Challenges Faced by Asset Reconstruction Companies (ARCs) Amidst Falling NPAs in India

Challenges Faced by Asset Reconstruction Companies (ARCs) Amidst Falling NPAs in India

Context:

With the Non-performing assets (NPAs) reaching a 12-year low of 2.8% in March 2024, the Asset Reconstruction Companies (ARCs) in India are also facing a slowdown.

• Ratings agency Crisil projects a 7-10% contraction in the assets under management (AUM) of ARCs in 2024-25 after a stagnant 2023-24.

Relevance:
GS-03 (Economy)

Key highlights:

1. With fewer new corporate NPAs, ARCs are forced to focus on less profitable retail loans, but retail NPAs have not increased significantly.
2. In October 2022, the Reserve Bank of India (RBI) mandated that ARCs must invest at least 15% in security receipts or 2.5% of the total issued, whichever is higher.
3. The RBI increased the minimum net owned funds requirement of ARCs’ from ₹100 crore to ₹300 crore which added more pressure on ARCs’ capital and leading to potential mergers or exits.
4. The state-owned National Asset Reconstruction Company Ltd (NARCL) offers government-guaranteed security receipts, making them more attractive to financial institutions.
5. Increased RBI scrutiny and the need for independent advisory committee approvals for all settlements have delayed processes, especially in retail loans.

What are ARCs?

• ARCs are those financial institutions that buy bad debts from banks at an agreed value and attempt to recover the debts.
• It was introduced by the Narsimham Committee-II (1998) and established under the SARFAESI Act, 2002.
• They are registered under the Companies Act, 2013, and the SARFAESI Act, and are regulated by the RBI.
• Funding: Raised from Qualified Buyers (QBs) such as insurance companies, banks, and asset management companies.

Non-Performing Asset (NPA)

• RBI defines NPAs as any advance or loan that is overdue for more than 90 days. Or in simple terms- “An asset becomes non-performing when it ceases to generate income for the bank,”
• Types of NPAs:
  • Sub-standard Assets: NPAs for ≤12 months.
  • Doubtful Assets: NPAs for >12 months.
  • Loss Assets: Uncollectible assets needing full write-off.

Recent Changes in ARCs Regulations by RBI

• It made ARCs to disclose returns and collaborate with rating agencies for more transparency.
• RBI replaced the previous requirement of 15% of all receipts and mandated ARC’s to invest in security receipts with atleast 15% of the transferors’ investment or 2.5% of the total receipts issued (whichever is higher).
• Further, in order to enhance corporate governance, RBI mandated that the chair of the board and at least half the directors in a board meeting must be independent directors.