Asset Reconstruction Companies: In Bad Books for Unfair Practices : Daily Current Affairs

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key Phrases: ARCs, NPAs, Stressed assets, CBDT, SARFAESI Act, IBC, National Asset Reconstruction Company Ltd (NARCL), India Debt Resolution Company Ltd. (IDRCL).

Why in News?

  • Income-Tax Department’s recent search action on four ARCs revealed that they had adopted various unfair and fraudulent trade practices in acquiring bad loans from banks

Highlights:

  • Central Board of Direct Taxes (CBDT) said that the amount at which NPAs have been acquired by ARCs has been found to be far less than the real value of the collateral securities covering the said asset/NPA.
  • The IT Department’s search revealed that the minimum cash payout made out by the ARCs to lender bank(s) for acquiring the stressed assets/NPAs has usually been using the funds of the borrower group.
    • Such funds have been routed through several layers of dummy companies controlled by the borrower group or through hawala channels.
  • It has also been found that the ARCs have been following non-transparent methods in disposal of assets that were acquired by them from the banks.
    • More often than not, the underlying assets had been re-acquired by the same borrower group, albeit at a fraction of their real values.
  • The IT Department found that ARCs concealed the profits on disposal of the underlying assets by diverting the actual profit to their related concerns, under the garb of consultancy receipts or unsecured loans/investments.
  • The Board noted that through this method, the ARCs have not only evaded the payment of due taxes but also deprived the lender bank(s) of their share of actual profits.

An Asset Reconstruction Company (ARC) is a special type of financial institution that buys the debtors of the bank at a mutually agreed value and attempts to recover the debts or associated securities by itself.

  • The asset reconstruction companies or ARCs are registered under the RBI and regulated under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002).
  • • The ARCs take over a portion of the debts of the bank that qualify to be recognised as Non-Performing Assets.
  • • Thus ARCs are engaged in the business of asset reconstruction or securitisation or both.

Concerns:

  • This development could be a body blow to ARCs as banks may avoid this channel of recovery.
  • Banks instead will prefer to pursue recoveries via the IBC (Insolvency and Bankruptcy Code) and the bank-led National Asset Reconstruction Company Ltd (NARCL) routes.
    • These allegations, if found true, would strengthen the case for the public sector bank owned National Asset Reconstruction Company, set up by the Centre.
  • They usher in best practices such as separation of the ARC’s sponsors from its management and price discovery through Swiss challenge
  • NARCL can ensure that banks enjoy greater oversight over NPA resolution attempts even after loans change hands, and thus perhaps, provide a fairer deal than private ARCs.
  • There is also fear among bankers that old cases of banks’ non-performing asset (NPA) sale to ARCs may be opened up.
  • The Reserve Bank of India’s “Committee to Review the Working of ARCs” has observed that the ARC framework is designed to allow originators to focus on their core function of lending, with ARCs acquiring sticky stressed financial assets from their books.
    • However, data parsed by the committee showed that the performance of the ARCs has been lacklustre, both in terms of ensuring recovery and revival of businesses.
    • During The Period From 2003-04 To 2012-13, Banks And Other Investors Were Only able to recover about 14.29% of the amount owed by borrowers, mostly through measures unrelated to business revival.

National Asset Reconstruction Company Limited (NARCL) has been incorporated under the Companies Act and has applied to RBI for license as an Asset Reconstruction Company (ARC). NARCL has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution. PSBs will maintain 51% ownership in NARCL.

India Debt Resolution Company Ltd. (IDRCL) is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake and the rest will be with private sector lenders.

What is Swiss Challenge?
  • Swiss challenge method is a new process of giving contracts. Any person with credentials can submit a development proposal to the government. That proposal will be made online and a second person can give suggestions to improve and beat that proposal.
    • An expert committee will accept the best proposal and the original proposer will get a chance to accept it if it is an improvement on his proposal.
    • In case the original proposer is not able to match the more attractive and competing counter proposal, the project will be awarded to the counter-proposal.
    • In 2009, the Supreme Court approved the method for award of contracts.

Way Forward:

  • The RBI working group, unearthed both process and market inefficiencies and suggested several tweaks:
    • To improve recoveries, it suggested that lenders sell their doubtful loans to ARCs before they matured as NPAs in the SMA (Special Mention Account) stage.
    • To enable debt aggregation, it recommended allowing ARCs to acquire stressed loans from non-bank entities such as FPIs, mutual funds and AIFs.
    • To usher in fairer valuation, it suggested that bank loans be auctioned to ARCs, after independent valuers set a reserve price.
  • Given that the tax department’s allegations revolve mainly around governance infractions at ARCs, these process fixes may need to be accompanied by a tighter governance framework.
    • RBI, as regulator for ARCs and banks, may decide to initiate forensic investigations into the books of the named ARCs.
    • ARC promoters must be subjected to more stringent ‘fit and proper’ criteria on the lines of those for banks and must be asked to file more comprehensive statutory returns on their transactions, with RBI maintaining a stricter supervisory vigil.

Conclusion:

  • Despite their limitations, ARCs have been useful globally to discover a fair price for stressed assets. The experience of national bad banks in jurisdictions like China are cautionary tales that warn against ignoring market processes. Hence, a holistic regulation of the sector is the need of the hour.

Source: The Hindu BL

Mains Question:

Q. Policymakers must find regulatory fixes rather than jettisoning the ARC idea altogether. Comment.