WHY DO WE REQUIRE ASSET RECONSTRUCTION COMPANIES?

• Relieving banks from the burden of NPAs thereby allowing them to channelise their focus on managing their core business including exploring new business opportunities;
• To maximise recovery while minimising costs;
• For building industry expertise in loan resolution;
• To develop capital markets through secondary asset instruments.

Generally, the standard business model of an ARC is to set up a separate trust for acquiring NPAs from banks/ financial institutions. The trust thereon issues security receipts (SRs), which are bought by the selling banks/ financial institutions themselves or by qualified institutional buyers (QIBs). The SRs represent an undivided right, title, and interest in the NPA and the underlying security interest thereon.

The prevailing legal framework has permitted only the QIBs to invest in the SRs, issued by the ARCs apart from the seller bank/ financial institutions, which has hampered the growth of the market for the SRs in the country. Due to lack of any significant commitment shown by the domestic QIB towards subscribing to the SRs issued by the ARCs, and with a view to deepen the investor base of QIB, which can invest in the said SRs, certain non-banking financial companies (NBFCs) and non- NBFCs corporate bodies, established in India with net own funds in excess of Rs. 50 crores, were permitted to invest in SRs as QIBs.

Further, the government permitted Foreign Direct Investment (FDI) in the equity capital of ARC upto 49 per cent and the Foreign Institutional Investors (FIIs), registered with the Securities and Exchange Board of India (SEBI), were permitted to collectively acquire not more than 49 per cent of SRs in each “scheme of tranche”, subject to the condition that single FII shall not invest more that 10 per cent in each such tranche of scheme of SRs. Such limit in each scheme of tranche of SRs has restricted the FII investment to the fullest extent in an ARC/ trust scheme, established on the basis of capital commitment received from QIBs (including FIIs) over multiple closings. In the recent years, the gross NPAs of the banking system have been on a rise. However, the growth in book value of NPAs sold by banks/ financial institutions to ARCs, which were created as a systemic response to tackle the menace of growing NPAs, has not been able to keep pace. One of the main reasons cited for the decline in the volume of sale/ purchase of NPAs has been the inability of the ARCs to raise funds towards financing the cost of acquisition of the NPAs. The asset reconstruction business is a capital intensive business, and the existing investors lack adequate resources to fund the expansion and further acquisition of NPAs.

Thus, in order to induct new money into the system for the purpose of acquisition, deepening and widening of the secondary market for SRs issued by the ARCs and to attract foreign experience and expertise in the restructuring segment, the government after consultations with stakeholders and the sector regulators, has decided to revised the ceilings of FDI and FII for the sector, as under:

• The ceiling for FDI in ARCs has been increased from 49 per cent to 74 per cent, subject to the condition that no sponsor shall hold more than 50 per cent of the shareholding in an ARC, either by way of FDI or by routing through an FII. Further, the foreign investment in ARCs would need to comply with the FDI policy in terms of entry route conditionality and sectoral caps.
• The foreign investment limit of 74 per cent in ARC would be a combined limit of FDI and FII. Hence, the prohibition on investment by FII in ARCs has been removed, provided that the total shareholding of an individual FII shall not exceed to 10 per cent of the total paid-up capital of the ARC.
• The limit of FII investment in SRs may be enhanced from 49 per cent to 74 per cent. Further, the individual limit of 10 per cent for investment of a single FII in each tranche of SRs issued by ARCs may be dispensed with. Such investment should be within the FII limit on corporate bonds prescribed from time to time, and sectoral caps under the extant FDI Regulations should be complied with.