Bad bank- a lantern at the end of a Tunnel

Securitization is an aspect of asset reconstruction. The recent budget exuded a sense of amelioration by hinting at establishing a “Bad Bank @ Asset Reconstruction Company”

Modus Operandi of an Asset Reconstruction Company (ARC)

ARCs purchase bad loans at deep discounts. The bank transfers its right to receive interest, principal, collaterals et al to the ARCs. ARC offer augmented repayment terms, encashment of collaterals, restructuring of debts etc. to churn out the maximum from the bad loan. When the proceeds from realization exceeds the cost of acquisition of bad loans, a profit is made. A management fee is also levied as a charge for managing the NPAs.

Source of Funds for an ARC:

ARCs sources of fund is not restricted to security receipts (SR- predominantly used). To comprehend security receipts (SR), lets recapitulate the securitization process. A Capital pool is created & certificates of ownership issued in lieu of the sum invested by fund providers. The capital pool accumulated contributes to the capital base of a Special Purpose Vehicle (SPV). The SPV buy assets with earnings potential / assets at a discount, so as to realize at a higher value. The realized gains are shared among the fund providers. In the example, juxtapose – SPV with ARC, certificates of ownership with security receipts (SR), fund providers with Institutional investors & assets with NPAs Take a minute to comprehend…

Regulatory Restrictions:

Earlier, ARC has to invest 5% in the SRs issued by them, through maturity. Say an NPA worth INR 1000 is bought at INR 100; presuming funded by SRs, ARCs need to invest INR 5 by themselves. The cap has been increased to 15% incumbent. Suffixing billions after the numbers considered, would lead to a phenomenal capital requisite for ARCs. Such is the circumstance with India, incumbent, necessitating the need for creation of a bad bank, with sovereign support.

Albeit a handful of ARCs are in operation, their size and capacity to digest bad loan books of India is beyond imagination. Let’s hope to find the lantern soon….

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me

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