Asset Reconstruction Companies (ARCs) - Business Model

Asset Reconstruction Companies (ARCs) - Business Model

Introduction:

Banks, as financial institutions, primarily engage in money lending and borrowing. The customer base of the banking sector is extensive, and lending money carries a significant risk.

Although banks can take legal action against defaulting borrowers, it is not always economically feasible. At times, the bank may choose to cut losses, clean up its balance sheet, and focus on more lucrative opportunities. This is where an Asset Reconstruction Company (ARC) comes into play.

An asset reconstruction company is a specialized financial institution that purchases the bad debts of a bank at a mutually agreed value and attempts to recover those debts or associated securities by itself.

The ARCs are registered under the Reserve Bank of India (RBI) and regulated by the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002).

ARCs take over a portion of the bank's debts, which qualify as Non-Performing Assets (NPAs). Therefore, ARCs are involved in the business of asset reconstruction, securitisation, or both.

All the rights previously held by the lender (the bank) in regard to the debt are transferred to the ARC. The necessary funds to purchase such debts can be raised from Qualified Buyers.

Asset Reconstruction refers to the acquisition of any right or interest of a bank or financial institution in loans, advances, debentures, bonds, guarantees, or any other credit facility extended by banks for the purpose of recovering the funds. These loans, advances, bonds, guarantees, and other credit facilities are collectively referred to as 'financial assistance.'

Securitization, on the other hand, means the acquisition of financial assets through the issuance of security receipts to Qualified Buyers or other means. These security receipts represent an undivided interest in the financial assets.

Qualified Buyers include Financial Institutions, Insurance companies, Banks, State Financial Corporations, State Industrial Development Corporations, trustee or ARCs registered under SARFAESI, and Asset Management Companies registered under SEBI that invest on behalf of mutual funds, pension funds, FIIs, etc. Qualified Buyers (QBs) are the only individuals or entities from whom the ARC can raise funds.

The working of the ARC can be summarized in the following diagram:

The business of asset reconstruction or securitisation can commence only after obtaining a registration certificate under Section 3 of the SARFAESI Act, 2002. The main requirement is that the 'net owned funds,' as prescribed in the RBI Act, should be Rs. 100 crore or more.

Process of Asset Reconstruction by ARC

The primary goal of acquiring debts/NPAs is to ultimately recover the owed amounts. However, the process is not simple. ARCs have the following options:

- Change or takeover of the borrower's business management.

- Sale or lease of the business.

- Rescheduling debt payments - offering alternative schemes or arrangements.

- Enforcing security interests based on the law.

- Taking possession of assets offered as security.

- Converting a portion of the debt into shares.

The ARC can take over only secured debts classified as non-performing assets (NPAs). If debentures/bonds remain unpaid, the beneficiary of the securities must provide a 90-day notice before the ARC can take over.

Non-performing Assets

Banks and other financial institutions categorize debts into four categories:

- Standard

- Sub-standard

- Doubtful

- Loss

The classification criteria depend on the type of financial institution and the regulatory authority governing it. A non-performing asset falls within the sub-standard, doubtful, or loss asset categories.

Introduction:

Banks, as financial institutions, primarily engage in money lending and borrowing. The customer base of the banking sector is extensive, and lending money carries a significant risk.

Although banks can take legal action against defaulting borrowers, it is not always economically feasible. At times, the bank may choose to cut losses, clean up its balance sheet, and focus on more lucrative opportunities. This is where an Asset Reconstruction Company (ARC) comes into play.

An asset reconstruction company is a specialized financial institution that purchases the bad debts of a bank at a mutually agreed value and attempts to recover those debts or associated securities by itself.

The ARCs are registered under the Reserve Bank of India (RBI) and regulated by the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act, 2002).

ARCs take over a portion of the bank's debts, which qualify as Non-Performing Assets (NPAs). Therefore, ARCs are involved in the business of asset reconstruction, securitisation, or both.

All the rights previously held by the lender (the bank) in regard to the debt are transferred to the ARC. The necessary funds to purchase such debts can be raised from Qualified Buyers.

Asset Reconstruction refers to the acquisition of any right or interest of a bank or financial institution in loans, advances, debentures, bonds, guarantees, or any other credit facility extended by banks for the purpose of recovering the funds. These loans, advances, bonds, guarantees, and other credit facilities are collectively referred to as 'financial assistance.'

Securitization, on the other hand, means the acquisition of financial assets through the issuance of security receipts to Qualified Buyers or other means. These security receipts represent an undivided interest in the financial assets.

Qualified Buyers include Financial Institutions, Insurance companies, Banks, State Financial Corporations, State Industrial Development Corporations, trustee or ARCs registered under SARFAESI, and Asset Management Companies registered under SEBI that invest on behalf of mutual funds, pension funds, FIIs, etc. Qualified Buyers (QBs) are the only individuals or entities from whom the ARC can raise funds.

The working of the ARC can be summarized in the following diagram:

The business of asset reconstruction or securitisation can commence only after obtaining a registration certificate under Section 3 of the SARFAESI Act, 2002. The main requirement is that the 'net owned funds,' as prescribed in the RBI Act, should be Rs. 100 crore or more.

Process of Asset Reconstruction by ARC

The primary goal of acquiring debts/NPAs is to ultimately recover the owed amounts. However, the process is not simple. ARCs have the following options:

- Change or takeover of the borrower's business management.

- Sale or lease of the business.

- Rescheduling debt payments - offering alternative schemes or arrangements.

- Enforcing security interests based on the law.

- Taking possession of assets offered as security.

- Converting a portion of the debt into shares.

The ARC can take over only secured debts classified as non-performing assets (NPAs). If debentures/bonds remain unpaid, the beneficiary of the securities must provide a 90-day notice before the ARC can take over.

Non-performing Assets

Banks and other financial institutions categorize debts into four categories:

- Standard

- Sub-standard

- Doubtful

- Loss

The classification criteria depend on the type of financial institution and the regulatory authority governing it. A non-performing asset falls within the sub-standard, doubtful, or loss asset categories.

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