Govt’s fillip to distressed assets – ARC to make a come back

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It is no secret that the Indian banking sector (particularly public sector banks) is suffering from burgeoning levels of Non-Performing Assets (NPAs). Whilst banks are subject to higher provisioning requirements as per the Reserve Bank of India (RBI) norms, the government appears to be treading a different path. So far the Asset Reconstruction Companies (ARCs) (i.e. entities specialising in turning around distressed assets) which are governed by the SARFAESI Act, 2002, have fallen short of achieving their objective due to the following reasons:

•Ineligibility of the sponsor entity to hold a controlling stake in an ARC has acted as a disincentive to people specialising in turnaround of distressed assets; this restriction even diluted the 100 per cent foreign ownership permitted in the ARCs.

•Only institutional players are welcome; no retail participation allowed

•Reluctance on the part of financial institutions to take a hit on their profit and loss (P&L) accounts arising out of disposal of distressed assets at a fair value to ARCs

•Uncertainty regarding the tax treatment of distribution received by investors from securitisation trusts. Recognising the aforesaid challenges, the government has proposed several amendments to revive the distressed asset market.

The government, for instance, has proposed that the sponsor of an ARC can hold 100 per cent stake, permit retail participation, grant full fiscally transparent status to trusts created by ARCs, etc.

So far, in the absence of adequate liquidity with the ARCs, distressed assets are being acquired even by non-financial entities.

Further, given the uncertainty associated with the returns that may arise from distressed assets, the ARCs are compelled to issue innovative debt instruments for raising funds which bear the characteristics of equity.

The regulatory easing measures may impact the aforesaid practices and are likely to enhance liquidity in the distressed asset market, which is the need of the hour given the quantum of distressed assets in the system.

Though financial institutions and their regulators may be grappling with the issue of NPAs, the government seems to have played its master stroke. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.

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