'There may be consolidation of ARCs going ahead': Pallav Mohapatra, MD & CEO of Arcil

Q: After a long NPA cycle, banks and the corporate sector are sitting on strong balance sheets. What does this mean for ARCs?

A: NPAs have indeed come down, and stress has stabilised in the corporate segment. The instances of new stress are also very few and far between. But there are still accounts that are not resolved, either because they are in the Insolvency and Bankruptcy Code (IBC) or outside for restructuring and resolution. There is a reasonable business opportunity for ARCs even in the current environment. For instance, cases in the NCLT [are] an attractive opportunity for ARCs… [while] the restructuring process has started, [they] take time in the NCLT courts (normally more than 300-350 days). Some banks or lenders to such defaulting companies want their money [back] quicker. Since there is a resolution plan or some indication [of pricing]… at the NCLT, ARCs can acquire these assets from the lending banks.

Another business opportunity has come after October 2022 with the Reserve Bank of India’s new regulatory guidelines. [These say that] ARCs with net owned funds of Rs 1,000 crore or more can become resolution applicants (RA) in the IBC process. But there is a catch: ARCs are financial sector entities... so, if these ARCs have tie-ups with strategic investors—I am not talking about financial investors—they can become RAs along with those investors. Then... the strategic investor through the ARC platform can make the payment for the resolution plan. And this debt, which will come from the lenders to the ARC, can be restructured over a period of time, which is beneficial to all the stakeholders.

Q: Will the next NPA cycle emerge from the retail and MSME sectors?

A: When all banks and financial institutions move into a particular segment or a specific group of segments, there is always a risk of overcrowding. Currently, every institution is joining the bandwagon to lend to retail and MSMEs, so stress is inevitable. RBI has recently introduced higher risk weights or higher capital requirements for unsecured retail loans. It has also asked banks to tighten their risk management for unsecured loans.

If competition grows in a segment or group of segments, there will be some dilution of credit standards. The first dilution occurs in the loan-to-value ratio. The second dilution involves accepting lower credit scores. This phenomenon is not limited to a single geography. We saw this in the US during the global financial crisis. We anticipate that slippages will start in the MSME sector… [as it] doesn’t have as deep pockets or easy access to debt capital or the capital market as large corporations... MSMEs rely primarily on bank debt or NBFC debt, leading to a high debt-to-leverage ratio. When their leverage ratio is high, events such as Covid-19, demonetisation, or other external factors can easily have an impact.

Q: How should accounts like MSMEs and retail be handled, considering the high volumes?

A: The use of tech is crucial, particularly in the case of MSMEs and retail. Without tech that can provide an end-to-end solution, the task of resolving MSME and retail loans becomes extremely challenging. Therefore, ARCs need to build capabilities in this area. RBI is also urging ARCs to develop their tech systems. For example, banks used to submit CRILC (Central Repository of Information on Large Credits) data to the RBI. CRILC data refers to any account with an exposure of more than Rs 5 crore, which had to be submitted at regular intervals to the RBI. But, RBI is now retrieving that data directly from the banks’ systems. Similarly, it is asking ARCs to develop a system so that reporting can be picked up directly by RBI from the ARCs’ systems. This approach reflects the belief that the risk of altering or tampering with data is significantly higher in manual systems but much lower in tech-based or digital ones.

Q: Which retail assets would interest ARCs?

A: In the case of secured loans, the pricing will definitely be higher than for unsecured loans. However, other factors such as ticket size, geography, age of the borrower, and vintage of the NPA also play a role. Performing manual calculations would be extremely challenging, which is why tech is critical in dealing with retail and MSME loans. For secured loans, one has the right under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act to sell properties through auction. The auction may result in either success or failure, but if successful, you recover the money. The threat of losing their property might pressure borrowers to settle.

In the case of unsecured loans, making contact is a major challenge. Tech, such as data scrubbing from credit information companies like CIBIL, can provide updated contact information for borrowers. This data scrubbing can significantly increase contactability from, say, 5-10% to 65-70%. As contactability improves, so does the probability of recovery. The recovery process can then proceed through various tech channels. The first might be SMS. The system tracks the number of text messages sent and determines how many failed to reach the recipients. Based on this data, it will decide which accounts should receive IVR calls. Further filtering identifies which accounts warrant physical calls or field agent visits. This systematic, scientific approach strengthens recovery efforts for unsecured loans. But, the acquisition price for unsecured loans, particularly credit cards in the retail segment, will be the lowest.

Q: Is the retail resolution market shifting to organised players like ARCs?

A: It’s a commercial world, so whoever offers a reasonable price, banks or lenders will want to sell to them. If ARCs quote a low price, over time, they might be seen as too conservative. However, the standing and market reputation of the ARCs are also considered. There have been instances where ARCs have demonstrated unique approaches. If banks, particularly those in the public sector, decide to sell, they might face scrutiny over their choice. Therefore, the market reputation of ARCs matters, and their abilities in resolution processes are evaluated. According to RBI’s October 2022 circular, when we make an offer to any seller, we must provide our track record of security receipts (SR) redemption. Without the appropriate tech, providing this track record would be impossible. Thus, the entire ARC ecosystem is evolving. In my assessment, with these developments and tighter regulations, which are beneficial for the ecosystem, there may be a consolidation of ARCs. Currently, there are 29 ARCs. By 2026, the minimum net-owned funds required will increase from Rs 100 crore to Rs 300 crore, and for RAs, it is expected to reach Rs 1,000 crore. These changes will push for the consolidation of ARCs.

Q: Is ARCs monetising NCLT cases for lenders a new thing?

A: We saw this opportunity in one case where we collaborated with a strategic investor, whose name I will not disclose. They were interested in a specific asset of strategic importance. We aggregated the debt from the lending banks and filed the application with the NCLT, which was admitted within two years because we were the majority lender. The strategic investor provided the resolution plan, and through their NBFC, they became a co-investor with us. The resolution plan was successfully executed in two years. Both of us exited the company. However, if any strategic investor feels that we, as an ARC, should continue with the company, we could reschedule the repayment period depending on realistic cash flow projections.

Q: ARCs have completed two decades of operations. What has been their performance?

A: In terms of SR redemption, ARCs are doing well. The SR redemption rate for banks has increased from around 20%, or even less, to more than 40-45%. ARCs are also performing well overall. With fewer ARCs remaining, they are likely to become a significant force in the stressed asset market.

Q: RBI has been focussed on compliance and corporate governance in banking and financial services. What changes are you seeing in the ARC space?

A: Compliance and corporate governance have become very important for ARCs. The days of lax governance are over. ARCs now face supervision similar to that of any bank in India. According to the October 2022 circular from RBI, there is a strong emphasis on governance, including the constitution of different board committees, the role of the board chairman, and preventing overlapping membership among committees. In terms of business practices, ARCs can no longer take an advance management fee; the fee must come from recoveries. For settlements, banks now require an internal advisory committee with external members to approve and recommend proposals to the board. This ensures transparency and proper governance. ARCs are also focussing on KYC and conducting real-time surveillance. Much of the RBI’s supervision and inspections are now conducted off-site.

@anandadhikari