One person who attended the dinner said the event was meant to underline Union Bank’s intent to offload bad loans. In FY25, the attendee said, the bank wanted to sell loans worth ten times more than those sold the previous year. The ambitious target came as music to the ears of an industry grappling with fewer bad-loan sales.
Asset recovery companies are grappling with challenges on three fronts today. First, the Reserve Bank of India (RBI) has mandated higher capital requirements, stronger fraud detection measures, and greater compliance. Second, with corporate bad loans dwindling, ARCs have been pushed towards smaller retail loans. The third and more recent challenge is the advent of India’s so-called bad bank, the state-owned National Asset Reconstruction Company Ltd (NARCL).
As a rule, the industry thrives when the level of corporate non-performing assets (NPA) is high and banks choose to offload these assets on ARCs at a discount. This allows lenders to spruce up their books, and focus on their core business without spending precious resources on recovering the toxic assets. However, overall NPAs have come down across the system—the gross bad loan ratio of banks (bad loans as a percentage of total loans) was at a 12-year low of 2.8% in March. Consequently, ARCs have seen their growth slow down.
Ratings agency Crisil estimates that assets under the management of ARCs will contract 7-10% in the current financial year, after staying unchanged in 2023-24. “We believe that the acquisition of stressed assets is going to moderate in the days ahead,” said Subha Sri Narayanan, director, Crisil Ratings. “When we look at the corporate loans segment, while there is a large pool of written-off assets, the fresh addition to non-performing assets has been muted in recent times.”
Kunal Shah, group chief financial officer and managing director of retail solutions at TruBoard Partners, an asset management platform, said that the earlier focus on corporate accounts had been driven by a desire for quicker and higher returns with less manpower and operating costs. “However, this strategy may not have fostered a mature market or prioritised long-term recovery efforts,” said Shah.
While the slowdown in growth from corporate accounts has led ARCs to turn to the retail business, the news isn’t great on that front either. “On the retail loans side, too, we have so far not seen a very sharp uptick in NPAs and hence, from an opportunity perspective, the scope seems to be limited there, too.”
A young industry
In 1998, a committee headed by former RBI governor Maidavolu Narasimham recommended the setting up of ARCs. Following this, the Union Budget of 1998-99 nudged banks with a high level of bad loans to set up ARCs. Parliament passed the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act in 2002 to give these new entities legal backing.
Currently, there are 27 ARCs registered with the RBI. The prominent ones include NARCL, Edelweiss ARC, JM Financial Asset Reconstruction Company Ltd, and Asset Reconstruction Company (India) Ltd or Arcil.
Lenders sell stressed loans to these ARCs at a discount, either for cash or a mix of cash and security receipts. These receipts are redeemable as and when the ARC recovers the specific loan, with the regulatory limit set at eight years. That apart, ARCs charge an asset management fee of 1.5-2% every year.
One of the largest deals in recent years involved Yes Bank selling bad loans to the tune of ₹48,000 crore to J.C. Flowers Asset Reconstruction Pvt. Ltd in December 2022 for ₹11,183 crore. The lender claimed the deal was the largest such transaction.
Before August 2014, ARCs used to pay just 5% upfront cash to banks. The rest was given in the form of security receipts the banks subscribed to. This changed under former governor Raghuram Rajan, when the RBI said ARCs had to pay at least 15% in cash. In October 2022, the RBI made changes to this guideline, as well; the central bank said that ARCs had to invest at least 15% of the investment made by banks in security receipts, or 2.5% of the total receipts issued, whichever was higher.
Now, in a sign that NPA levels are being contained, security receipts issued by ARCs grew at a slower pace year-on-year in FY24, as per data from the ARC association. While the growth rate was 20% in FY23, it stood at 15% in FY24.
One of the largest deals in recent years involved Yes Bank selling bad loans to the tune of ₹48,000 crore to J.C. Flowers Asset Reconstruction Pvt Ltd in December 2022 for ₹11,183 crore.
Crisil believes there is still a large opportunity in the existing stock of stressed corporate assets, with banks having written off over ₹13 trillion of NPAs between fiscal years 2018 and 2024. However, Narayanan said that this vintage stock is a focus more for NARCL, whereas private ARCs are looking at bad loans of more recent origin as their resolution is typically faster.
The primary advantage of NARCL over private ARCs is that its security receipts are guaranteed by the government and it buys assets under the 15% upfront payment arrangement, as compared to the full cash payment expected of others. But the bad bank, too, has not been performing as expected.
NARCL was incorporated in July 2021, after finance minister Nirmala Sitharaman had announced it in her budget speech that February. While bankers had pegged the bad bank’s acquisition target at ₹2 trillion worth of bad loans, this target was not achieved due to severe delays. Mint reported on 7 August that NARCL, which had crossed the ₹1 trillion milestone in FY24, now aims to acquire over ₹2 trillion worth of bad loans by FY26, citing Vivek Joshi, secretary of the finance ministry’s department of financial services.
Regulatory clampdown
Banking regulator RBI has also been tightening regulations on ARCs. In October 2022, it increased the requirement for minimum net owned funds of ARCs to ₹300 crore from ₹100 crore. However, the RBI offered a glide path and said ARCs could first get to ₹200 crore, by the end of March 2024.
Net owned funds are similar to net worth and defined as the difference between what a company owns and owes. Initially, this sparked fears that smaller ARCs would not be able to survive or would be taken over by their larger peers. However, industry executives say that most ARCs have been able to meet this requirement.
“ARCs are better capitalized now and aggregate net owned funds of the ARC industry have increased from ₹13,000 crore in FY23 to ₹16,000 crore in FY24. ARCs generally were able to meet the ₹200 crore regulatory benchmark by March 2024,” said Hari Hara Mishra, chief executive of the Association of Asset Reconstruction Companies.
ARCs are better capitalised now and aggregate net owned funds of the ARC industry have increased.
— Hari Hara Mishra
According to Crisil’s Narayanan, regulatory changes have typically been aimed at structurally strengthening the sector, and the RBI’s aim seems to be to ensure that the balance sheets of ARCs are robust.
“While the requirement of ₹300 crore net owned funds is still some time away, there will be a number of ARCs that will be able to bring in additional capital to meet the requirement, but there will also be some that won’t be able to do so, thus leading to consolidation in the sector,” she said. There are more compliance and operational costs that ARCs will incur as a result of these regulatory changes and that could impact smaller ARCs more, she added.
In addition, there are other regulatory pills that the industry finds hard to swallow. In October 2022, the RBI made changes to how ARCs settle dues with defaulters. The regulator said ARCs must get an independent advisory committee to vet all settlement proposals. While the intent was to ensure ARCs did not go on a one-time-settlement rampage instead of trying to resolve an account, there has been some amount of collateral damage, industry insiders said.
“This has forced us to take every small proposal to the committee. Since we have started buying a lot of retail loans, every individual loan—no matter how small—has to be taken to this committee,” said a senior executive at an ARC. “On top of that, many proposals are stuck because the advisory committees do not want to approve them as they fear getting pulled up later, thwarting recoveries.”
The regulator said ARCs must get an independent advisory committee to vet all settlement proposals. While the intent was to ensure ARCs did not go on a one-time-settlement rampage, there has been some amount of collateral damage.
The stricter settlement conditions have had an impact. As per India Ratings and Research, recoveries across retail loans saw a drag as ARCs started taking measured steps. “The agency has observed a slowdown in the recovery timelines for its rated security receipts backed by non-performing mortgage loan pools in the recent vintages compared to earlier vintages,” it said in a statement in June 2023, eight months after the RBI’s revised norms were released.
The regulator has also not shied away from taking on big names. One recent case involved Edelweiss ARC, India’s largest ARC by assets under management. In May, the RBI barred it from acquiring any fresh loans, effectively choking its primary source of business.
The regulator said that ECL Finance—another Edelweiss group entity pulled up by the RBI—acquired loans from non-lender group entities for ultimate sale to the group ARC, circumventing regulations. Edelweiss ARC, the RBI noted, had also not placed the regulator’s supervisory letter, issued after the previous inspection for 2021-22, before the board.
It did not end there; the following month, the RBI rejected the reappointment of R.K. Bansal, a veteran banker formerly with IDBI Bank, as the MD and CEO of Edelweiss ARC. Bansal had at one point chaired the empowered group of the now-disbanded corporate debt recast cell.
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An email sent to Edelweiss ARC is yet to elicit a response.
In a much older development, The Economic Times reported on 1 March 2023 that the RBI had sent show cause notices to a few ARCs, seeking answers as to why their licences should not be cancelled, citing two people close to the development. This, the report said, was after a special audit conducted by the RBI following search and seizure operations by the income-tax department in December 2021 on 60 premises of four ARCs: Omkara ARC, Rare ARC, CFM ARC, and Invent ARC.
Asked about the show-cause notice, Manish Motilal Lalwani, managing director of Omkara ARC, one of the newer entrants in the industry, declined to comment. Instead, he asserted that the ARC had complied with all the issues pointed out by the RBI in its audit. “The RBI pointed out some compliance gaps and gave us time to comply. We have done that within the deadline.”
According to Lalwani, the RBI pointed out non-appointment of a chief risk officer, and directed it to follow the revised KYC norms, besides other issues. Subsequently, the ARC created a full-fledged risk department headed by a former banker with 30 years’ experience. “We have a separate risk department and now we also have a CRO heading it,” he said.
Trust deficit
In May, during a meeting between RBI officials and industry bosses, RBI deputy governor Rajeshwar Rao warned that sale of assets to ARCs was being used by defaulting promoters to regain possession of those assets, circumventing Section 29A of the Insolvency and Bankruptcy Code (IBC). Section 29A of the code bars defaulting promoters from bidding for their insolvent firm under the corporate insolvency resolution process.
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The industry says it has already started taking corrective steps. According to the ARC Association’s Mishra, recovery companies have been strengthening due diligence processes and oversight mechanisms, including taking the support of third-party consultants if required, to ensure that transactions comply fully with regulations.
The meeting between the ARC chiefs and RBI officials took place less than two weeks before the Edelweiss issue became public. “They must have been aware of the incident and it seemed like the RBI, apart from some serious suggestions, was pointing fingers at all of us for not staying within the lines,” said the senior ARC executive cited earlier, who attended the meeting. The executive said there is a trust deficit between the sector and the regulator as well as banks, which are reluctant to lend to ARCs. “We are children whom the parents do not trust,” he lamented.
On the same day Rao spoke, Swaminathan J., another deputy governor of the central bank, made a speech that made ARCs sit up. He took issue with the way ARCs settled loans with borrowers. The RBI has data that shows that instead of trying to rescue a distressed asset, ARCs were simply going for one-time settlements. “Arguably, these measures could have been taken by the lenders themselves,” Swaminathan pointed out.
Industry executives say that the trust deficit with the RBI seems to stem from this focus on recovery through settlements. One-time settlements are usually at a deep discount to the value of an outstanding loan, and according to ARC industry executives, the RBI feels the industry should do more to rescue an asset instead of taking the easy way out. As Swaminathan pointed out, settlements can be made by banks as well, without selling assets to an ARC.
While the industry has been facing its share of challenges, experts said it must evolve to stay relevant. ARCs, which have so far been focussing on managing assets and earning a yearly management fee, need to focus on recovery, they said. In October 2022, the RBI also laid down rules on when ARCs can charge management fees, pushing them towards greater recovery efforts.
The constant prodding by the regulator is forcing the industry to get its act together. For the RBI to trust them, ARCs will need to comply with norms and not circumvent them, as alleged, to suit their business needs. While this will be a big positive, compliance won’t necessarily bring in more business or spark a revival in momentum. For that to happen, India’s asset recovery companies will have to wait for more corporate failures.
