The slideshow highlights the challenges and issues faced by ARCs in India and makes recommendations on the steps that should be taken by the financial regulators to fix these issues

1. Open issues with Asset Reconstruction
Companies (ARCs) in India
Ritika Chhabra
21 December 2016

2. Background
There are 18 ARCs registered in India1
The SARFAESI Act, 2002 is main governing act. RBI is main
regulatory body
ARC model has not worked well in past - only Rs. 197 billion2
of Rs. 5,700 billion gross NPAs of banks (3.5%) transferred to
ARCs in FY16
Below we discuss issues and challenges related to ARCs and
provide recommendations
1
http://www.arcindia.co.in/
2
Ernst & Young

3. Valuation mismatch
Problem
Banks apply lower discounts to NPAs for sale while ARCs
apply higher discounts
Valuation mismatch results in deals falling apart
For example - Only Rs. 197 billion of NPAs were sold out of
Rs. 1,300 billion put up for sale to ARCs in FY16
Recommendation
Introduce standard set of guidelines for valuation of NPAs to
be carried out by an external agency before the sale.
Design an auction platform for receiving bids for better price
discovery.

4. The 85:15 structure
Problem
RBI tightened skin in the game rules in August 2014
Linking management fee to NAV ensures accountability of
ARCs in dealing with stressed assets
But increasing minimum contribution of ARCs from 5% to
15% is restrictive
Result - ARCs asked for higher discount to sustain, the NPA
sales dropped
Recommendation
Rationalize the skin in the game rules. The minimum
contribution of ARCs should be lowered to 5% from 15%, as
per international norms.

5. Rules for provisioning for NPAs
Problem
Provisioning for NPAs on bank books spread over 4 years
while sale of NPAs requires upfront reporting
Banks hold NPAs for longer period to reduce their losses or to
book profit on sale
Banks allowed to provision for loss of sale to ARCs over 2
years till March 2016 and over 4 quarters till March 2017
Recommendation
Allow banks to apply same provisioning rules for NPAs sold to
ARCs as for the NPAs which are not sold.

6. Financing of ARCs
Problem
Capital shortage is a major problem for ARCs
Nature of business makes it difficult to raise capital through
conventional means
Currently ARCs have capacity of acquiring only 5% of total
NPAs given their net worth3
Recommendation
Allow institutional investors in India to invest capital in ARCs.
3
Ernst & Young

7. Regulatory interference
Problem
Excessive regulatory interference by RBI in functioning of
ARCs
The new bill (discussed in next slide) further increases powers
of RBI such as control over management, fees and expenses
and policy of an ARC
Undue regulations make ARC business unattractive esp. for
foreign entities
Recommendation
ARCs should be treated as hedge funds or private equity funds
like in US and UK which follow a pure market based model
with lesser intervention from banking regulator.
ARCs should be regulated by SEBI that regulates capital
markets in India.

8. The Enforcement of Security Interest and Recovery of
Debt Laws and Miscellaneous Provisions (Amendment)
Act, 2016
Problem
The new bill will replace SARFAESI Act and RDDBFI Act
The bill seeks to overhaul DRTs, rationalize stamp duty and
reduce the recovery time
Some issues with the proposed bill - increases the powers of
RBI (discussed above), not very clear on on interaction
between individual recovery laws and collection insolvency
laws (The Bankruptcy Code)
Recommendation
Clear guidelines to be laid down for the new Bill and the
Bankruptcy Code to be consistent with each other for
speedier recovery.

9. Investment by FPIs
Problem
Tax uncertainty - 5% with-holding tax rate for FPIs only till
July 2017, increases post that
Investment in SRs come under corporate bonds - investment
limit of Rs. 2.4 trillion by FPIs
Recommendation
There should be clarity on with-holding tax rate on
investment in SRs by FPIs.
Investment in SRs should be outside the purview of
investment limit in corporate bonds.

10. Summary of recommendations
1. Introduce valuation guidelines for sale of NPAs
2. Design an auction platform
3. Lower upfront cash payment requirement to 5% from 15%
4. Equal bank balance sheet treatment of NPAs sold and NPAs
not sold
5. Allow domestic institutional investors to invest capital in ARCs

11. Summary of recommendations (contd..)
6. Allow lesser intervention from RBI
7. ARCs to be regulated by SEBI
8. Ensure consistency between the new Bill and the Bankruptcy
Code
9. Clarity on WHT rate on FPI investments
10. Remove corporate bond investment restrictions for FPIs on
SRs

12. Thank you