To understand what an asset reconstruction company is we must first understand the meaning of Asset Reconstruction.
It means to acquire the right or interest of any bank or Financial institution in any financial assistance with the purpose to realize such financial assistance. Such acquisition should be made by an Asset Reconstruction Company (ARC).
It means :
- Any loan or advance granted or,
- Any guarantees given or
- Letter of credit established or,
- Any other credit facility established
- By any bank or financial institution.
Asset reconstruction Company (ARC)
- An Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from banks and financial institutions so that the banks and financial institutions can clean up their balance sheets. Or in other words, ARCs are in the business of buying bad loans from banks.
- Such companies help the banks by buying bad assets at a mutually agreed price so that the banks can focus on their normal banking activities rather than going after the defaulters by wasting their time and effort.
- Such a company should be registered with the Reserve bank. It must be noted that ARC is not a banking company although it is registered with RBI. It cannot carry out any other business except the business of securitization or reconstruction. The legal basis for setting up ARC’s in India is provided under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI), Act, 2002.
Capital Requirements for an ARC
As per amendment ARC’s should have a minimum net owned funds of Rs. 100Cr. The term net owned fund is not defined anywhere in the SARFAESI Act, 2002 hence one have to refer Section 45I of the RBI, Act.
How ARCs get funding to buy bad assets from banks?
- Regarding funds, an ARC may issue bonds and debentures for meeting its funding requirements. But the chief and perhaps the unique source of funds for the ARCs is the issue of Security Receipts.
- As per the SARFAESI Act, Security Receipts is a receipt or other security, issued by a reconstruction company (or a securitization company in that case) to any Qualified Institutional Buyers (QIBs) for a particular scheme. The Security Receipt gives the holder (QIB) a right, title or interest in the financial asset that is bought by the ARC. These SRs issued by ARCs are backed by impaired assets.
- “Qualified buyer” means a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or another asset reconstruction company which has been granted a certificate of registration under the SARFAESI Act, 2002.
- An ARC cannot raise funds from investors which is not a qualified buyer (QB). For example, a manufacturing company looking to invest surplus cash by investing in the ARC.
Rules for the acquisition of assets and its valuation by ARCs
- SARFAESI Act permits ARCs to acquire financial assets (NPAs) through an agreement with banks. Banks and FIs may receive bonds/ debentures in exchange for NPAs transferred to the ARCs. A part of the value can be paid in the form of Security Receipts (SRs).
- NPAs shall be acquired at a ‘fair price’ in an arm’s length principle by the ARCs.
Resolution Strategies that can be followed by ARCs while restructuring the assets
SARFAESI Act stipulates various measures that can be undertaken by ARCs for asset reconstruction. These include:
- taking over or changing the management of the business of the borrower,
- the sale or lease of the business of the borrower
- entering into settlements and
- Restructuring or rescheduling of debt.
- enforcement of security interest
The last step of ‘enforcement of security interest’ means ARCs can take possession/sell/lease the supported asset like land, building etc.
ARCs and the secured creditors cannot enforce the security interest under SRFAESI unless at least 75% by value of the secured creditors agree to the exercise of this right.