Asset reconstruction companies ought to focus on reviving distressed businesses

Instead of just being agents that buy non-performing loans from lenders for recovery, ARCs should evolve to their full potential into entities that not only recover assets, but also rehabilitate and turn around distressed businesses. The regulatory framework adjustments in India can allow ARCs to shift from a reactive stance to a more proactive role in the business ecosystem.

With 28 licensed ARCs operating in the country, collectively holding assets under management worth about ₹5 trillion, this sector has grown significantly since the Reserve Bank of India (RBI) first allowed this licensed category under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act in 2002.

Despite the presence of these entities for over two decades, ARCs have yet to properly try aiding the revival of distressed businesses. Their primary focus has remained on the recovery of bad loans, with little attention paid to turnarounds. 

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While this was relevant when ARCs were first mooted, today there is much to gain from early identification of assets turning bad, their purchase by ARCs and subsequent repair for value maximization. With appropriate regulation and access to finance, ARCs can play a transformative role in the Indian financial ecosystem.

The ARC industry’s evolution hinges on a more proactive role in early detection of distressed assets. The current special mention account (SMA) and non-performing assets (NPA) framework, though helpful, may still let companies slide into default before action is taken. 

To prevent this, ARCs and banks could use covenant-based indicators and trend-based red flags—such as, say, a non-financial matrix that includes lack of innovation and customer continuity—for early warning signs, enabling a quicker sale of potentially distressed assets before they become NPAs.

This shift, aimed at timely prevention of value erosion, would need regulatory support as well as collaboration between banks and ARCs. The latter acquiring standards assets need to follow the same prudential norms as banks and other regulated entities for NPA classification.

The Insolvency and Bankruptcy Code (IBC) has enabled struggling businesses to be revived under the law, but it kicks in only once a company defaults and is taken to bankruptcy court. Its record has several turnarounds to its credit. 

The examples of Bhushan Steel and Essar Steel, which went through IBC processes, show how large distressed companies can be revitalized under new ownership with a clear roadmap. Yet, often, by the time a company defaults and becomes an IBC case, it is too late. 

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Since the Indian economy is better served by faltering companies being brought back from the brink before that point arrives, India needs a formal turnaround ecosystem that goes beyond the last-resort IBC mechanism.

So far, Indian ARCs have developed expertise in asset recovery, financial restructuring and legal frameworks related to insolvency. They understand the mechanics of stressed assets and have built strong networks with banks, legal advisors and debtors.

Apart from a mindset change, ARCs would need skill-building and capital to support turnarounds. Consider capital. Turnaround plans may require money to be raised for the purpose, so ARCs would need access to either a blind fund pool managed by them or funds from non-bank capital providers. 

Private credit, especially alternate investment funds, could play an important role. Allowing ARCs to manage such funds within RBI-set limits would enhance capacity and improve risk management, with RBI oversight ensuring financial stability. 

If ARCs manage or arrange new capital from regulated entities, prudential norms on loan restructuring should apply, with safeguards to prevent any misuse of these provisions.

For skills, India should leverage its management institutions to lay greater emphasis on turnaround studies. It could train not just resolution professionals, who are required by the IBC system, but finance professionals in general to specialize in this field.

The broad idea is for turnaround expertise to be brought to bear well ahead of actual business failures, as defined regulatorily by a default. As this would require debtor managements to be open to advice from ARCs, only if the latter develop their capabilities can they acquire credibility.

As for regulators, they would find it easier to oversee a credit market where regulated lenders focus on asset growth and proper risk pricing, while ARCs buy weakening assets and focus on how best to repair them before any traditional recovery methods are applied. 

Also read: Mint Explainer: What are ARCs and how have they performed? 

Should ARCs demonstrate an ability to restore asset quality, they would find is easy to raise capital for it. They will need to be trusted institutions, of course, so apart from a deep talent pool, they will also need high governance standards.

With pre-IBC revivals, the risk of India running into another twin balance sheet crisis would markedly reduce. And asset reconstructors will finally live up to their name.