Mumbai: The Reserve Bank of India (RBI) has permitted asset reconstruction companies (ARCs) to buy bad loans from their sponsor banks, provided these loans are auctioned “in a transparent manner, on arm’s length basis, at prices determined by the market factors," the central bank said in a notification on its website.

ARCs have also been allowed to use a part of their funds raised from qualified institutional buyers (QIBs) to ‘restructure’ financial assets, RBI said.

As part of the restructuring process, companies are either given more time to pay back money or given loans at a softer interest rates to nurse them back into health. QIBs are the main source of funding for ARCs and so far funds raised through them could be used only to acquire distressed assets from banks.

“Securitisation companies or reconstruction companies with acquired assets in excess of 500 crore can float the fund under a scheme which envisages the utilization of part of funds raised from QIBs for restructuring of financial assets acquired out of such funds," RBI said.

However, only 25% of the funds raised through QIBs can be utilized by ARCs for restructuring a loan. “The funds raised to be utilized for reconstruction (within the ceiling of 25%) should be disclosed upfront in the scheme. Further, the funds utilized for reconstruction purposes should be separately accounted for," RBI said.

P. Rudran, managing director and chief executive officer of Asset Reconstruction Co. (India) Ltd (Arcil), the largest company of its kind in India, said RBI’s move will help in bringing clarity to the business at a time when bad loans are at record levels.

“Allowing ARCs to particularly use money raised from QIBs to restructure loans will help because it allows us to fund the company’s working capital and balance sheet requirements which in turn will help the company recover quickly," Rudran said.

ARCs were always allowed to buy bad loans from their sponsor banks. However, questions were raised especially as many of these sales were done on a bilateral basis.

RBI’s clarification means that sponsor banks selling loans to ARCs have to auction these loans and can no longer do bilateral deals.

State Bank of India, IDBI Bank Ltd, ICICI Bank Ltd and Punjab National Bank are the sponsors of Arcil.

RBI has also allowed promoters of the defaulting company or borrowers to buy back their assets from ARCs, provided the settlement is helpful in “minimizing or eliminating the cost of litigation and .... loss of time or when the recovery process is uncertain".

In cases where the value of the secured assets backing the loan has fallen rapidly and where a settlement from the promoters is beneficial for restructuring, promoters have been allowed to buy back their assets.

Valuation of such assets have to be worked out by ARCs after factoring in the likely positive or negative changes in the value of the secured asset on account of passage of time and the likely diminution in realization due to accumulation of statutory dues, liability to employees etc.

“ARCs shall frame a policy duly approved by the board of directors, which should include the above aspects," RBI said in the notification.

Bad loans on the books of listed banks have risen consistently over the past two years, largely on account of a slowing economy. From 1.32 trillion at the end of the March 2012, such loans swelled to 1.79 trillion by December 2012, and to 2.43 trillion at the end of December 2013.​