both state-owned and private-sector banks are set to establish an Asset Reconstruction Company (ARC). Notably, no equity contribution will come from the government in this initiative. This proposed ARC is to carry an Asset Management Company (AMC) on board, responsible for managing and selling bad assets. The goal is to resolve the currently unresolved stressed assets worth between Rs. 2 lakh crore to Rs. 2.5 lakh crore locked in roughly 70 large accounts. This new body can be seen as the government’s variation of a bad bank.
Purpose and Legal Grounds for Establishing the ARC
ARCs serve as specific financial institutions that purchase non-performing assets (NPAs) from banks and other financial institutions. By acquiring these bad assets, ARCs can assist banks in tidying up their balance sheets, allowing them to focus on daily banking activities. Instead of chasing defaulters, banks can now sell off their bad assets to ARCs at mutually agreed values.
This structure has its roots in the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. It offers legal grounds for setting up ARCs without requiring court intervention. Following the act’s endorsement, many ARCs have cropped up and registered with the Reserve Bank of India (RBI), which holds the regulatory power over these bodies.
ARC’s Capital Requirements
According to a 2016 amendment in the SARFAESI Act, every ARC must possess a minimum net owned fund of Rs. 2 crore. However, in 2017, the RBI increased this minimum requirement to Rs. 100 crore. Moreover, ARCs are required to maintain a capital adequacy ratio of 15% of their risk-weighted assets.
The New ARC: Need and Functionality
From all the existing ARCs, only three or four are adequately capitalized, with the remaining operating on thin capital — thus bringing up the urgent need for a new asset resolution structure. A report by the RBI indicated that banks’ gross non-performing assets might surge to 13.5% by September 2021, from 7.5% in September 2020 under the baseline scenario.
The proposed ARC will obtain stressed assets at net book value, deducting any provisions made by banks against these assets. This move will allow banks to offset their losses that stem from NPAs, which form part of the stressed assets. Banks will receive a 15% cash return and 85% worth of security receipts against the bad debt to be sold to the ARC.
Role of Central Government and Expected Benefits
While the government will not provide any direct equity support to the ARC, it may offer a sovereign guarantee to meet regulatory requirements. The newly-formed structure is expected to relieve banks from the burden of stressed assets, leading to more efficient resolution of bad debts.
Other Proposed Reforms: The Development Financial Institution and Privatisation
In addition to setting up the ARC, the government has also proposed a Development Financial Institution (DFI) subsuming India Infrastructure Finance Company Limited (IIFCL). This institution is supposed to permit long-term infrastructure funding worth Rs. 5 lakh crore over the next three years.
As for privatisation, the government plans to privatise two state-owned banks and one insurer. These companies will be identified via a process defined by the government. NITI Aayog will conduct the first round of selection, proceed it to the core group of secretaries on disinvestment, and finally, these selected companies will be evaluated by the alternate mechanism.