Asset Reconstruction Companies (ARCs), once seen as primary vehicles to relieve banks of their bad loan burden, have failed to live up to their initial promise. A Reserve Bank of India-appointed committee noted that ARCs had recovered just over 14 per cent of the book value of the assets they acquired, while reviving just 20 per cent of the businesses. This patchy record is attributed to many factors – from the ageing of bad loans to ARCs’ low capitalisation and inadequate skill-sets to oversee revival.
More worrying though, are the range of governance lapses at ARCs unearthed by the Income Tax department last year. After raiding the premises of four unnamed ARCs, the department alleged that ARCs had bought out bad loans from banks at unrealistically low prices, had a nexus with borrowers, sold the re-possessed assets back to defaulters at beaten-down prices and diverted the proceeds. This is perhaps why RBI, while recently laying down new ground-rules for ARCs, has focused more on tightening their governance, than on fixing their business model. The new RBI rules subject ARCs to a tighter Board-managed structure by requiring them to have an independent director as the Chairperson and stipulating Audit, and Nomination and Remuneration, committees. As with banks, the appointment of MD/CEOs or directors by an ARC and shareholding changes will now require prior RBI approval and will be subject to ‘fit and proper’ criteria. ARCs can charge their management fee only out of the recoveries they effect. To reduce scope for malpractice when ARCs negotiate settlements with borrowers, every such deal must now be vetted by an independent advisory committee.
In a critical move designed to prevent defaulting promoters from getting back in the driving seat, RBI plans to impose the eligibility criteria for bidders under section 29A of the IBC, to ARCs selling assets. To ensure that only adequately capitalised players stay in the business, the minimum net worth for ARCs has been raised from ₹100 crore to ₹300 crore. No new ARC licenses will be given to entities with lower net worth and existing ARCs will need to meet the ₹300 crore norm by March 2026, to stay in business. . ARCs with net worth of over ₹1,000 crore can now participate as resolution applicants in IBC cases. CRISIL estimates that the new rules will reduce ARCs’ capital outgo by 80-85 per cent in cash-based transactions, but points out that over half the existing ARCs do not meet the ₹300 crore net worth norm. With tighter rules around bad loan acquisitions and sales, and RBI applying stringent criteria to approve new investors in ARCs, a shakeout in the sector resulting from these regulations appears quite likely. But with the IBC and the National Asset Reconstruction Company now offering more transparent routes to bad loan resolution for banks, survival of the fittest may not be such a bad thing for this sector.