Asset Reconstruction

(SARFAESI Act, 2002)

Submitted by:
Harpreet kaur
6928

Introduction

One of the major problems faced by the banks and financial institutions in India is
that of bad debts, termed as Non-Performing Assets.

Non-performing assets means an asset or account of a borrower, which has been

classified by the bank or financial institution as sub-standard, doubtful or loss asset.
In India the problem of recovery from NPAs was recognized in 1997 by
Government of India.
The Narasimhan Committee Report mentioned that an important aspect of the
continuing reform process was to reduce the high level of NPAs as a means of
banking sector reform.

RBI report-trend and progress of banking 2013 released on 21st November

2013:
At present juncture, the key issues related to the Indian banking sector includeeffective reduction in NPAs and improvement in the recovery proces s

The Genesis

The genesis of asset reconstruction business in India owes its origin to enactment of the
SARFAESI Act (THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL
ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT), 2002
which was enacted by the parliament in December 2002.
Prior to the Securitisation Act, 2002, banks and financial institutions had no option but to
enforce their security interests through the court process, which was extremely time
consuming.

THE PURPOSE

SARFAESI Act enables and empowers the secured creditors

To take possession of the securities
Sale or lease or assign the right over the security
Manage the same or appoint any person to manage the same.

Methods of Recovery under the

Act
Securitization
Asset Reconstruction
Enforcement of Security interest without the intervention of the Court.

Asset reconstruction: Are companies created to manage and recover non-performing

assets acquired from the banking system. Banks and financial institutions with a large

proportion of their bad loans can sell to a separate entities i.e. Asset reconstruction companies .
The objective is to help the banks in making clean books by reducing NPAs.
It means acquisition by any securitization company or reconstruction company of any
right or interest of any bank or financial institution in any financial assistance for the
purpose of realization of such financial assistance ( sec 2b).
Financial assistance: means any loan or advance granted or any debenture or bonds
subscribed or any guarantees given or letters of credit established or any other credit facility
extended by any bank or Financial institution.

Objectives of Asset reconstruction

company

To create a new class of legal entities whose main business would be

securitization and asset reconstruction.
This means taking over non-performing assets of other institutions
using their specialized skills to recover the loan / manage such assets.

Registration of ARC

Section 3 of the SARFAESI Act deals with the registration of securitization or

reconstruction companies. Application for registration is to be made to the Reserve Bank in

such a form and manner as maybe prescribed by it.
The Reserve Bank may inspect the records and see that all the conditions specified in the Act.

Qualification for registration (Sec 3)

ARC means the company formed and registered under the companies act 1956, for the
purpose of asset reconstruction.
The company shall have minimum own funds of Rs. two crores or a capital adequacy of 15%
of total financial assets acquired or to be acquired.
The company shall not have made losses during any of the three preceding financial years.
Adequate infrastructure for this particular type of business.

Acquisition of assets

ARC may acquire the assets of bank or FI in the following

manner;
By issue of debenture
By issue of bond
Any other security in the nature of debentures
Any other terms and conditions for transfer of such financial
assets

On transfer of assets all the rights and obligations including

legal proceedings of bank or FI would vest in ARC.

Activities of assets reconstruction

companies (Sec 9)
The proper management of the business of the borrower
The sale or lease of a part or whole of the business of the
borrower
rescheduling of payment of debts payable by the
borrower
Enforcement of security interest
Settlement of dues payable by the borrower
Taking possession of secured assets in accordance with
the provisions of this act.

Functioning of ARC

Suppose, Mr.A has opened factory with Rs.100 crores. He

financed this, via mixture of Debt + equity in following way.
Holder

Equity (IPO->Shares)
Debt (loans, Bonds)

Total

Rupees in Cr.

Mr. A and his family

20

public
Business loan from SBI

30
40

Bonds

10
100

Initially the company runs well and good.

What is Qualified Institutional Buyer

(QIB)

These entities have the expertise and the financial strength to evaluate and invest in
the capital markets. These entities invest in asset reconstruction companies. QIBs
are the main source of funding for ARCs and so far funds raised through them
could be used only to acquire distressed assets from banks.

Examples:

Scheduled Commercial Banks

Foreign Institutional Investor
Mutual Funds
Venture Capital Investors
Insurance Companies
Pension/ Provident Funds

Foreign investment in ARC

ARC buy bad loans from banks and arrange money from QIBs to buy bad loans from banks.
But Problem is that Indian QIBs do not invest much in ARCs.
Therefore ARCs capacity to buy NPA is very low.
Previously Foreign investors could invest only upto 49% in ARC.
Now, Government also increased foreign investment limit in ARCs. This would attract more
investment in ARCs and help in quicker purchase and disposal of NPAs

Foreign investment in ARC

percentage

Earlier

49%

Now (December-24-2012)

74%

Power to perform following functions

Auction the assets fully or partially. (sell the machinery now, rent the building and wait
for land prices to go up for two years and then sell it.)

Sell the property in combination with other NPA properties of other defaulters.
Restructure the EMIs of borrower. For e.g. instead of 1 lakh per month, give us
75,000 per month.
Change the Management of that asset, appoint its own directors/officers.
Order the borrower to outsource or lease his business to a another company.

ARC New Power: convert Debt into equity

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or
partially).
RBI guidelines for ARCs provide a strict time frame of 5 years (including 1 year
planning period) for resolution, thus bringing in a sense of urgency for the ARCs, right
at the acquisition stage itself.

Transaction flow in Asset reconstruction industry

The trust set up by ARC for asset

resolution-acquires NPAs from banks/FIs.
NPA are acquired from banks/FIs at fair
value based on assessment of realisable
amount and time to resolution. The
maximum life of the trust as prescribed by
the regulations is five years.
Accordingly, the trusts issues securities
receipts (SR) to the investors which are
usually QIBs.
SR represent undivided right, title and
interest in the trust fund. After acquiring
the NPA, the trust becomes the legal
owner and the security holders its
immediate beneficiaries.
The Trust redeems the investment to the
SR holders out of the money realise from
the borrowers.
The ARC facilitates the whole working
and manage the assets.

Benefits of Asset reconstruction

Industry

Relieving banks of the burden of NPAs: As the cash realisation activity from defaulting
borrowers is a lengthy and cumbersome procedure, relieving banks of the burden of NPAs
will allow them to focus better on managing the core business including new business
opportunities.
Restore depositor and investor confidence :The transfer should help restore depositor and
investor confidence by ensuring the lenders financial health. The banks use it as a method to
hide off the bad loans from their balance sheet. ARCs are meant to maximise recovery value
while minimizing costs.
Building industry expertise in loan resolution : ARCs also helps building industry expertise
in loan resolution and restructuring management, besides serving as a catalyst for important
legal reforms in bankruptcy procedures and loan collection.

Some asset reconstruction companies

Asset Reconstruction Company (India) Limited (Arcil) is

India's first and largest asset reconstruction company, to commence
business of resolution of Non-Performing Assets (NPAs) upon acquisition
from Indian banks and financial institutions.
Sponsored banks :It is sponsored by prominent banks and financial
institutions namely State Bank of India (SBI), IDBI Bank Limited (IDBI), ICICI
Bank Limited (ICICI) and Punjab National Bank (PNB).
It commenced business by acquiring its first tranche of financial assets on
31stDecember, 2003.
Since inception, Arcil has acquired more than Rs. 70,000 crore worth of
NPAs from the Indian banking system.
In the process, it has also empowered the Indian banking system to grow
faster and remain stronger in a challenging economic environment.

Conclusion

The growth of Asset reconstruction sector is important for the Indian Economy.
Some kind of fiscal incentives should be provided to fuel the growth of the
industry. Also as total NPA in the Indian banks is reducing the ARCs should look
forward towards other avenues of business like, business turnaround management
and debt restructuring. There should be mechanism to review to working of ARC
which should work upon increasing the transparency in the sector .As more and
more private players enter into this sector, this space is really worth watching for.