SARFAESI Act and ARCs

SARFAESI Act and ARCs

Subject: Economy

Context:

The Reserve Bank of India (RBI) has allowed asset reconstruction companies to act as resolution applicants under the Insolvency and Bankruptcy Code (IBC).

Details:

• ARCs can now operate as resolution applicants, which is not allowed under the SARFAESI Act.
• To qualify as an RA, the companies need to have a minimum net owned fund of ₹1000 crore and a board-approved policy to take up the role of an applicant.
• It should have a committee comprising a majority of independent directors for submitting resolution plans under the IBC
• The ARCs should also make additional disclosures in their financial statements on assets acquired under IBC.
• Non-complying ARC shall be subject to supervisory action, including prohibition on undertaking incremental business till it reaches the required minimum NOF
• RBI has also raised the minimum capital requirement for setting up ARCs to ₹300 crore from the existing ₹100 crore

Concept:

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act of 2002

• The act was framed in order to address the problem of Non-Performing Assets (NPAs) or bad assets of banks/financial institutions through different mechanisms.
• It allows only secured creditors (lenders whose loans are backed by a security such as mortgage) to take possession over a collateral security if the debtor defaults in repayment.
• After giving a notice period of 60 days to the defaulting borrower, banks/financial institutions can:
  • take possession of the pledged assets of the borrower,
  • take over the management of such assets,
  • appoint any person to manage them or
  • ask debtors of the borrower to pay their dues too, with respect to the asset.
• The act provides procedure for registration and regulation of asset reconstruction companies (ARC) and allows them to carry out the business of :
• Asset reconstruction:
  •  It is the activity of converting a NPAs or bad assets into performing assets.
  • The ARCs can acquire financial assets (NPAs) from banks and try to recover dues through measures such as:
    • the proper management of the business of the borrower, by changing or taking over the management
    • the sale or lease of a part or whole of the business
    • rescheduling of payment of debts payable etc.
• Securitization:
  • It is the process of conversion of existing loans into marketable securities by ARCs through issue of security receipts.
• Creation of a Central Registry: by the Central Government for the purposes of registration of transaction of securitization and reconstruction of financial assets and creation of security interest.
• Application against measures to recover secured debts: 
  • can be filed by borrowers/lenders with Debt Recovery Tribunal (with appeal to Debts Recovery Appellate Tribunal) established under Recovery of Debts due to Banks and Financial Institutions Act, 1993.
• Provisions of this Act not applicable to:
  • any security interest created in agricultural land
  • any case in which the amount due is less than twenty percent of the principal amount and interest
  • any security interest for securing repayment of any financial asset less than one lakh rupees.
• Thus, the  Act provides three alternative methods for recovery of non-performing assets, namely:
  • Securitisation-Securitization is the practice of pooling together various types of debt instruments (assets) such as mortgages and other consumer loans and selling them as bonds to investors.
  • Asset Reconstruction-Asset reconstruction is the activity of converting a bad or non-performing asset into performing asset with the help of Asset reconstruction companies.
  • Enforcement of Security without the intervention of the Court-If the borrower defaults, the bank may enforce security interests by:
    • Take possession of the security;
    • Sale or lease or assign the right over the security;
    • Appoint Manager to manage the security;
    • Ask any debtors of the borrower to pay any sum due to the borrower.

Asset reconstruction companies (ARCs)

• Asset reconstruction is defined as the acquisition of banks/financial institutions right or interest in any financial assistance by an ARC for realization of such financial assistance.
• ARCs or bad banks are the specialized agencies which facilitate bad loan resolution for banks by buying the debtors of the bank at a mutually agreed value and attempting to recover the debts or associated securities by itself; making its own profit by selling the loan at a price higher than what it paid to acquire the loan.
• In India, ARCs are incorporated under the Companies Act and registered with RBI under section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI), Act 2002.
• ARCs need to maintain a minimum NOF (Net Owned Fund) of Rs 100 crore (raised to 300 cr) and a capital adequacy ratio of 15% of its risk weighted assets.
• Asset Reconstruction Company (India) Ltd or Arcil, was the first ARC of India set up in 2002 by four banks SBI, ICICI Bank, PNB and IDBI Bank.