New RBI Norms, To Structurally Strengthen ARCs & Consolidation

The new regulatory guidelines for asset reconstruction companies (ARCs) will lead to consolidation in the sector apart from structurally fortifying them with improved governance, better disclosures, lower funding needs for asset acquisitions, and robust balance sheets, says a report. According to Crisil Ratings' analysis, the new norms announced by the Reserve Bank last Tuesday for ARCs, however, will require them to increase net-owned funds by fourfold to Rs 300 crore from Rs 100 crore in a phased manner by March 2026, which could be challenging for smaller ones.

But business profiles of ARCs will benefit from two crucial changes in the regulatory framework: lower funding requirements for asset acquisitions and two, an option to participate as a resolution applicant under the bankruptcy code. Under the new norms, ARCs investments in security receipts (SRs) are envisaged at a minimum of 15 per cent of the investment of the SR transferor, or 2.5 per cent of the total SRs issued, whichever is higher, in each asset class under each scheme on an ongoing basis until SRs are redeemed.

Earlier, ARCs could invest at least 15 per cent of SRs issued in each class under each scheme even if there were other investors other than the selling lenders present. According to Subha Sri Narayanan, a director at the agency, the revision in the minimum investment in SRs is a significant benefit for ARCs as this will free up their funds and support growth over the medium-term as in cash transactions, it could lead to 80-85 per cent savings.

It can be noted that the proportion of cash-based transactions in SRs has been increasing steadily and stood at 36 per cent in February 2022 compared to 4-5 per cent in February 2017 and the agency expects the momentum to continue with lower funding requirements for cash-based transactions.

The agency considers RBI allowing ARCs to become resolution applicants in the IBC process, as a step in the right direction as this will enhance business options available and potentially open a new revenue stream. But to be a resolution applicant, ARCs will need net-owned funds of over Rs 1,000 crore, which only a few of the 28 may be able to garner.

The regulator has also introduced several measures to strengthen the governance framework of ARCs such as enhancing the independence of their boards, capping the tenure of board members as well as a performance review process for them. The mandate to have enhanced disclosure norms pertaining to financial information, track record of returns generated and recovery ratings on SRs in offer documents is expected to bring in more transparency and ultimately boost investor interest in ARCs, the report said.

The guidelines on charging management fees only from the recovery of underlying assets should persuade ARCs to focus on faster resolution. According to Gautam Shahi, another director at the agency, while the revised guidelines are clearly aimed at strengthening the sector, it could throw up a few challenges. More than half of the ARCs have net owned funds lower than the increased requirement of Rs 300 crore and therefore a number of them may not be able to bring in additional capital. Also, new governance measures are likely to increase compliance and operational costs, which could be challenging for small ARCs, which will over time lead to consolidation.

(PTI)