Asset Reconstruction Company Essay Example

by retired High Court Judges. These committees will review and recommend compromise proposals for old and unresolved NPA cases.

The revised guidelines from RBI pertain to compromise settlement of Non-performing Assets (NPAs) of public sector banks. These guidelines apply to chronic NPAs up to Rs. 10 crore that have become doubtful or loss as of March 31, 2000, and have an outstanding balance below Rs. 10 crore on said cut off dates. The guidelines also cover cases where banks have taken action under the Securitisation Act 2002, as well as cases pending before Courts/DRTs/BIFR, provided consent decree is obtained from the respective authorities. However, cases involving willful default, fraud, and malfeasance are excluded. The settlement formula determines the amount and cut-off date for NPAs classified as Doubtful or Loss as of March 31, 2000.

The minimum amount that should be recovered would be 100% of the outstanding balance in the account as on the earlier of the date of transfer to the protested bills account or the date on which the account was categorized as doubtful NPA's. For NPA's classified as Sub-standard as of March 31st, 2000 which later became doubtful or a loss, the minimum amount that should be recovered would be 100% of the outstanding balance in the account as on the earlier of the date on which the account was categorized as doubtful NPAs or the date on which this classification occurred, plus interest at the existing Prime Lending Rate from April 1st, 2000 until the final payment is made. Payment.

The preferable method of payment for settlements in both mentioned cases is a single lump sum payment. However, if the borrowers cannot pay the

full amount upfront, they must initially pay at least 25% of the settlement amount. The remaining 75% of the settlement, along with interest at the current Prime Lending Rate, is then collected in installments over a one-year period from the settlement date until the final payment.

To expedite legal processes, Lok Adalat institutions play a significant role in assisting banks with resolving disputes related to accounts classified as "doubtful" or "loss" with an outstanding balance of Rs.lakh. These institutions facilitate compromise settlements through Lok Adalats. Additionally, Debt Recovery Tribunals (DRTs) now have authority to organize Lok Adalats to handle cases involving Non-Performing Assets (NPAs) totaling Rs.10 lakhs or more.

As of September 30, 2001, public sector banks had recovered Rs.40.38 crore through the Lok Adalat forum. It is expected that progress made through this channel will increase in future years due to recent initiatives undertaken by public sector banks and DRTs in Mumbai.The passage of the Recovery of Debts due to Banks and Financial Institutions (amendment) Act in March 2000 has strengthened the functioning of Debt Recovery Tribunals (DRTs). This Act has incorporated various provisions that are expected to improve the efficiency of DRTs and expedite the recovery of Non-Performing Assets (NPAs). Some of these measures include assigning multiple Recovery Officers, seizing the defendant's property/assets before judgment, imposing penalties for non-compliance or breach, and appointing a receiver with asset management powers. Currently, there are 22 strategically located DRTs across the country, along with Appellate Tribunals in Allahabad, Mumbai, Delhi, Calcutta, and Chennai. However, challenges like a shortage of judges and loopholes in legislation still persist for DRTs. As a result, only 23,393 out of 57,000 cases have

been resolved so far with a recovery rate of just 4.36 percent. The implementation of the Securitisation Act in 2002 has also contributed to these efforts.

The Act passed on June 21, 2002 gives banks the power to take action if a corporate borrower defaults on loans. If the borrower does not repay within 180 days, the bank can issue a notice. If payment is still not received within the next 60 days, the bank can seize and sell the borrower's offered security to recover what is owed. This Act also prevents courts from intervening or issuing orders that could benefit defaulting borrowers. Essentially, this Act removes judicial involvement in loan recovery and ensures a speedy process by establishing specific timeframes for action. Previously, only mortgage securities were subject to possession rights under the transfer of securities act; however, this Act expands those rights to include all types of securities such as mortgage, fixed charge, floating charge, hypothecation etc.. Liens and pledges are exempt from these provisions. Asset reconstruction involves an acquirer (securitization or reconstruction company) obtaining any rights or interests in financial assistance from banks or financial institutions to recover funds. An entity responsible for acquiring non-performing assets declared by lending institutions is called an Asset Reconstruction Company (ARC). The objective of the Corporate Debt Restructuring (CDR) mechanism established in 2001 is to facilitate restructuring of corporate debts exceeding Rs.0 crore with banks and financial institutions.The process known as CDR, or Corporate Debt Restructuring, allows viable corporate entities to restructure their debts outside the existing legal framework with the aim of reducing new non-performing assets (NPAs). The CDR structure is based in IDBI, Mumbai and

consists of a Standing Forum and Core Group responsible for administering it. However, the implementation of this mechanism has not lived up to expectations. In response to this issue, the Reserve Bank of India (RBI) has formed a high-level Group led by Deputy Governor Shri.Vepa Kamesam. The purpose of this group is to review and enhance the implementation procedures of the CDR mechanism, as announced by Hon'ble Finance Minister in Union Budget 2002-03.

The Group aims to evaluate the functionality of the CDR Scheme, address any challenges in its implementation, and propose measures to improve its efficiency. The Credit Information Bureau of India Ltd. (CIBIL) is currently formalizing information sharing arrangements. The Reserve Bank of India (RBI) is reviewing the suggestions made by the S.R. Iyer Group, headed by Chairman of CIBIL, regarding the implementation of a scheme for sharing default information with the financial system. Key recommendations include disclosing details about accounts involved in legal proceedings, regardless of claimed amount or credit provided by a financial institution, as well as accounts considered irregular where the borrower has consented to disclosure.

This is to prevent individuals who exploit the absence of an information sharing system among lending institutions from borrowing significant sums against the same assets and property. This practice has significantly contributed to the increasing non-performing assets (NPAs) of banks. The Reserve Bank of India (RBI) is examining the Kohli Group's recommendation on willful defaults/diversion of funds. They are developing a comprehensive definition that includes such types of defaulters, which will enable effective denial of credit to this group of borrowers and allow for criminal prosecution of willful defaulters. Additionally, what exactly is an Asset Reconstruction

Company?

The text explains that asset reconstruction involves the acquisition of a bank or financial institution's rights or interests in financial assistance by a securitization or reconstruction company. This is done with the purpose of realizing such financial assistance. The company that undertakes these non-performing assets declared by the Lending Institution is known as an Asset Reconstruction Company (ARC). ARCs essentially act as debt collectors, possessing extensive powers that were previously only held by debt recovery tribunals and civil courts, not by lenders' debt recovery departments themselves.

An Asset Reconstruction Company (ARC) is established to achieve the following aims: • To purchase problematic loans from banks and make special efforts to recover value from the assets, if necessary through special legislation, granting the ARC special powers for recovery. • Restructuring of weak banks to divest their bad loan portfolio is crucial for executing a comprehensive restructuring strategy for such banks. The need for an ARC arises due to the fact that in normal circumstances, banks and financial institutions are responsible for recovering most of their lending. However, throughout this process, they ultimately end up with a remaining portion of delinquent debts that belong to intentional defaulters or industries on the decline. This is because no credit institution can achieve a 100% recovery performance due to the inherent risks associated with lending.

The banks and financial institutions are sometimes unable to give enough attention to difficult cases where credit is left over or unrecovered. When the volume of overdue credit outstanding becomes large, it becomes difficult for them to dedicate substantial time and effort to this time-consuming task. In such cases, it is feasible to outsource this responsibility to

specialized agencies, known as Asset Reconstruction Companies. These agencies have professional expertise in handling recovery and make it their core business. They are well-equipped and prepared to handle chronic cases and willful dodgers.

The ARCs have the function of recycling assets that would otherwise become scrap or waste, and turning them into productive and beneficial use. Banks ; FIs transfer their rights to specific debts, including their security rights on collateral, to the ARC. This allows the ARC to take over the role of the banker and pursue recovery of outstanding debt through various methods. The issue of non-performing loans has both a stock and flow problem. The stock problem refers to the accumulated volume of bad loans held by banks, while the flow problem is the ongoing increase in bad loans.

The text discusses stock solutions, which are necessary in cases of systemic banking distress. These solutions involve actions such as liquidating unviable banks, managing impaired assets, and restructuring viable banks. On the other hand, flow solutions are more effective when banking distress is limited, not systemic, and if the official safety net is restricted or the supervisory authority is willing to intervene in institutions with worsening capital bases. There are two main approaches to resolving the issue of bad loans: the creditor-led approach and the ARC approach, also known as the bank-led approach.

The bank-led approach involves each bank taking responsibility for restructuring or recovering its own assets. The government can provide additional capital to the banks or offer fiscal incentives to write off bad loans, and can also support the recovery efforts by enacting appropriate security enforcement legislation. It makes sense for the bank itself

to handle problem loans, as they are the ones who created the problem in the first place. Banks have access to loan files and institutional knowledge of the borrower, making them better equipped to resolve non-performing assets (NPAs) compared to centralized Asset Reconstruction Companies (ARCs). This approach also incentivizes banks to maximize the recovery value of bad debt and prevent future losses by improving loan approval and monitoring procedures. Additionally, banks following this approach can continue providing new loans as part of debt restructuring.

However, there are several problems with the individual bank-led approach to resolving NPAs, especially when the problem loans are caused by a crisis. Banks are afraid of the risk of more loans becoming bad, so they avoid lending, which worsens the crisis. In many cases, borrowers take on more loans in the guise of restructuring, resulting in more non-performing amounts. The ARC Approach, which involves dedicating one or more specialized units, is used to address this problem. This approach recognizes that NPAs created by a systemic crisis are different from those caused by bad lending practices, and therefore, focused attention and appropriate legislation are needed to resolve the issue.

Banks may face a deeper crisis if they are responsible for resolving problem loans instead of creating new ones. The provisioning requirements of these banks also pose a risk of capital erosion, causing them to avoid creating new assets. This is crucial for helping the country overcome the crisis. Asset reconstruction or management companies (ARCs) should aim to maximize recovery value and minimize costs, utilizing their expertise in loan resolution. It is evident that the use of ARCs or distinct loan workout units has

played a significant role in systemic issues within the banking sector and should be considered as part of best practice.

Advantages of a centralized public ARC include banks having informational advantages over ARCs due to their collected borrower information. Additionally, leaving loans in banks may provide better recovery incentives and help prevent future losses by improving loan approval and monitoring procedures. Banks can also provide additional financing during the restructuring process. However, if assets transferred to the ARCs are not actively managed, the existence of an ARC may lead to a general deterioration of payment discipline and further decline in asset values. There are different models of ARCs, which can be categorized based on ownership or multiplicity.

Various ownership models for ARCs have been explored by different countries. These models encompass the following:

- Establishing a separate unit or department within a bank, known as asset workout departments or units. However, this approach is typically considered a final resort and is not widely employed due to its reliance on the overall strength and legal authority of the bank.

- Creating bank subsidiaries and affiliated companies, an approach adopted in Australia and several continental European nations. In China, the Big Four banks have also formed their own ARCs which were subsequently privatized.

There are several advantages to this model:
- Use of in-house experience and knowledge about the NPAs,
- Maintenance of important banking relationships,
- Strengthening expertise in resolving bank NPAs, and
- Establishment of new business relationships with new investors involved in asset workouts.

Another important factor is that a bank-based ARC is likely to have more operational flexibility compared to a government entity. This flexibility is particularly beneficial in retaining qualified personnel and

structuring transactions.

• Private companies: Private companies, although with significant shareholding of banks, have also been utilized in Thailand.

In India, the approach to managing distressed assets is similar to the centralized ARC model. These private ARCs enjoy the same benefits as centralized ARCs, such as streamlined asset management and transparent disposition processes. This approach also mitigates the risk of competition among bank-based ARCs, which could potentially reduce sale values. However, as the number of institutions and interconnected debtors increases, it becomes crucial to have government coordination and oversight. The question of whether to have a single ARC or multiple ARCs depends on the market demand.

All countries that have implemented centralized Asset Reconstruction Companies (ARCs) have provided governmental support and granted special legal powers to these ARCs. In India, the centralized ARC model is one among many. However, this model carries certain risks. If an excessive number of ARCs are established, some may resemble banks. Moreover, since the selling price of bad loans is merely a theoretical value (represented by a bond or debenture), ARCs may engage in competition based on the prices they offer for these loans, resulting in an artificial inflation of their worth. The risk associated with an excessive number of ARCs is that at least a few will become as troubled as the loans they acquire.

ARC Models: Based on Resolution Approach: ARCs have various approaches to resolve the loans they acquire. One approach is a rapid sale, where the ARC aims to quickly sell its own assets after acquisition. Another approach is a workout or corporate restructuring, where the ARC actively restructures either the loan or the borrower's business to improve its health.

This may involve compelling the borrower to sell non-core assets, merge with other entities, or dispose of parts of its operations. It's important to note that each ARC may choose a different approach based on the specific case at hand.

International studies have been conducted on the success of two approaches mentioned above, as stated in ‘The use of Asset Management Companies in the Resolution of Banking Crises: Cross-Country Experience’ by Daniela Klingebiel. According to Klingebiel, the analysis of seven cases revealed that corporate restructuring ARCs were not successful in achieving their narrow goals of expediting corporate restructuring in two out of three instances. This suggests that ARCs are not effective tools for accelerating corporate restructuring. However, the Swedish ARC was an exception as it successfully managed its portfolio and often acted as the lead agent in the restructuring process. The Swedish ARC benefited from special circumstances such as acquiring mostly real estate assets, which are easier to restructure compared to manufacturing assets. Additionally, the Swedish ARC was only a small fraction of the banking system, allowing it to maintain independence from political pressures and sell assets back to the private sector.
On the other hand, rapid asset disposition vehicles had a slightly better success rate, with two out of four agencies (Spain and the US) achieving their objectives. Klingebiel suggests that these successful experiences indicate that ARCs can be effectively used for asset disposition purposes, including resolving insolvent and unviable financial institutions. She further emphasizes that disposition agencies have performed better than restructuring agencies.

The success of disposition agencies is attributed to various factors, including easily liquefiable real estate assets, effective management, political independence, a

skilled resource base, sufficient funding, favorable bankruptcy and foreclosure laws, reliable information and management systems, and transparent operations and processes. However, in the cases of the Philippines and Mexico, the success of the ARCs was hindered from the beginning. These governments transferred politically motivated or fraudulent loans and assets to the ARCs, making it challenging for a government agency to resolve or sell them. Consequently, both agencies failed to achieve their main objective of asset disposition, resulting in a delay in the realignment of asset prices. This highlights the development of ARCs in India as an alternative scenario.

The concept of Asset Reconstruction was initially introduced in the Narasimhan Committee Reports. The committee recommended the establishment of an Assets Reconstruction Fund (ARF) to remove non-performing assets from banks' balance sheets at a discounted rate. Recapitalization through capital infusion was also used by some banks, but it was expensive and time-consuming. Despite this, the problem persisted and led to a reconsideration of the ARF concept.

In the Second Narasimhan Committee Report, it was proposed that core non-performing assets of banks would be transferred to a new entity called an ARC (Asset Reconstruction Company). The ARC would issue NPA swap bonds based on realizable value determined through proper assessment. The key elements included: -

• The Reserve Bank of India (RBI) suggested a maximum lifespan of seven years for ARCs with a minimum initial paid-up capital of Rs. 100 crore in early 2001.
• The RBI also proposed that ARCs should have authorized capital of Rs. 500 crore.
• In a draft scheme leading up to the establishment of ARCs, the RBI suggested these entities should operate as private sector companies with 49% ownership
  

subscribed by public sector banks and financial institutions, while offering the remaining 51% to the public.

The suggestion is that the ARCs, which will be created to address the problem of non-performing assets (NPAs) in the banking sector, should only deal with the previous bad debt of the banks. Thus, after the establishment of the ARC, companies would not be allowed to handle any new NPAs that are added by banks. The RBI also recommends that the NPAs should be assessed at a fair discounted value, determined through consensus between bank-appointed valuers and the ARC. The management of ARCs should consist of a board of directors with professionals from various fields including banking, finance, law, engineering, and valuation expertise. The issue of NPAs is closely connected to the legal framework.

The legal framework establishes rules for market participants, defining their rights and responsibilities, ensuring transaction legality, and granting regulators the authority to enforce standards and ensure compliance. To address concerns regarding inefficiency and time consumption expressed by financial institutions, banks sought permission to seize securities and sell them as a means of settling debts. In response, the government established the Andhyarujina Committee in 1999. This committee was led by T R Andhyarujina, a senior advocate at the Supreme Court of India and former Solicitor General. The committee put forth several significant recommendations such as empowering Debt Recovery Tribunals (DRTs), ensuring expert personnel availability at DRTs, resolving conflicts between Winding Up Courts and the jurisdiction of the Board for Industrial and Financial Reconstruction (BIFR), establishing uniform procedures across all tribunals in the country, allowing banks to privately sell movable and immovable property with safeguards for swift recovery, introducing

a new law enabling banks to sell property without court intervention if certain conditions are met. Additionally, the committee provided a draft model Bill titled "Securitisation Bill 2000," also known as The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002.
The legislation was prompted by two main factors. Firstly, the financial sector faced a rising burden of Non-performing Assets, which amounted to Rs.82,846 crores as of March 31, 2002. Secondly, there was an urgent requirement for legal reforms to adapt to changes in the industrial and financial sectors.

The current legal structure in the country allows criminals and law evaders to exploit its lenient and complicated provisions, causing delays or hindrances in taking punitive action against them. This impedes the implementation of necessary remedial measures promptly.

Consequently, there is a significant backlog of cases in the Debt Recovery Tribunals (DRTs) and law courts, resulting in slower processing. This slowdown further worsens the issue of Non-performing Assets.

Hence, it is crucial to enforce stricter measures to tackle the growing problem of Non-performing Assets, especially when dealing with willful defaulters who have become skilled at avoiding repayment by repeatedly engaging in this behavior. The goal is to effectively address this problem.

The

object clause of the Act defines the legal measure as "An Act to regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto". The Act permits the establishment of ARC/SC companies, which must be registered with and regulated by RBI. Both types of companies, Securitisation Companies and Asset Reconstruction Companies, are granted the same powers and functions under the Act. The Act covers three

distinct actions related to financial assets held by banks and FIs: 1. Securitisation of financial assets 2. Establishment of asset reconstruction companies and 3. Enforcement of security interest.

The three actions mentioned are not separate, but rather interconnected. Securitisation works alongside ARC/SC companies to operate with minimal capital by providing a self-generated source of funding. Additionally, the enforcement of security interest helps these companies to take action.