Introduction
The Reserve Bank of India (‘RBI’) released the Master Direction – Reserve Bank of India (Asset Reconstruction Companies) Directions, 2024, dated 24.04.2024 (‘Directions’), which shall apply to every Asset Reconstruction Company (‘ARC’) registered with RBI under s. 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’).
The directions have been segregated into seven sections addressing the introduction, registration and related matters, guidelines on asset reconstruction and securitisation, prudential regulations, governance conduct, accounting and disclosures, and miscellaneous instructions.
Section-I: Introduction
This section deals with the extent of applicability of Directions and provides definitions. It creates a specific exemption clause under which the RBI may grant general or specific exemption(s) to ARCs.
The Directions define net owned funds and non-performing assets (‘NPAs’) as follows:
Net owned fund has been defined as the amount arrived at by reducing from the owned fund, the amounts representing an investment of the ARC in shares of its subsidiaries, companies in the same group, all other ARCs, and the book value of debentures, bonds, outstanding loans and advances made to, and deposits with its subsidiaries and companies in the same group.[i]
NPA has been defined as an asset in the book of the ARC in which:
interest or principal is overdue for a period of 180 days or more from the date of acquisition or from the due date as per the contract between borrower and originator, whichever is later, or
interest or principal is overdue for a period of 180 days or more from the date fixed for the receipt thereof in the plan formulated for the realisation of the assets referred to in para 10 of these Directions,
interest or principal is overdue on expiry of the planning period, where no plan is formulated for the realisation of assets referred to in para 10 herein,
any other receivable if overdue for a period of 180 days or more in books of ARC. [ii]
Exemption: Para 5 of the directions confers discretionary power on the RBI to exempt any or all the ARC from any or all requirements of these directions. [iii]
Section II- Registration and Related Matters
This section outlines the registration mechanism for ARCs, the criteria for determining net-owned funds, the activities that may be undertaken by ARCs, and the restrictions that may be imposed upon them while undertaking any of the allowed activities.
The ARC must apply and obtain a certificate of registration from the RBI before the commencement of business operations.[iv] To commence the business of securitisation or asset reconstruction, the ARC must maintain a minimum net owned fund of INR 300 crore and thereafter on an ongoing basis.[v]
Section III- Guidelines on Asset Reconstruction and Securitisation
This section details the criteria and norms to be adhered to by the ARCs for the acquisition and realisation of financial assets. It allows for a change in or takeover of management of the business of the borrower subject to various stipulations.
The ARCs are permitted to change or take over the management of the business of the borrower to realise its dues from the borrower subject to the guidelines prescribed in these directions.[vi] Further, it has been mandated under the Directions that the consent of at least 60% of the secured creditor must be obtained for enforcement of security interest.[vii]
Furthermore, ARCs have been permitted to convert the debt into equity of the borrower entity; however, the shareholding shall not exceed 26% of the post-converted equity of the entity under reconstruction. [viii] However, subject to certain compliances, ARCs may be exempt from this threshold requirement.
Section IV: Prudential Regulations
This section lays down the minimum capital adequacy ratio requirements that ARCs need to maintain, norms pertaining to the classification of assets held in the books of the ARC and the provisioning requirements of such assets. The ARCs are mandated to maintain on an ongoing basis a minimum capital adequacy ratio of 15% of its total risk-weighted assets. [ix]
Assets have been classified in the following manner: - [x]
Section V: Governance and Conduct
The Directions emphasize the importance of robust governance and risk management practices within ARCs. The guidelines prescribe specific norms regarding the composition of ARC boards, the appointment of key personnel, risk management frameworks, internal controls, and compliance mechanisms such as pertaining to Financial Action Task Force (‘FATF’) compliances. The Directions in this section further prescribe the fit and proper criteria for the appointment of directors and CEO, sponsors/investors, and constitution of committees such as audit committee, nomination, and remuneration committee.
Section VI: Accounting and Disclosures
This section lays down the guidelines pertaining to accounting standards and the requisite disclosures required to be made in the balance sheet on the part of an ARC. It further envisages the timelines and forms which need to be filed by the ARCs.
ARCs have been mandated to prepare their balance sheet and profit and loss statement as of 31st March every year. [xi] It has been provided that management fees shall be calculated and charged as a percentage of the Net Asset Value (‘NAV’) calculated at the lower end of the range of the recovery rating specified by a Credit Rating Agency (‘CRA’), provided that the same is not more than the acquisition value of the underlying asset.[xii]
Further, the Directions provide that the pre-acquisition expenses, such as those incurred for the purpose of conducting due diligence, etc., should be expensed immediately by recognising them in the profit and loss statement for the period in which the expense(s) is incurred. [xiii]
Section VII- Miscellaneous Instructions
This section lays down the norms to which the ARCs must adhere, such as conducting internal audits, guidelines relating to credit information companies, submission of financial statements to information utilities, and adherence to KYC norms. It further provides for the penal consequences for any non-compliance in regard to the same.
ARCs are mandated to put in place an effective internal control system providing for periodical checks and reviews of asset acquisition procedures and asset reconstruction measures.[xiv] They have been mandated to become a member of at least one RBI registered credit information company.[xv] It has been prescribed that contravention of provisions of these Directions are to be dealt with in accordance with the SARFAESI Act.[xvi]
Our Analysis
The Directions compile the existing scattered directions of the RBI on ARCs into one comprehensive Master Direction to represent the overall monitoring, governance, and compliance of the ARCs. Further, the recent RBI Master Directions on ARCs represent a comprehensive and forward-thinking approach to regulating these important financial institutions. By setting clear standards and expectations for ARC operations, governance, and risk management, the guidelines aim to promote a more resilient and efficient framework for addressing stressed assets in the Indian banking system.
End Notes
[i] Para 3(viii).
[ii] Para 3(ix).
[iii] Para 5.
[iv] Para 6.
[v] Para 7.
[vi] Para 11.
[vii] Para 14.
[viii] Para 16.
[ix] Para 18.
[x] Para 19.
[xi] Para 24.
[xii] Para 26.
[xiii] Para 26.8.
[xiv] Para 32.
[xv] Para 33.
[xvi] Para 38.
Attaching the RBI Notification for ready reference:
Authored by Huzaifa Salim, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.
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