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Mumbai: The government may raise the level of foreign direct investment, or FDI, in asset reconstruction companies (ARCs) and allow foreign institutional investors, or FIIs, higher investment limits in security receipts (SRs) which such companies typically issue against a pool of bad assets.

Both proposals are critical to boost the asset reconstruction business in India at a time when bad loans in the banking system have been on the rise in a slowing economy.

The finance ministry is considering a proposal to hike the maximum permissible stake a single FII can pick up in a bad asset bought by an ARC from a bank to 49% from 10% earlier, according to two people familiar with the matter. The maximum collective stake that multiple foreign entities can hold in such an asset may also be increased to 74% from 49% earlier, they added. None of them wanted to be identified.

FDI in ARCs can also go up from 49% to 74%. Even though there is no sub-limit within the 49% permissible limit, typically the Reserve Bank of India (RBI) does not allow one single entity to hold more than 10% stake in an ARC currently.

Barring Asset Reconstruction Co. (India) Ltd (Arcil), India’s oldest and largest ARC, none of the other 12 companies in the sector has been able to acquire substantial bad assets from banks due to paucity of funds.

“An advisory group comprising executives of asset reconstruction companies had made a recommendation to the government (for raising the limit of foreign investment)," said Birendra Kumar, managing director and chief executive of International Asset Reconstruction Co. Pvt. Ltd. “It will be a positive development if the government were to allow this."

RBI and the finance ministry have been discussing both the proposals.

Typically, ARCs set up separate trusts to acquire individual assets. These trusts issue SRs against the bad assets bought. The SRs are bought by banks themselves as qualified institutional buyers, or QIBs, as well as other investors. Banks do ask for upfront payment in cash, too, instead of S

There are several regulatory restrictions put by RBI on the source of funding that ARCs can tap. Out of the available sources, banks, notified financial institutions and non-banking financial companies do not lend much to ARCs. Another source of liquidity for ARCs could have been domestic funds, but there are a very few in India focused on distressed assets.

P.H. Ravikumar, managing director and chief executive of Invent Assets Securitisation and Reconstruction Pvt. Ltd, said that if there were more funds from foreign investors at the disposal of ARCs they would be able to bid for more assets.

“Over the last two years, all the ARCs put together haven’t managed to acquire assets worth more than 1,000-2,000 crore," Ravikumar said. “If the limit of foreign investment is increased to these limits, we can buy assets to the tune of 5,000-7,000 crore."

Since these foreign investors are minority shareholders at present, they don’t take an active part in the revival of assets. The situation may reverse if they were allowed a sizable stake, Ravikumar added.

ARCs will play a crucial role in reducing the burden of bad loans on banks, at a juncture where non-performing assets (NPA) in the banking system have grown rapidly.

A 6 February Mint analysis of 34 listed banks that had announced their December quarter results showed that their gross NPAs had grown to 76,644 crore, a 30.51% year-on-year increase. The analysis didn’t include NPAs of State Bank of India (SBI) since India’s largest bank was yet to announce its December quarter earnings as on that date. SBI said on 13 February that its NPAs at the end of December touched 40,098.43 crore, or 4.61% of its total advances, the highest proportion since September 2005.

Many corporate and retail borrowers have been unable to repay debt as economic growth slowed to under 7% this fiscal from 8.4% in the previous one. After declining continuously between fiscal years 1995-96 to 2007-08, the total stock of bad loans has seen a sharp rise, RBI deputy governor Anand Sinha said in February.

“From 15% in 1995, NPAs came down till 2008, but they have risen sharply by 91%, or 46,670 crore, between 2005-06 and 2010-11," Sinha said at Mint’s annual banking conclave in Mumbai.

Another policy intervention that ARCs have been hoping for to incentivize the effort and resources required to buy and revive a distressed asset is to allow them to covert a portion of the debt attached to it into equity.

At present, there are regulatory restrictions on ARCs picking up a stake and they make money by earning a fee in lieu of managing the trust through which the asset is acquired and the debt, recovered.

Kumar of International Asset Securitisation said that an amendment to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, to allow conversion of debt to equity had been moved in the winter session of Parliament in 2011 and is pending before a standing committee.

The SARFAESI Act provides the framework in which ARCs operate.

aveek.d@livemint.com

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