RBI in talks with Sebi to allow mutual funds to sell debt to ARCs

Debt recast companies have been advised by banking regulator that Reserve Bank of India (RBI) & Securities & Exchange Board of India (Sebi) are holding conversations over mutual funds selling their debt to asset reconstruction companies (ARCs). ARCs are unable to buy debt from mutual funds at this time. In this regard, chief executives of ARCs were met last week by RBI's deputy governors, who are in charge of regulation & supervision, as well as executive directors & other authorities. 

This move complies with suggestions made by RBI committee, chaired by Sudarshan Sen, which was established to thoroughly examine how ARCs operate. November 2021 marked committee's submission of its report. One of its main suggestions was to let mutual funds to sell debt to ARCs.

These days, non-financial companies are actively receiving funding from mutual funds, alternative investment funds (AIFs), foreign portfolio investors (FPIs), & other sources through subscription of debt securities. Additionally, debt securities, especially unsecured debt, are being purchased by retail investors. Therefore, expanding pool of businesses from whom ARCs can acquire financial assets would be beneficial, according to Sen committee.

Regardless of asset size, it was advised that "the Reserve Bank may consider permitting ARCs to acquire financial assets from all regulated entities, including AIFs, FPIs, AMCs (asset management companies) making investment on behalf of MFs & all NBFCs (including housing finance companies) & from retail investors." According to committee, taking such actions would encourage debt accumulation, which is prerequisite for effective resolution of stressed assets.

What’s Present Scenario

Presently, in event of company default, MFs are required to value bonds to zero. In certain situations, opening ARC channel may result in some recovery, according to D P Singh, joint CEO & deputy MD of SBI MF.
According to Singh, mutual funds primarily invest in premium bonds. "In event of financial restructuring, other firms involved in debt-like mutual fund are not just those under RBI regulation. For greater advantage of financial sector eco system, unified set of guidelines that apply to all organizations is necessary, according to chief of asset reconstruction company.

As part of its supervisory engagements, RBI has been actively interacting with banks, cooperative banks, & non-banking financial organizations (NBFCs). RBI stressed in statement that it was crucial for ARCs to have strong governance as cornerstone of their business model after meeting with ARCs. During meeting, regulator also discussed supervisory concerns.

What Does RBI Data Says?

Sales by banks to ARCs increased in 2022–2023 (RBI statistics), in part because of assets sold to recently operationalized National Assets Reconstruction Company Ltd (NARCL). 9.7% of gross non-performing assets (NPAs) of scheduled commercial banks during this time period were sold to ARCs; this represents considerable increase from 3.2% sold in 2021–2022.

According to RBI, purchase cost of ARCs as percentage of asset book values decreased from 33% at end of March 2022 to 29.8% at end of March 2023.