SECURITISATION & FUNCTIONING OF

ASSET RECONSTRUCTION COMPANIES

SUBMITED BY

Vikrant Yadav
PRN: 11020441334
Finance-Marketing (D-53)
2011-13

Under the Guidance of

Mr. Aneesh Day

SYMBIOSIS INSTITUTE OF MANAGEMENT STUDIES (SIMS)

(CONSTIUENT OF SYMBIOSIS INTERNATIONAL UNIVERSITY)

February 2013

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Certificate

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Acknowledgement
I would like to express my gratitude to all those who have gave
me the possibility to complete this project. I want to thank to our
Internal Faculty Guide Prof. Aneesh Day for showing us the path
to commence this project in the first instance. He looked closely
at the final version of the project for correction and offered
suggestions for improvement.

Thank You,
Vikrant Yadav

Date:
Place:

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Table of Contents
1.

Executive Summary............................................................................................. 6

2.

Introduction.......................................................................................................... 7

3.

Need for Securitisation companies/ Asset Reconstruction Companies.................9

4.

Global Scenario.................................................................................................... 9

5.

Indian History..................................................................................................... 16
Narasimham committee I (1991) - ARF.................................................................16
Narasimham committee II (1998) ARC................................................................16
SARFAESI 2002...................................................................................................... 18

6.

Working of the SCs/RCs...................................................................................... 19

Securitisation........................................................................................................ 19
Asset Reconstruction............................................................................................. 19

7.

Flow of Securitisation......................................................................................... 21

8.

Benefits of Securitisation................................................................................... 22
Benefits to the Originators, especially FIs.............................................................22
Benefits to the Investors....................................................................................... 23

9.

Recommendations.............................................................................................. 24
1. Permission for HNI investors to buy Security Receipts issued by the Trust set
up by the Securitization Companies/Reconstruction Companies...........................24
2.

Individual FII investment limit to be increased................................................24

3.

Double Stamp Duty to be abolished................................................................25

4.

Reserve price for NPA sale.............................................................................. 26

5.

Restructuring Support Finance........................................................................27

10.

References...................................................................................................... 28

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Executive Summary
Asset Reconstruction Companies are special entities which use market forces to consolidate and
attractively package lender interests and arrange funding for asset reconstruction. The
requirement of Asset reconstruction arises in India from the bad loans emerging out of a systemic
banking crisis.
Asset Reconstruction Companies more popularly known as Asset Management Companies in
other countries were established by the SECURITISATION AND RECONSTRUCTION OF
FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST
BILL(SARFAESI), 2002.
ARCs are established to assists banks and financial institutions to manage the problems of
liquidity, asset liability mismatch and recovery of NPAs by taking possession of the NPAs from
the banks and financial institutions.
ARCs in India adopt a trust structure, through which they issue pass through securities or pay
through securities. A standard business model of a typical ARC is to buy distressed assets from a
Bank/Financial Institutions; and then choose between directly securitizing them or first
reconstructing the asset and then securitizing it before sale to investors. Another prospect to
invest in the reconstruction exercise lies in partnering the ARC in reconstructing debt. This
opportunity is unavailable to retail investors & only Qualified Institutional Buyers can participate
in it.
Any instrument issued by an Asset Reconstruction Company needs to possess certain features
before it becomes palatable to the investors. These include credibility, marketability of the issuer
& credit enhancer, transparency, wide distribution, homogeneity & the presence of an SPV
(special purpose vehicle).

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1.

Introduction

Asset reconstruction refers to the acquisition of asset from the Banks/FIs by any
securitization or reconstruction company for the purpose of realizing the asset.
Asset reconstruction originated from the recommendation of setting up an Asset
Reconstruction Fund by the Narsimham Committee Report 1991. The money for setting up
the fund was supposed to be contributed by the Central government which was to be used for
bailing out the banks from the bad loans in their portfolio. However faced with difficulties
and an increase of debt burden on the Central government this idea was scrapped and the
Narsimham Committee Report 1998 recommended formation of asset reconstruction
companies(ARCs), the likes of which had already been doing well in Malaysia, Korea and
several other nations in the world.

Objectives of the Study:

1. To analyze the need and impact of securitization in restoration of liquidity in financial

system.
2. To provide recommendations for amendments in SARFAESI Act to facilitate
concerned entities.

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2.

Literature Review

Over the years, a lot of attempts have been made by the researchers to evaluate the
various aspects of securitized instruments and examine the justifiability of its
introduction in the financial markets.
Ketkar and Ratha (2001) suggested that developing countries cannot obtain low-cost,
long-term loans during financial crises. Thus, securitization of future flow receivables can
help investment-grade public and private sector entities in these countries obtain credit
ratings higher than those of their governments and raise funds in international capital
markets.
Kothari and Gupta (2004) studied the development of MBS market in India and
examined the relevance of securitization, both agency-backed securitization (i.e. MBSs
issued by government sponsored agencies which promote mortgage secondary markets)
and private label securitization (i.e. mortgage backed issues securitized by non-agency
financial institutions) over the development of housing refinance market in India.

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3.
Need for Securitization
companies/ Asset Reconstruction
Companies
SCs/RCs were required to clean the balance sheets of the banks/ Financial Institutions by
removing the bad loans' from the books of banks/ Financial Institutions. This enables
banks/Financial Institutions to
1. Release funds tied up in bad loans for lending to productive manufacturing sector.
2. Increase the availability of liquidity in the market for lending.
3. Shore up their balance sheets.

4.

Global Scenario

In recent times many countries have experienced banking problems requiring a major and
expensive overhaul of their banking system. As cross country evidence suggests, stock solutions
tend to be necessary where banking distress is systematic and often include liquidation of
unviable banks, dumping and management of impaired assets and restructuring of viable banks.
For the management and disposal of bad debt, governments have made widespread use of
publically owned Asset Management Companies (AMC) that either dispose off assets hived from
bank balance sheets or restructure debt. AMCs have become very popular including in Asian
Financial crisis.

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Some of the measures adopted by the countries worldwide are:

A.

United States of America

Asset liability mismatches and other economic issues led to a major banking crisis in the mid
1980s in the US. From the period ranging from 1980 through 1991, a total of 1,400 banks in the
US failed or sought government assistance. During the same period, 1,100 savings and loan
associations or thrifts (as they are referred to in the US) also failed.
This financial slump led to the insolvency of the Federal Savings and Loan Insurance
Corporation (FSLIC) which used to provide government insurance guarantee over thrift retail
deposits. The FDIC (Federal Deposit Insurance Corporation) which used to provide a similar
insurance cover over retail bank deposits underwent a similar crisis. The Bank Insurance Fund
(BIF) administered by the FDIC carried a deficit balance of USD 7 bn at the end of 1991.
To stabilise its economy and financial sector, the US government passed legislation for setting
up of the Resolution Trust Corporation (RTC) in 1989, to resolve the issue of NPLs in the US.
The directive given to RTC was to take over the NPA of failed thrifts and actively manage these
assets to maximize value. The RTC had a daunting task of resolving assets adding together
approximately USD 1 trillion. The RTC was able to resolve all these assets successfully, and it
ceased operations in 1996.

B.

Mexico

During the 1995 economic crisis, Mexican banks suffered failures on account of huge NPA. To
revive the banking sector, the government received financial assistance from the US, the World
Bank, and the Inter-American Development Bank. This allowed the Mexican government to
provide support to the failing banks through the Bank Fund for Savings - Fondo Bancario de
Proteccin al Ahorro or Banking Fund for the Protection of Savings (FOBAPROA). The
justification behind the creation of FOBAPROA was that it would acquire the NPA of the
Mexican banks and would provide capital to them if they faced liquidity problems in the event
of economic crises. The FOBAPROA took over debt of approximately USD 552 bn which was
equivalent to 40% of GDP of Mexico in 1997.
In January 1995 the Mexican government started PROCAPTE (Programa de Capitalizacin
Temporal or Temporary capitalization program), while FOBAPROA was acquiring
outstanding debt of banks. The PROCAPTE allowed faster access to a higher volume of foreign
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capital and the solvency of banks. FOBAPROA acquired the debt of the insolvent FIs with a
condition that the stockholders of these financial institutions would re-invest their capital in the
market.
In 1996 the UCABE (Unidad Coordinadora para el Acuerdo Bancario Empresarial or
Coordinating unit for the Bank-Entrepreneur Agreement) was created to restructure debt. A
total of 54 companies took advantage of the UCABE to re-structure USD 9.7 bn.
FOBAPROA is different from the Asian AMCs, as it is essentially a recapitalisation exercise.
FOBAPROA is a trust established by Banco de Mexico to provide preventive support to
problem banks.

C.Korea
During the 1997-1998 Asian financial crisis, thousands of Korean companies went bankrupt,
leaving banks with huge portfolios of nonperforming loans. The Korean government moved
aggressively to deal with the problem; among other steps,

It closed, merged, or sold scores of banks and financial institutions

Mandated banks to raise their capital adequacy ratios

Strengthened asset classification standards for banks

Required banks to make adequate provisions for nonperforming loans.

Instituted reforms to increase corporate accountability and transparency.

It also started the Korean Asset Management Corporation (KAMCO) to acquire and dispose of
the banks Non Performing Loans. Koreas NPL market peaked in 2000 and a few large-volume
NPL sales to investors were closed in 2001. While banks were reducing their portfolios of
corporate NPLs, their consumer NPLs began to increase as overextended consumers defaulted
on their credit card debt. In 2002, banks began to dispose off their consumer NPLs, and when
Koreas credit bubble burst in early 2003, they shifted their focus from corporate loans to writeoffs and sales of portfolios of consumer NPLs. The change in NPL pools from corporate to
predominantly consumer loans also led to changes in the makeup of NPL buyers, with domestic
investors such as savings and loans, mid-sized corporate restructuring companies (CRCs), and
collection agents forming investment groups to acquire consumer NPLs. Foreign investment
banks and private equity funds that had been buying corporate NPLs generally shunned
consumer NPLs, choosing instead to target M&A deals and a diminishing number of corporate
NPL opportunities. With the continuing disposition of their NPL portfolios, financial institutions
have managed to improve their asset quality, which has resulted in a more stable banking
system. In 2005, Korean banks posted record earnings and a record low NPL ratio.
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KAMCO adopted a number of techniques to dispose of the NPA it acquired from problem
banks. These include traditional methods such as collection of rescheduled repayments,
competitive auctions and recourse to the original seller, and other innovative techniques which
included bulk (pooled) sales, individual sales, issuance of asset backed securities (ABS) and
joint venture partnerships.
The choice of a particular method depended on the type and size of NPA. Bulk or pooled sales
included issuing Asset Backed Securities and international bidding with an aim for early
resolution of NPA and quick cash flows. Individual sales focused on discovering the market
value of each individual asset and include foreclosure auction, public auction of collateral, and
sales of individual loans. Joint venture partnerships were used as a tool for promoting
cooperation with foreign and domestic investment companies who are specialists in asset
management and corporate restructuring.

D.

Malaysia

Net non-performing loan (NPL) ratio in the banking system since the Asian financial crisis has
gradually been on a decline from a high of 13.6% (3-month classification) in December 1998 to
5.5% in June 2006.Danaharta, the national AMC, was set up in 1998 to tackle the NPL problem
that arose during the Asian financial crisis with the objective of removing the NPLs from the
financial institutions and subsequently to extract maximum recovery from the NPL.
The legislation called the Pengurusan Danaharta Nasional Berhad Act 1998 (Danaharta Act),
was critical in allowing Danaharta to acquire NPLs from financial institutions through statutory
vesting. It also conferred extensive powers to the national AMC to aid in speedy recovery of
NPL.
Danaharta ceased operations on December 31, 2005 after being in existence for seven and a half
years. The total residual recovery assets of Danaharta at that point stood at close to RM 3 bn.
Upon Danahartas closure of operations, control of these assets reverted to Danahartas
shareholder, Minister of Finance Incorporated (MOF Inc). MOF Inc appointed a wholly owned
subsidiary, Prokhas Sdn Bhd, to act as a collection agent for the residual recovery assets.

E.Thailand
The Thai Government formulated the Thai Asset Management Corporation (TAMC) policy in
February 2001 with a view to boost the stability of the financial sector and to promote efficient
management of non-performing assets and minimize economic losses. The TAMC Decree came
into force on June 9, 2001 with the creation of a national asset management corporation, the
Thai Asset Management Corporation (TAMC) to resolve the high level of NPA in statecontrolled and private financial institutions in Thailand. The TAMC is managed by a Board of
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Directors appointed by the Minister of Finance with due approvals from the Council of
Ministers.
The TAMC is a government agency with 100% share of the Financial Institutions Development
Fund (FIDF). To acquire and resolve the high incidence of NPA in the Thai financial sector, the
TAMC issued Baht 170 bn (approximately USD 3.7 bn) 10-year notes guaranteed by the FIDF
to financial institutions.
TAMCs main aim is to accept the transfer and management of sub-quality assets in the Thai
banking sector. TAMC has unprecedented powers to ensure this. Additionally it has been
empowered to establish limited companies, guarantee credit for debtors, and lend money to
debtors. TAMC after four years has largely succeeded in NPL resolution. As of Q2, 2005,
TAMC has resolved Baht 772.4 bn (USD 8.8 bn) of NPL from a total NPL of Baht 778 bn (USD
9 bn). 74% of the NPL were resolved through debt restructuring or rehabilitation in the Central
Bankruptcy Court.

F. China
The Chinese government set up four state-owned asset management corporations (AMCs) in
1999 to address the problem of NPLs on the bank balance sheets. The objective of these AMCs
was to buy bad debts of the four major state-owned commercial banks and resolve them over 10
years. As the big four banks hold almost 65% of the Chinese banking sectors loan portfolio,
they were the main focus of any bank restructuring efforts.
The Chinese government adopted the model of separate and decentralised NPL management as
followed by the Swedish authorities. Each of the four AMCs pairs up with one of the big four
banks.

The Ministry of Finance (MoF) provides each AMC with an initial equity capital of RMB 10 bn
(USD 1.2 bn). Chinas AMCs have done well in meeting their recovery targets. For example, as
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of year-end 2005, China Cinda AMC (Cinda) reported collecting RMB 62.84 bn (USD 7.8 bn)
of cash from RMB 201.21 bn (USD 24.9 bn) of face value. In addition, NPL sales by the AMC
are accelerating, with Huarong selling RMB 36.4 bn (USD 4.5 bn) of Category 5 NPL to Silver
Grant, a Hong Kong listed asset management and investment company.
Huarong also sold RMB 14.5 bn (USD 1.8 bn) of assets to an Equity Joint Venture (EJV) with
Deutsche Bank/AIG. Huarong and Deutsche Bank/AIG will jointly manage the entity. Huarong
is the majority shareholder and has a majority of the seats on the board. The EJV has a 15-year

life and will function as an operating platform for a variety of investments. The EJV structure is
a pioneering effort to help the AMC transform themselves into independent commercial
investment companies (subject to the approval of regulators).

G.

Indonesia

Since Indonesias 1998 financial crisis, rehabilitation of its banking industry has been a longterm process. The Indonesian Bank Restructuring Agency (IBRA), a special purpose institution
established by the government in 1998, was liquidated in February 2004 after completing the
mandate to restructure and rehabilitate the banking industry. IBRA was comprised of Asset
Management Credit (AMC) and Asset Management Investment (AMI). AMC was responsible
for handling NPLs of the closed or taken-over banks by the government, while AMI was
responsible for taking care of the pledged or given-up assets related to the NPLs. During these
years, IBRA recovered an estimated 28% of its approximately IDR 600 trillion (USD 61 bn)
non-performing loan portfolio. During 2002-2004, foreign investors also participated in this
rehabilitation process by acquiring controlling stakes in certain major private banks such as
Bank Danamon, Bank Niaga, and Bank International Indonesia (BII). These foreign banks are
seen as better-equipped strategic investors, who can meet any additional capital requirements,
competitive pressures, and the need for international banking experience, including risk
management practices. To prepare the state banks as anchor banks and to privatise them, the
government publicly listed Bank Mandiri in 2002 and Bank Rakyat Indonesia in 2003 on the
Jakarta Stock Exchange.
After IBRA was liquidated, its remaining unsold assets were transferred to the state asset
management company, Perusahaan Pengelola Asset (PPA), which was established under the
control of the Ministry of Finance. Under PPA, further divestments to foreign investors were to
continue.

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Comparison of ARCs in East Asian Countries

Structure used and the reasons for setting up of ARC
The infamous currency crisis of 1997 left the economies in East Asia in shreds. It was a period
of financial crisis that gripped much of Asia. The crisis had considerable macro level effects.
There was a pointed decline in the values of almost all assets including stock prices, currency
and on businesses. All this resulted in extraordinarily high levels of non-performing loans in
these economies. In 1997, the financial crisis in Indonesia was at its peak, 70% of the loans
were estimated to be under-performing. Similarly in Malaysia, Thailand and Korea the under
performing loans were in the range of 30-50%. There was a prudent need for a mechanism for
the revival of these NPAs.
The following table shows the comparison of these counties and the model followed

AMC
APT
BBAM
CBAM
DBP
FRA/TAMC
IBRA

Asset Management Corporation

Asset Privatization Trust
Bank Based Asset Management Company
Central Bank Asset Management
Development Bank of the Philippines

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KAMCO
PNB

5.

Financial Sector Restructuring Authority

Indonesian Bank Restructuring Agency
Korea Asset Management Corporation
Philippine National Bank

Indian History

Narasimham committee I (1991) - ARF

With the proportion of bad debts and Non performing assets (NPA) high prior to 1991 the
Narsimham Committee report 1991 proposed the creation of an Asset Reconstruction Fund. This
proposed fund would take over the bad debts and doubtful debts from the banks and financial
institutes which would help the banks to improve their liquidity position as well as their
profitability.

However, it was felt that centralised all India fund may not be effective in securing recoveries
due to

Lack of widespread geographical outreach as enjoyed by the banks.

Banks may slacken their efforts in monitoring the other accounts due to which even the
healthy accounts may turn ' bad' over period of time.

The large fiscal deficit.

Narasimham committee II (1998) ARC

Narasimham committee report II, 1998 recommended two alternatives for tackling the NPA
problem,

1. All loan assets in the doubtful and loss categories which represent the bulk of the hard
core NPAs in most banks should be identified and their realizable value determined.
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These doubtful assets could be transferred to an Asset Reconstruction Company (ARC)

which would issue to the bank NPA Swap bonds representing the realizable value of the
assets transferred. The ARC could be set up by one bank or a set of banks or even in the
private
sector. Funding of such an ARC could be facilitated by treating it on par with venture
capital for purpose of tax incentives. Banks may also fund such assets in effect by
securitizing them.
2. Another approach suggested was to enable banks in difficulty to issue bonds which could
form part of Tier II capital. This approach will help the banks to strengthen capital
adequacy which has been eroded because of the provisioning requirements for NPAs. As
the banks in trouble may find it difficult to attract subscribers for bonds, Government will
be required to guarantee these instruments which would then make them eligible for SLR
investments by banks and approve instruments by GIC, LIC and Provident Funds.

Following the Narasimham committee report II, 1998 the need for helping the banks/ FIs to
recover their sticky dues expeditiously was recognized. Hence it was proposed in the Union
Budget for the year 2002-03 to set up a Pilot Asset Reconstruction Company in India.
Accordingly an ordinance was promulgated on June 21, 2002, empowering Reserve Bank of
India to determine policy and issue directions in matters relating to regulation of Securitisation
Companies/ Asset Reconstruction Companies to be set up under the provisions of the ordinance.
The main purpose of issuing the ordinance was to enable the banks and Financial Institutions to
improve recovery by exercising powers to take possession of the underlying securities of the bad
loans, sell them and reduce non performing assets by adopting measures for recovery or
reconstruction of these non performing loans.
The ordinance was replaced with the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002) in December 2002.

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SARFAESI 2002
Following the Narasimham Committee recommendations The Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act was passed
in the year 2002. This Act was enacted to regulate securitization and reconstruction of
financial assets and enforcement of security interest and for the matters connected
thereto. This Act enabled the banks and financial institutions to realize long-term assets,
manage liquidity problems, asset liability mis-match and improve recovery by exercising
powers to take possession of securities, sell them and diminish non-performing assets by
adopting measures for recovery or reconstruction. The Act further provided for setting up
of asset reconstruction companies which are empowered to take possession of secured
assets of the borrower including the right to transfer by way of lease, assignment or sale
& realize the secured assets and take over the management of the business of the
borrower.
RBI further issued guidelines in the year 2003 which provided the regulatory framework
for several critical aspects of securitization.

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6.

Working of the SCs/RCs

The Act provides different alternatives for recovery of Non Performing Assets, namely:

Securitisation
Asset Reconstruction

Securitisation
It means issue of security by raising of receipts or funds by ARCs/SCs. A reconstruction
company or securitisation company may raise funds from the QIBs by forming schemes for
acquiring financial assets. The ARC/SC shall keep and maintain separate and distinct accounts in
respect of each such scheme for every financial asset acquired, out of investments made by a
QIB and make sure that realisations of such financial asset is held and applied towards
redemption of investments and payment of returns assured on such investments under the
relevant scheme.

Securitisation is:1.
2.
3.
4.
5.

Acquisition of financial asset by the SC/RC

Repackaging these assets into new financial assets in the shape of security receipt.
Issue security receipts to the QIBs.
Collecting the balance amount due from the borrowers.
Using the same to redeem the SRs subscribed by the QIBs as per underlying agreement
for issue of such SRs.

Asset Reconstruction
The ARCs/SCs for the purpose of asset reconstruction should provide for any one or more of the
following measures:
1. The proper management of the business of the borrower, by change in, or takeover of, the
management of the business of the borrower
2. The sale or lease of a part or whole of the business of the borrower
3. Rescheduling of payment of debts payable by the borrower
4.
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Enforcement of security interest in accordance with the provisions of this Act

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5. Settlement of dues payable by the borrower

6. Taking possession of secured assets in accordance with the provisions of this Act.

Thus it is clear that the process of securitization of acquired assets involves acquisition
of assets by a SC/RC, transfer of these assets to trust and issue of Security Receipts by
the SC/RC in the capacity of trustee of the trust, to the Qualified Institutional Buyers.
The asset reconstruction, on the other hands, involves evolving of resolution strategy for
the acquired assets by employing any of the methods given in Section 9 of the
(SARFAESI) Act, 2002

The SC/ARC registered with the RBI,

works as an agent for any bank or FI for the purpose of recovering their dues from the
borrower on payment of such fees or charges

act as a manager amid the parties, with no financial liability for itself;

acts as receiver if selected by any court or tribunal.

Apart from above functions any SC/RC cannot commence or carryout other business without
the prior approval of RBI.

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7.

Flow of Securitisation

Banks / FIs

ARC as Asset
Manager

Sale of Loan
Assets
Purchase
Consideration

Trusts of
ARCs

Scheme
Borrower wise
SR
s
Payment for
Subscription to SRs

Investors

Reconstruction

Cash
Realization

Redemption of SRs

Borrower

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8.

Benefits of Securitization

Globalization, deregulation of financial markets and growing cross border business transactions
has reset the ambience among financial institutions, increasing diverse opportunities for
financial engineering. Securitization increases the capacity of lending of an FI without having to
find additional capital or deposits. Securitization facilitates specialization and is gaining wide
acceptance as the most innovative form of asset financing. A noteworthy impact of
securitization is the profiling and placement of different risks and rights of an asset with the
most efficient owners. Securitization provides capital relief, expands opportunities for risk
sharing and risk pooling, improves market allocation efficiency, enhances liquidity, improves
the financial ratios of FIs and banks, creates numerous streams of cash flows for the investors, is
customized to the risk profile of a number of customers and facilitates asset-liability
management(ALM). The requirements of capital adequacy in recent years have also motivated
financial institutions and banks to perform securitization. On the demand side, investors are
motivated to buy these securities as they view these as having risk characteristics and
compatible with the profile.

Benefits to the Originators, especially FIs

For Financial Institutions, securitization is an opportunity offered in the form of capital
relief, capital allocation efficiency, and improvements in financial ratios.

Lower cost of borrowing: Securitization reduces the total cost of financing as assets are
transferred to a separate bankruptcy-resistant entity. To that degree FIs need not maintain
capital to maintain their capital adequacy norms. Also, cos./institutions with a riskier
credit profile can benefit from lowered borrowing costs.

A source of liquidity: FIs could face a liquidity crunch either due to their risky credit
profile or delayed receivables. The liquidity provided from securitization acts as a very
potent tool, that FIs could use to adjust the asset mix quickly and effectively. Also, the
risks associated with an asset portfolio can be identified and apportioned to arrive at an
effective asset mix.

Improved financial indicators: Securitization leads to capital relief that improves the
companys leverage and in turn the Return on Equity (ROE). The repercussions of
securitization on the balance sheet of a company can vary depending on the strategy for
its capital structure and its appetite for increasing or decreasing leverage.

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Asset-Liability Management: Securitization offers the flexibility in structuring and

timing cash flows to each n every security tranche. Securitization provides a means
whereby customised securities can be created which helps in matching the tenure of the
liabilities and assets.

Diversified fund sources: With securitizing its receivables, the instrument of which
could be sold to global investors, the originator has an opportunity to diversify its funding
source.

Positive signals to the Capital Markets: Lenders are at times trapped in a situation
where they cannot rollover their debt due to downgrading of their credit ratings, possibly
due to economic changes. Within these circumstances, securitization enables lenders like
FIs to increase the rating of debt much higher than that of the issuer through the intrinsic
credit value of the asset. This enables the Financial Institutions to obtain funding.

Avenue for divestiture: Securitization provides an optimal exit route for entities that
wish to exit a business comprising of financial assets without going through the mergers
and acquisition route.

Benefits to the Investors

Portfolio Diversification: As investments in the SRs are uncorrelated to the other

investments made by QIBs it offers an opportunity to them to diversify their portfolio.

High Returns: Many securitized products offer relatively attractive yields. These high
profits don't come for free though; compared to many other types of bonds/investments,
the timing of the cash flows from securitized products is relatively uncertain. This
uncertainty is the reason, why investors demand higher returns.

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9.

Recommendations

1.Permission for HNI investors to buy Security

Receipts issued by the Trust set up by the
Securitization Companies/Reconstruction
Companies.
Current Scenario
According to Sec 7 of SARFASEI Act every securitization company or Reconstruction
Company shall issue the security receipts through the trust set up exclusively for the
purpose. The trusteeship of such trust shall vest with the Securitization Company or
Reconstruction Company. The trust shall issue security only to qualified institutional
buyers and such security receipts shall be transferable/ assignable only in favour of other
qualified institutional buyers.
Problem
With only Qualified Institutional buyers being allowed to buy the SRs issued by the trust
set up by the SCs/RCs the depth in this market is limited. Also the true price will not be
easily found with only QIB buyers.
Solution
To tackle this problem on an initial stage HNI buyers should be allowed to buy the SRs
issued by the SC/RCs as this will increase the depth of the market, help in price discovery
and also lead to further growth of this sector in terms of marketability and liquidity.

2.Individual FII investment limit to be increased

Current Scenario
According to the SARFASEI Act FDI investments in the equity capital of an ARC can be
up to 49%. Also the FII investment limit is 49% in the SRs issued by ARCs with sub-cap
of 10% for the participation by individual FIIs.

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Problem
With a 10% cap on individual FII investment the liquidity in the buyers of SRs
segment gets affected. With the sector growing more and more FII inflow is
expected and thus this cap is a road block in their investment strategy.
Solution
This sub-cap should be removed, however the overall cap of 49% should remain the
same. This will increase interest of FII buyers in this sector and will also increase the
liquidity in the market. It will also help the new ARCs to raise funds easily for the trust
set up by them.

3.Double Stamp Duty to be abolished

Current Scenario
The stamp duty payable on Assignment Agreement for acquisition of financial assets by
ARC varies from state to state. Some states have issued notification restricting the
maximum stamp duty payable on Assignment Agreement to one lakh rupees; such a
notification is yet to be issued by all states.
Problem
In India, stamp duty is payable on any instrument which seeks to transfer rights or
receivables. Hence, the process of transfer of the receivables from the originator to the
SPV involves an outlay on account of stamp duty, which can render securitization
commercially unviable in states that still have a heavy stamp duty. Some states have
reduced their stamp duty rates, though a few still maintain quite high rates ranging from
5-12 per cent. Also Acquisition of assets by ARCs has multi-Sate effect. For example
ARC is located in State A the Bank whose assets are to acquired is in State B and the
location of the assets may be in State C. In terms of the present stamp duty laws if rates
of duty are different the difference has to be paid in each State.
This hampers the growth of this sector in the states with high stamp duty as ARC are
reluctant to purchase NPAs which are from these states or from banks which are from
these states.

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Solution
There should be a uniform stamp duty all over India. This should be low as growth in this
sector is required and measures should be taken to make the NPAs commercially viable
for the ARCs to purchase.

4.Reserve price for NPA sale

Current Scenario
Currently Seller banks adopt competitive bidding process for sale of their NPAs. These
processes are defined by the banks themselves and they are free to reject offers after the
ARCs have submitted their bids.
Problem
Despite adopting a process as defined by the banks themselves, transactions are aborted/
not closed even after running the defined process and receipt of multiple bids on the
pretext that bids are lower than their expected price. This is genuine reason is some cases,
however many banks use this in order to gain a reserve price which is the best offer by
the ARC to negotiate with the clients.
ARCs spend considerable time and resources in conducting due diligence of the assets on
sale. This not acceptance of bids by the banks is a problem which needs to be addressed.
Solution
It should be made mandatory for Banks to disclose a reserve price before an auction
process is carried out. This will ensure that ARCs who feel reserve price is high will not
participate in the process and will not waste their resources. It will also to lead to
transaction going through as ARCs will submit a bid higher than the reserve price which
the Banks will have to accept.

5.Restructuring Support Finance

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Current Scenario
Funds can be infused in an NPA bought by an ARC that is transferred to a trust by the
ARC only. Funds are required for making the NPA good. These funds can be required for
managing the immediate cash flow of the NPA so that in can continue its operations and
make good the loan it has taken.
Problems
Infusion of funds by the ARC only limits the funds that can be infused to make a NPA
good. An ARC holding around 5% share in the scheme of which the NPA is the collateral
will be sometimes reluctant to infuse funds as the percentage holding would be less
compared to the cash requirement the borrower has. Investors holding the remaining 95%
are not allowed to infuse funds. Their funds are utilized only for acquisition of financial
assets.
Solution
Funds mobilized from the investors may be allowed for additional funding required to
make the NPA good as a part of restructuring strategy. This should be done by passing a
special resolution where at least 75% of the investors agree to deploy these additional
funds for restructuring.

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10. References

Reserve Bank of India, Guidelines to Securitisation Companies and

Reconstruction Companies, Banks and Financial Institutions.
The Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2002.
Setting up & working of asset reconstruction companies in India- A
Ketkar, Suhas and Ratha, Dilip, (2001), Securitization of Future Flow
Receivables: A Useful Tool for Developing Countries, Finance &
Development

Kothari, Vinod and Gupta, Abhishek, (2004), Development of RMBS

markets in India: Issues and Concerns, Project work at the Indian Institute
of Management, Bangalore

Its time to clear the asset recast logjam article, Rajiv Ranjan
http://www.topcafirms.com/index.php/white-paper/72-asset-reconstructioncompanies-an-overview
http://kalyan-city.blogspot.in/2010/09/narasimham-committee-report-19911998.html
http://www.dnb.co.in/Arcil2008/Reconstruction.asp