India has a vast banking industry with the primary function of lending and borrowing money. Banks take all precautions to lend their money to only those customers who can repay them. However, there can be cases when a customer defaults on their payment. And the bank suffers a loss from such a customer. It creates a massive amount of defaulters with the banks or financial institutions. The majority of unsuccessful businesses have to shut down because of financial pressure.
To minimise this loss, asset reconstruction companies come into the picture. When the customer becomes a defaulter, the bank can reduce its loss by giving away such default companies to the asset reconstruction companies (ARCs) at agreed values. It helps in cleaning the balance sheets of banks and financial institutions. Asset Management Companies in other countries perform many of the same functions as ARCs in India. India’s first ARC was a company named ARCIL. It has been a pioneer in this field, having established industry standards for the rest of the market to follow.
Did you know?
Asset Reconstruction Companies are registered under the RBI and regulated by the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act 2002).
Also Read: What is Working Capital?
What Are Asset Reconstruction Companies?
They are specialised financial institutions that buy the bank's debtors at a pre-decided value and try to recover the debts or related securities of the debtor. The debtor that is taken over by the Asset Reconstruction Companies (or ARCs) is classified as Non-Performing Assets or bad assets. It helps the banks or financial institutions clean up their balance sheets, and the banks or financial institutions can now focus on their normal banking functions. All the rights and interest that the bank had over such a debtor get transferred to the ARCs. Thus, an ARC is involved in two activities - Asset Reconstruction and Securitization. Let us know about both the terms.
Let us understand the meaning of asset reconstruction.
- When banks grant loans, advances or are involved in lending, the bank has some right or interest in that transaction.
- When the ARCs take the bad assets, all such rights or interests are also transferred.
- The asset reconstruction company can then realise all such rights and interests.
- The financial assistance that can be over by the asset reconstruction companies is loans, advances, bonds, guarantees and other credit facilities.
Let us understand the meaning of securitisation.
- When an asset reconstruction company acquires financial assets, a kind of security receipt is issued to the qualified buyers.
- This security receipt means an undivided interest in the financial assets.
This term may be new to some of you. So let us dig deeper into its concept.
- Qualified buyers are the only body from which the asset reconstruction companies can raise funds.
- They include Financial Institutions, Insurance companies, Banks, SFCs, SIDCs, trustees or ARCs registered under SARFAESI and Asset Management Companies registered under SEBI that invest on behalf of mutual funds, FIIs, etc.
- Thus, they play a crucial role, and without them, the entire function of asset reconstruction would not happen.
How Does the Asset Reconstruction Process Work?
Let us look at the steps for quickly understanding the entire concept:
Step 1: The borrowers and debtors take financial assistance from the banks or financial institutions.
Step 2: In return, the borrowers or debtors provide security.
Step 3: The banks or financial institutions may classify them as non-performing or bad assets if they fall in that category.
Step 4: The bank or financial institutions then transfers them to asset reconstruction companies.
Step 5: The asset reconstruction company then realises these financial assets.
Step 6: Qualified Buyers purchase security receipts from the asset reconstruction company.
Step 7: Such security receipts have an undivided interest.
However, the entire process can only occur after receiving the registration certificate. The main requirement is that the ‘net owned funds’ as per the RBI Act should be more than ₹100 crores.
Asset Reconstruction Process
The main aim of the asset reconstruction companies is to realise the debts which have not been paid. In this regard, they have to follow a process as follows:
- The ARC can make changes or take over the management of the company of the defaulter.
- It can also sell or lease such businesses.
- It can offer alternative options for repaying the debts.
- It can also enforce the security interest as per the laws.
- It can also take possession of such assets that were offered as security.
- It also has the power of converting debt into shares.
- It can also enter into settlements.
Types of Debt That ARCs Can take Over
Asset reconstruction companies can take over only those debts classified as non-performing assets.
For debentures or bonds that remain unpaid, the beneficiary of such securities should be informed in a notice of 90 days before it can be taken over.
Classification of Debts
Banks or financial institutions are required to classify their debts into the following types:
- Standard assets.
- Sub-standard assets.
- Doubtful assets.
- Loss assets.
These four classes have been defined per law. Whether they would classify as an NPA would depend on the criteria.
We have discussed the concept of asset reconstruction companies, the process, classification of debts and other details. We hope you now understand their importance. By recovering NPAs, ARCs help boost the country's economy by bringing liquidity to the market.