Regulatory framework for securitization or reconstruction companies
RBI has revised the guidelines for both the Asset Reconstruction Companies and the Banks selling to them in order to have a balanced environment with more focus on the type of asset quality that is being transferred to them and also the valuation methodology around the same.
Background & objectives
Prolonged slow growth has adversely affected the Indian economy. The banking system is sitting on pile of huge non-performing loans and coupled with restructured loans, they are estimated to be around 15 % of bank loans. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was passed in the year 2002 with an aim to provide a statutory framework to banks for bad loan recovery.
With the BASEL III capital requirements kicking in soon, the PSU banks are severally undercapitalized and the NPA problem only aggravates the situation further. As per the earlier guidelines when an asset is sold off to an ARC, about 5% of value of asset sold is given back to bank in cash which is directly written back to the P&L account by the bank. The remaining 95% of the value is issued as Security Receipt (SR) by the Securitization Company (SC) or Reconstruction Company (RC). In the past few years the business of Asset Reconstruction Company (ARC) (also referred to as SC/RC) was booming and there were concerns raised by the regulator on the valuation of the loan book taken over by them. Also the management fee charged by them was linked to the value of outstanding SRs leading to high payout to the ARCs.
The earlier model with back ended recovery was really attractive for the ARCs and seemed to disadvantageous to the Banks selling to them. However in order to create a balanced environment for both the ARCs and the Banks selling to them, RBI has revised the guidelines with more focus on the type of asset quality that is being transferred to them and also the valuation methodology around the same.