In line with the announcement made in the Union budget, the government has notified the relaxed foreign investment norms in asset reconstruction companies (ARCs), as it looks to effectively deal with the burgeoning bad debts in the Indian banking system.

In a press note, the department of industrial policy and promotion permitted 100% foreign direct investment in asset reconstruction companies to come in without any prior government approval—under the automatic route.

Earlier, while 49% foreign investment was permitted under the automatic route, investors needed prior government approval to increase their stake beyond 49%.

The press note has also proposed to link the investment limit of a sponsor to the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act.

At present, a sponsor is not allowed to hold more than 50% in an asset reconstruction company. But in this year’s budget speech, finance minister Arun Jaitley had sought to allow a sponsor to hold up to 100% stake in the asset reconstruction company, a move the government hopes will see specialized asset reconstruction companies setting up business in India as they will not need to scout for a local partner.

“To tackle the problem of stressed assets in the banking sector, asset reconstruction companies have a very important role. I, therefore, propose to make necessary amendments in the Sarfaesi Act, 2002, to enable the sponsor of an ARC to hold up to 100% stake in the ARC and permit non-institutional investors to invest in securitization receipts," he said.

To be sure, the government will have to amend the Sarfaesi Act to allow the promoter to hold up to 100% in the ARC.

However, the cap on total holding by a foreign portfolio investor in an ARC has been retained at 10% of the paid-up capital.

Jaitley, in an interview to Mint last month, had said that the government intends to bring in amendments to the Sarfaesi Act and the debt recovery tribunal Act in the ongoing budget session to tackle the rising non-performing assets of banks.

An ARC typically buys the bad loans from a bank, looks at ways to make the asset more attractive and then sells it.

The government is hoping that the ARCs will play a more active role in taking the bad debts off the books of banks.

Gross non-performing assets of 39 listed banks zoomed to 4.37 trillion in the December quarter, from 2.92 trillion in the year-ago period with many state-run banks reporting losses in the quarter.

In the quarter ended March too, state-run banks are expected to show similar results, thus denting their profitability and increasing their capital requirements.

Further, the government has also allowed foreign portfolio investors to invest up to 100% of each tranche in securities receipts issued by ARCs subject to sectoral caps, as against the earlier cap of 74%.

Vikas Vasal, partner-tax, KPMG in India, said in a note that the liberalization could see more foreign investments coming into the sector.

“It’s a welcome move and should help address the issue of stressed assets to some extent in the banking sector, as more investments flow into ARCs in near future," he said.

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