Introduction:

Banks, as financial institutions, are primarily involved in activities like lending and borrowing money. The banking sector has an extensive customer base, and with that comes the significant risk associated with lending. Although banks have the option to initiate legal proceedings against borrowers who default, it isn't always a viable economic solution. Sometimes, banks might opt to minimize losses, clean up their balance sheets, and focus on more profitable ventures. This is the juncture where an Asset Reconstruction Company (ARC) becomes essential.

An ARC is a dedicated financial entity engaged in buying bad debts from banks at an agreed value, with the aim of recovering those debts or their associated securities independently. These ARCs are registered under the Reserve Bank of India (RBI) and fall under the regulation of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002).

ARCs take on a portion of the bank’s debts recognized as Non-Performing Assets (NPAs). Consequently, ARCs operate in the realm of asset reconstruction and securitisation. All rights that the lender (the bank) once wielded regarding the debt are transferred to the ARC. To finance these debt acquisitions, funds can be sourced from Qualified Buyers.

Asset Reconstruction entails acquiring any rights or interests a bank or financial institution has in loans, advances, debentures, bonds, guarantees, or any other credit extended for the purpose of fund recovery. These various financial facilities are collectively termed as 'financial assistance.'

Securitization involves acquiring financial assets through the distribution of security receipts to Qualified Buyers or other methods. These security receipts offer an undivided interest in the financial assets.

Qualified Buyers encompass Financial Institutions, Insurance companies, State Financial Corporations, State Industrial Development Corporations, ARCs under SARFAESI, and Asset Management Companies under SEBI investing on behalf of mutual funds, pension funds, FIIs, etc. Only Qualified Buyers (QBs) can provide funding to ARCs.

For ARCs to operate in asset reconstruction or securitisation, they must receive a registration certificate under Section 3 of the SARFAESI Act, 2002. The essential requirement is that the 'net owned funds', as stipulated by the RBI Act, should be Rs. 100 crore or more.

Process of Asset Reconstruction by ARC

The main aim of acquiring debts/NPAs is to recover the owed sums. Nonetheless, the procedure is complex. ARCs have several strategies they can employ, including:

• Changing or taking over the borrower's business management.
• Selling or leasing the business.
• Rescheduling payment terms by suggesting alternative plans or setups.
• Enforcing security interests legally.
• Possession of secured assets.
• Converting a part of the debt into equity shares.

An ARC can only acquire secured debts classified as NPAs. If bonds or debentures are unpaid, a 90-day notice must be given by the securities' beneficiary before ARC takeover is possible.

Non-Performing Assets

Banks and other financial bodies classify debts into:

• Standard
• Sub-standard
• Doubtful
• Loss

The classification depends on the nature of the financial institution and its governing authority. NPAs are categorized under sub-standard, doubtful, or loss assets.

Note: MSMEs (Micro, Small and Medium Enterprises), CIBIL (Credit Information Bureau India Limited), MICR Code (Magnetic Ink Character Recognition), RTGS (Real-Time Gross Settlement), IMPS (Immediate Payment Service), NEFT (National Electronic Funds Transfer), and NBFCs (Non-Banking Financial Companies) are some of the associated terms in the banking ecosystem.