RBI MD S No 04 - ARC

 

The Banking Tutor

RBI Master Directions Series

S No 004                                                                                             17-08-2024

Master Directions - Asset Reconstruction Companies

ARCs play a critical role in the resolution of stressed financial assets of banks and financial institutions, thereby enhancing the overall health of the financial system. To ensure prudent and efficient functioning of ARCs and to protect the interest of investors, Reserve Bank of India issues the Master Direction – Reserve Bank of India (Asset Reconstruction companies) Directions, 2024 (the Directions), hereinafter specified. 

Before commencement of the business of securitisation or asset reconstruction, an ARC shall apply for registration and obtain a Certificate of Registration (CoR) from the Reserve Bank as provided under Section 3 of the Act. 

ARC, which has obtained a CoR from the Reserve Bank, can undertake both securitisation and asset reconstruction activities. 

ARC shall commence business within six months from the date of grant of CoR by the Reserve Bank. Reserve Bank may grant extension up to twelve months from the date of grant of CoR on receipt of the application from the ARC. 

Net owned fund 

To commence the business of securitisation or asset reconstruction, an ARC is required to have a minimum net owned fund (NOF) of ₹300 crore and thereafter, on an ongoing basis.

ARCs existing as on October 11, 2022 have been provided the following glide path to achieve the minimum required NOF of ₹300 crore:

 

Minimum required NOF
on October 11, 2022	by March 31, 2024	by March 31, 2026
₹100 crore	₹200 crore	₹300 crore

In case of non-compliance at any of the above stages, the non-complying ARC shall be subject to supervisory action, including prohibition on undertaking incremental business till it reaches the required minimum NOF applicable at that time. 

Activities of ARCs 

An ARC shall commence/ undertake only securitisation and asset reconstruction activities and functions. 

ARCs have been permitted to undertake those activities as Resolution Applicants under Insolvency and Bankruptcy Code, 2016 (IBC) which are not specifically allowed under the Act. This permission shall be subject to the following conditions: 

a) The ARC has a minimum NOF of ₹1,000 crore. 

b) The ARC shall have a Board-approved policy regarding taking up the role of Resolution Applicant which may, inter alia, include the scope of activities, internal limit for sectoral exposures, etc. 

c) A committee comprising of a majority of independent directors shall be constituted to take decisions on the proposals of submission of resolution plan under IBC. 

d) The ARC shall explore the possibility of preparing a panel of sector-specific management firms/ individuals having expertise in running firms/ companies which may be considered for managing the firms/ companies, if needed. 

e) In respect of a specific corporate insolvency resolution process (CIRP), the ARCs shall not retain any significant influence or control over the corporate debtor after five years from the date of approval of the resolution plan by the Adjudicating Authority under IBC. In case of non-compliance with this condition, the ARCs shall not be allowed to submit any fresh resolution plans under IBC either as a Resolution Applicant or a Resolution Co-Applicant. 

An ARC may, as a sponsor and for the purpose of establishing a joint venture, invest in the equity share capital of another ARC. 

An ARC may deploy its funds for undertaking restructuring of acquired loan account with the sole purpose of realizing its dues. 

An ARC may deploy any surplus funds available with it in – 

a) Government securities and deposits with scheduled commercial banks, SIDBI, NABARD etc. 

b) Short-term instruments viz., money market mutual funds, certificates of deposit and corporate bonds/ commercial papers which have a short-term rating equivalent to the long-term rating of AA- or above by an eligible credit rating agency (CRA), subject to a cap of 10% of the NOF of the ARC on maximum investment in such short-term instruments. 

No ARC shall invest in land or building. However, this restriction shall not apply to –

a) investment by the ARC in land and building for its own use up to 10% of its owned funds; and

b) land and building acquired by the ARC in satisfaction of claims in ordinary course of its business of reconstruction of assets in accordance with the provisions of the Act. 

Any land and/ or building acquired by the ARC, in the ordinary course of its business of reconstruction of assets while enforcing its security interest, shall be disposed of within a period of five years from the date of such acquisition or such extended period as may be permitted by the Reserve Bank in the interest of realisation of the dues of the ARC. 

An ARC shall not raise monies by way of deposit. 

Before bidding for the stressed assets, ARCs may seek adequate time, of not less than two weeks, from the auctioning banks to conduct a meaningful due diligence of the account by verifying the underlying assets. 

The share of financial assets to be acquired from the bank/ financial institution should be appropriately and objectively worked out keeping in view the provision in the Act requiring consent of secured creditors holding not less than 60% of the amount outstanding to a borrower for the purpose of enforcement of security interest. 

For easy and faster realisability, all the financial assets due from a single debtor to various banks/ financial institutions may be considered for acquisition. Similarly, financial assets having linkages to the same collateral may be considered for acquisition to ensure relatively faster and easy realisation. 

Both fund and non-fund based financial assets may be included in the list of assets for acquisition. Assets classified as special mentioned accounts (SMAs) in the books of the originator may also be acquired. 

Acquisition of funded assets should not include takeover of outstanding commitments, if any, of any bank/ financial institution to lend further.

Terms of acquisition of security interest in non-fund transactions, should provide for the relative commitments to continue with bank/ financial institution, till demand for funding arises. 

An ARC can sell financial asset to another ARC subject to the following conditions: 

a) The transaction is settled on cash basis; 

b) Price discovery for such transaction shall not be prejudicial to the interest of SR holders;

c) The selling ARC shall utilize the proceeds so received for the redemption of underlying Security Receipts (SRs); and

d) The date of redemption of underlying SRs and total period of realisation shall not extend beyond eight years from the date of acquisition of the financial asset by the first ARC. 

ARCs shall not acquire financial assets from the following on a bilateral basis, whatever may be the consideration: 

a) a bank/ financial institution which is the sponsor of the ARC; 

b) a bank/ financial institution which is either a lender to the ARC or a subscriber to the fund, if any, raised by the ARC for its operations; 

c) an entity in the group to which the ARC belongs. 

However, they may participate in the auctions of the financial assets provided such auctions are conducted in a transparent manner, on arm’s length basis and the prices are determined by the market forces. 

The ARC shall formulate the policy for realisation of financial assets under which the period for realisation shall not exceed five years from the date of acquisition of the financial asset concerned.  

The Board of the ARC may increase the period for realisation of financial assets so that the total period for realisation shall not exceed eight years from the date of acquisition of the financial asset concerned. 

In case, the ARC is one of the lenders in an account, where a resolution plan has been finalised and the same extends beyond the maximum resolution period allowed for ARCs, the ARC may accept a resolution period co-terminus with other secured lenders.

Measures of Asset Reconstruction

Change in the management of the business of the borrower 

An ARC may resort to change in or takeover of the management of the business of the borrower for the purpose of realisation of its dues from the borrower. 

On realisation of its dues in full, the ARC shall restore the management of the business to the borrower. However, if any ARC has converted part of its debt into shares of a borrower company and thereby acquired controlling interest in the borrower company, such ARC shall not be liable to restore the management of the business to such borrower. 

Rescheduling of debts payable by the borrower 

All proposals of Rescheduling of debts should be supported by an acceptable business plan, projected earnings and cash flows of the borrower. 

The proposals should not materially affect the asset liability management of the ARC or the commitments given to investors. 

Enforcement of security interest 

The ARCs are required to obtain, for the purpose of enforcement of security interest, the consent of secured creditors (including ARCs) holding not less than 60% of the amount outstanding to a borrower. 

Settlement of dues payable by the borrower 

Settlement of dues with the borrower shall be done only after the proposal is examined by the IAC. 

Settlement with the borrower should be done only after all possible steps to recover the dues have been taken and there are no further prospects of recovering the debt. 

The net present value (NPV) of the settlement amount should generally be not less than the realizable value of securities. If there is a significant variation between the valuation of securities recorded at the time of acquisition of financial assets and the realisable value assessed at the time of entering into a settlement, reasons thereof shall be duly recorded. 

The settlement amount should preferably be paid in lump sum. In cases, where the borrower is unable to pay the entire amount in lump sum, IAC shall make specific recommendations about minimum upfront lump sum payment and maximum repayment period. 

Conversion of any portion of debt into equity of a borrower entity 

In cases of financial assets, which have turnaround potential after restructuring but normally with huge default and unsustainable level of debt, it shall be necessary to arrive at sustainable level of debt, on the basis of evaluation of detailed business plan with projected level of operations, which can be serviced by the entity. 

A part of residual unsustainable debt may have to be converted into equity for an optimal debt equity structure. While ARCs are permitted to have significant influence or have a say in the decisions surrounding the borrower entity’s turnaround through conversion of debt into equity, they should not be seen to be running the entities. The shareholding of the ARC shall not exceed 26% of the post converted equity of the entity under reconstruction. 

However, ARCs satisfying the conditions mentioned below are exempted from the limit of shareholding at 26% of post converted equity of the borrower entity. 

Securitisation 

Special features of Security Receipts (SRs) 

a) SRs cannot be strictly characterized as debt instruments since they combine the features of both equity and debt. However, these are recognized as securities under Securities Contracts (Regulation) Act, 1956. 

b) The cash flows from the underlying assets cannot be predicted in terms of value and intervals. 

c) These instruments, when rated, would generally be below investment grade. These instruments are privately placed. 

d) The trusts shall issue SRs only to QBs and such SRs shall be transferable/ assignable only in favour of other QBs. 

e) The trusts shall hold and administer the financial assets for the benefit of the QBs. 

ARCs shall, by transferring funds, invest in the SRs at a minimum of either 15% of the transferors’ investment in the SRs or 2.5% of the total SRs issued, whichever is higher, of each class of SRs issued by them under each scheme on an ongoing basis till the redemption of all the SRs issued under such scheme. 

Rating/ Grading of SRs 

Every ARC shall mandatorily obtain initial rating/ grading of SRs from a SEBI registered CRA within a period of six months from the date of acquisition of assets and declare the Net Asset Value (NAV) of the SRs issued by it. 

Thereafter, ARCs shall get the rating/ grading of SRs reviewed from the CRA as on June 30, and December 31 every year and declare the NAV of SRs forthwith, to enable the QBs to value their investments in SRs. 

The rating shall be assigned on a specifically developed rating scale called ‘recovery rating (RR) scale’. Each rating category in the recovery scale shall have an associate range of recovery, expressed in percentage terms, which can be used for arriving at the NAV of SRs. 

ARCs shall require the CRAs to disclose the assumptions and rationale behind the rating and shall disclose these to SR holders. 

ARCs shall retain a CRA for at least six rating cycles (of half year each). If a CRA is changed mid-way through these six rating cycles, the ARC shall disclose the reason for such change. 

Restructuring support finance: 

An ARC can utilize a part of funds raised under a scheme from the QBs for restructuring of financial assets acquired under the relative scheme subject to the following conditions:

a) ARCs with acquired assets in excess of ₹500 crore can float the fund under a scheme which envisages the utilization of part of funds raised from QBs for restructuring of financial assets acquired out of such funds. 

b) The extent of funds that shall be utilized for reconstruction purpose should not be more than 25% of the funds raised under the scheme. The funds raised to be utilized for reconstruction (within the ceiling of 25%) should be disclosed upfront in the scheme. Further, the funds utilized for reconstruction purposes should be separately accounted for. 

Disclosures: 

Every ARC intending to issue SRs shall make disclosures specified.

Prudential regulations 

Capital adequacy ratio: 

Every ARC shall maintain, on an ongoing basis, a capital adequacy ratio of minimum 15% of its total risk weighted assets. Capital for the purpose of calculation of capital adequacy ratio will have the same meaning as NOF. The risk-weighted assets shall be calculated as the weighted aggregate of on-balance sheet and off-balance sheet items. 

Assets which have been deducted from owned fund to arrive at NOF shall have risk weight of 0%. 

Asset classification 

Every ARC shall, after taking into account the degree of well-defined credit weaknesses and extent of dependence on collateral security for realisation, classify the assets held in its own books into - Standard assets and NPAs. 

Assets acquired by the ARC for the purpose of asset reconstruction may be treated as standard assets during the planning period, if any. 

Where the terms of agreement regarding interest and/ or principal relating to a standard asset have been renegotiated or rescheduled by an ARC (otherwise than during planning period), the asset concerned shall be classified as sub-standard asset with effect from the date of renegotiation/ rescheduling or continue to remain as a sub-standard or doubtful asset as the case be. The asset may be upgraded as a standard asset only after satisfactory performance for a period of 12 months as per the renegotiated/ rescheduled terms. 

Provisioning requirements: Every ARC shall make provisions against NPAs, as under:

Asset category	Provisioning required
Sub-standard assets	A general provision of 10% of the outstanding amount
Doubtful assets          (i)	100% provision to the extent the asset is not covered by the estimated realisable value of security
Doubtful assets          (ii)	In addition to item (i) above, 50% of the remaining outstanding amount
Loss assets	The entire asset shall be written off (If, for any reason, the asset is retained in the books, 100% thereof shall be provided for).

Prior approval of the Reserve Bank is required for appointment/ re-appointment of a Director or Managing Director (MD)/ Chief Executive Officer (CEO). 

ARCs shall undertake due diligence to determine the suitability of the person for the post based upon track record, integrity and other ‘fit and proper’ criteria. 

The ARC shall require the directors to execute a covenant in the format specified, at the time of their joining the ARC, binding them to discharge their responsibilities to the best of their abilities, individually and collectively. This deed shall be preserved by the ARC and should be made available to the Reserve Bank as and when called for. 

Age of the MD/ CEO and Whole-time Directors (WTDs)

No person shall continue as MD/ CEO or WTD beyond the age of 70 years. Within the overall limit of 70 years, as part of their internal policy, ARCs’ Boards are free to prescribe a lower retirement age. 

Tenure of MD/ CEO and WTDs 

Tenure of MD/ CEO or WTD shall not be for a period of more than five years at a time and the individual shall be eligible for re-appointment. However, the post of the MD/ CEO or WTD shall not be held by the same incumbent for more than fifteen years continuously. Thereafter, the individual shall be eligible for re-appointment as MD/ CEO or WTD in the same ARC, if considered necessary and desirable by the Board, after a minimum gap of three years, subject to meeting other conditions. During this three-years cooling period, the individual shall not be appointed or associated with the ARC in any capacity, either directly or indirectly. The ARCs shall put in place appropriate measures to ensure succession planning. 

Fair Practices Code (FPC)

1) The ARC shall follow transparent and non-discriminatory practices in acquisition of assets. It shall maintain arm’s length distance in the pursuit of transparency. 

(2) In order to enhance transparency in the process of sale of secured assets, 

a) invitation for participation in auction shall be publicly solicited; the process should enable participation of as many prospective buyers as possible; 

b) terms and conditions of such sale may be decided in wider consultation with investors in the SRs as per the Act; and 

c) ARCs shall ensure compliance with Section 29A7 of the IBC in dealing with the prospective buyers. 

(3) ARCs shall release all securities on repayment of dues or on realisation of the outstanding amount of loan, subject to any legitimate right or lien for any other claim they may have against the borrower. If such right of set off is to be exercised, the borrower shall be given notice about the same with full particulars about the remaining claims and the conditions under which the ARCs are entitled to retain the securities till the relevant claim is settled/ paid. 

(4) ARCs shall put in place a Board-approved policy on the management fee, expenses and incentives, if any, claimed from trusts under their management. 

(5) Any management fee/ incentives charged towards the asset reconstruction or securitisation activity shall come only from the recovery effected from the underlying financial assets. 

(6) In the matter of recovery of loans, ARCs shall not resort to harassment of the debtor. ARCs shall ensure that the staff are adequately trained to deal with customers in an appropriate manner. 

a) ARCs, as principals, are responsible for the actions of their recovery agents. 

b) It is essential that the recovery agents observe strict customer confidentiality. 

c) ARCs shall ensure that recovery agents are properly trained to handle their responsibilities with care and sensitivity, particularly in respect of aspects such as hours of calling, privacy of customer information, etc. They should ensure that recovery agents do not induce adoption of uncivilized, unlawful and questionable behaviour or recovery process. 

d) ARCs shall ensure that they or their agents do not resort to intimidation or harassment of any kind, either verbal or physical, against any person in their debt collection efforts, including acts intended to humiliate publicly or intrude upon the privacy of the debtors' family members, referees and friends, sending inappropriate messages either on mobile or through social media, making threatening and/ or anonymous calls, persistently9 calling the borrower and/ or calling the borrower before 8:00 a.m. and after 7:00 p.m. for recovery of overdue loans, making false and misleading representations, etc. 

(7) ARCs should constitute a grievance redressal machinery within the organisation. 

(8) ARCs shall keep the information, they come to acquire in course of their business, strictly confidential and shall not disclose the same to anyone including other companies in the group except when (a) required by law; (b) there is duty towards public to reveal information; or (c) there is borrower’s permission. 

(9) The FPC shall be placed in public domain for information of all stakeholders. 

(10) Every ARC shall prepare its balance sheet and profit and loss account as on 31st March every year. 

Investments 

Considering the nature of investment in SRs where underlying cash flows are dependent on realisation from NPAs, it can be classified as available for sale. Hence, investments in SRs may be aggregated for the purpose of arriving at net depreciation/ appreciation of investments under the category. Net depreciation, if any, shall be provided for. Net appreciation, if any, should be ignored. 

All other investments should be valued at lower of cost or realisable value. Where market rates are available, the market value would be presumed to be the realisable value and in cases, where market rates are not available, the realisable value should be the fair value. However, investments in other ARCs shall be treated as long term investments and valued in accordance with the applicable accounting standards. 

Income recognition 

Yield on SRs should be recognised only after the full redemption of the entire principal amount of SRs. 

Upside income should be recognized only after full redemption of SRs. 

Management fees are to be reckoned as a percentage of the actual outstanding value of SRs, before the availability of NAV of SRs. Management fees may be recognized on accrual basis. Management fees recognized during the planning period must be realized within 180 days from the date of expiry of the planning period. 

Management fees recognized after the planning period should be realized within 180 days from the date of recognition. 

Unrealised management fees should be reversed thereafter. Further, any unrealized management fees shall be reversed if, before the prescribed time for realisation, NAV of the SRs fall below 50% of face value. 

Interest and any other charges in respect of all the NPAs shall be recognised only when they are actually realised.

Any unrealised income recognised by an ARC before the asset became non-performing and remaining unrealised, shall be derecognised. 

Expenses incurred at pre-acquisition stage for performing due diligence etc. for acquiring financial assets from banks/ financial institutions should be expensed immediately by recognizing the same in the statement of profit and loss for the period in which such expenses are incurred. Expenses incurred at post-acquisition stage for formation of the trusts, stamp duty, registration, etc. and which are recoverable from the trusts, should be reversed, if these expenses are not realised within 180 days from the planning period or downgrading of SRs, i.e., NAV is less than 50% of the face value of SRs, whichever is earlier. 

Internal audit: 

ARCs shall put in place an effective internal control system providing for periodical checks and review of the asset acquisition procedures and asset reconstruction measures followed by them and matters related thereto. 

Guidelines regarding Credit Information Companies 

Every ARC shall become a member of at least one credit information company (CIC) which has obtained certificate of registration from the Reserve Bank and shall provide them accurate data/ history of the borrowers periodically.

ARCs should submit the list of wilful defaulters as at end of March, June, September and December every year to the CIC of which it is a member. 

Every ARC shall place on its website the list of suit-filed accounts of wilful defaulters. 

ARCs shall file and register the records of all transactions related to securitisation, reconstruction of financial assets and creation of security interest, if any, with CERSAI (Central Registry).

Miscellaneous Points 

ARCs shall follow the Know Your Customer (KYC) Directions 

ARCs shall report to IBA the details of chartered accountants, advocates and valuers (who have committed serious irregularities in the course of rendering their professional services) for including in the IBA database of third-party entities involved in fraud. However, ARCs shall have to ensure that they follow meticulously the procedural guidelines issued by IBA  and also give the parties a fair opportunity to explain their position and justify their action before reporting to IBA. If no reply/ satisfactory clarification is received from them within one month, ARCs shall report their details to IBA. ARCs should consider this aspect before assigning any work to such parties in future. 

Qualified Buyers 

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. The Qualified Buyers (QBs) are the only persons from whom the ARC can raise funds.

(Source: RBI MD dated 24-04-2024)

                                                                                                          Sekhar Pariti

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