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Asset reconstruction companies (ARCs) are eyeing stressed retail and small business borrowers as the next big growth opportunity as banks see more stress building up in these sectors, according to Pallav Mohapatra, managing director and chief executive officer, Asset Reconstruction Company (India) Ltd (Arcil).

ARCs can focus on acquiring and recovering small-ticket bad loans with the help of technology following the creation of the National Asset Reconstruction Company Ltd (NARCL), Mohapatra said in an interview.

Lenders have decided to initially transfer 22 bad loan accounts totalling 89,000 crore to the proposed NARCL, aiding the cleanup of their balance sheets. The aggregate amount of bad loans likely to be transferred in tranches will be 2 trillion.

When corporate loan demand declined despite ample liquidity, banks had to look for some growth avenues and, therefore, pivoted towards the retail sector, Mohapatra said. However, the two covid-19 waves have disrupted cash flows of retail and small business borrowers and that is a segment he sees ample opportunities in.

“During the first and the second wave, the cash flow of individuals has definitely been adversely impacted and there will be some stress in retail loans and it is, therefore, another good business opportunity for ARCs. In case of retail and micro, small, and medium enterprises (MSMEs), methods of acquisition and recovery used for corporate loans would not work. It has to be more dependent on technology," he said.

Arcil will focus on increasing the proportion of upside income from redemption of security receipts (SRs), instead of relying on fee income, Mohapatra explained. ARCs typically charge 0.5-4% of the assets as management fee every year. While ARCs are more dependent on management fees than an upside on security receipts, this trend should change, Mohapatra said.

“So far, I have seen that fee-based income has taken a greater role in ARC revenues. The model has to move from a fee-based income to an SR redemption upside income. This is a win-win for selling banks, ARCs, and even the investors. By getting better SR redemption, bad loans are being resolved while the earning of a mere management fee does not ensure that. Gradually, ARCs will have to move to this model," he said.

ARCs are now tying up with investors to acquire assets in 100% cash deals from banks, Mohapatra said. While ARCs may be well-capitalized and have enough money, it is debatable whether it is wise to put in the money for these full-cash deals, he said. The former banker also said that ARCs have requested the Reserve Bank of India (RBI) to allow their share in the deal to fall from 15% to 5% when tying up with an investor for an all-cash deal.

“In case of 100% cash deals, it is the trust created by ARCs that pay the selling bank for acquiring assets. ARCs are now trying to find investors as selling banks are not willing to subscribe to SRs. ARCs are thus looking for investors who can put in 70-85% of the funds in the trust and the SRs are in turn issued to them. If there is a viability in the stressed asset, investors will definitely come," he said.

Arcil is open to acquiring new ARCs through the inorganic route, Mohapatra said. Arcil had earlier bid for the ARC of Indiabulls Group, but did not succeed in the bidding process.

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