Asset recast firms to be allowed to convert bad loans into equity

Written by Gireesh Chandra Prasad | Gireesh Chandra Prasad | Sunny Verma | New Delhi | Updated: Aug 2 2012, 10:26am hrs
The government is set to allow asset reconstruction companies (ARCs), such as Arcil, Pegasus and Reliance ARC, to convert the bad loans they acquire from banks to equity in the debtor company in a move aimed at making corporate turnaround an easier and remunerative business in the wake of slowing economic growth.

Senior officials in the government said the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill, 2012, will be tabled in Parliament in the monsoon session beginning on August 8. The Bill seeks to strengthen both the Sarfaesi Act and the Recovery of Debts due to Banks & Financial Institutions (RDBF) Act.

It proposes to remove a major hurdle that prevented ARCs from investing in rescuing an indebted and poorly run company as corporate turnaround often needs more capital and a change in the way business is done. ARCs now do not have the freedom to convert the bad debt they acquire into equity as they are bound to restructure bad loans as per RBI guidelines, which are silent on debt-equity conversion by these entities. Banks, on the other hand, ensure that they have the option to convert a loan into equity by making it a part of the loan contract they sign with the borrower, explained Sumant Batra, past president of UK-based INSOL International, a global body of bankruptcy judges and bankers.

Allowing ARCs to convert debt into equity would enable them to invest in turning around an insolvent company as they could recover the costs as well as be rewarded by way of any appreciation in the share price, said Batra.

As per official data, the outstanding amount of large borrowers with public sector banks alone was R5,80,000 crore at the end of March, 2011. ARCs have now acquired assets worth close to R1 lakh crore. The RBI has approved about a dozen ARCs, of which, Arcil, promoted by 15 banks including SBI, IDBI Bank and HDFC, has gained market leadership.

Sources said the proposed Bill will also allow multi-state co-operative Banks to invoke the Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act of 2002 and take possession of a borrowers pledged assets if dues are not paid within 60 days of demanding repayment. This proposed right would give a comfort level to co-operative banks in making lending decisions and could help in improving credit offtake.

Sources said the proposed Bill also seeks to expand the scope of the central registry conceived under debt recovery laws to cover even mortgages dating before 2011. This would give a clearer picture of the charges on various assets when banks consider loans against them, said a person familiar with the development. However, the government does not want to allow non-banking finance companies (NBFCs) other than housing finance companies to invoke the Sarfaesi Act. The rights of lenders under the Sarfaesi Act is only meant for public financial institutions, said the source.