Wary that they may take advantage of the Budget announcement allowing a sponsor to fully own an asset reconstruction company (ARC), the Reserve Bank of India is likely to impose stringent conditions on banks intending to float such companies.

This is aimed at preventing banks from carrying out ‘left pocket, right pocket’ management of bad loans.

The central bank may seek suitable amendments to the Banking Regulation Act, 1949, to ensure that banks do not sell bad loans only to their own ARCs in their eagerness to clean up the balance-sheet.

A senior official in the asset reconstruction industry said the regulator is expected to prescribe a cap on the bad loans a bank can sell to its wholly-owned ARC and ensure an arm’s length relationship between the parent and the subsidiary.

The possibility that a bank and its wholly-owned ARC subsidiary could cut asset sale deals that are advantageous to the former could see the central bank seek suitable amendments to the Act.

Poor response Given that hardly 15 per cent of the ₹1,10,000 crore of bad loans put on the block by banks were bought by ARCs in FY16, banks may find floating their wholly-owned ARC subsidiary an attractive proposition after the Budget announcement.

This is more so as they are staring at a Reserve Bank of India deadline of March 2017 to clean up their balance-sheets.

In the Budget for FY17, Finance Minister Arun Jaitley had proposed necessary amendments in the Sarfaesi (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, 2002 to enable the sponsor of an ARC to own up to 100 per cent of the entity and permit non-institutional investors such as individuals to invest in securitisation receipts.

Permitting individuals to invest in securitisation receipts (issued by an ARC to a bank as a consideration for purchasing a bad loan, and to investors for putting in money to help the ARC acquire the loan) needs to be examined from the credit rating angle in order to protect the small investors’ interest, said an official at another asset reconstruction company.

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