Asset Reconstruction Companies or ARC’s, primarily belong to the services sector in the Indian economy and are belong to the finance services industry. Their primary job is to buy back bad loans from banks, NBFC’s and other retail firms for a discounted price offered by these institutions and which can take the form of cash or security receipts. The purpose is to clean the lenders off their bad debts.
Here when the term ‘bad debts’, is used there is a clear distinction made between actual loan write- offs and technical loan write offs. The former cannot be bought back by the ARC’s simply because these debts aren’t alive as against the former that are merely written off in the books.
The next step for the ARC’s is recovery of the bad loans from the debtors which is done by taking over the assets which are hypothecated to the loan usually within a period of 60 days.
More on ARC’s can be found on the following link:
Akin to, many other firms in any industry, ARC’s also have an industry structure which plays a role in their functioning. Applying porter’s five forces to the ARC’s an industry analysis of the ARC’s could be done.
Pointing towards competition, there can emerge many more ARC’s in the future since the industry has many porous borders which can be easily percolated with differentiation. New entrants hence can turn out to be their future competitors. Banks can turn into competitors by providing discount, securities, and further credit period to the buyers by having a substitute product available to the buyers and by integrating forward thus converting their bad loans into recoverable ones in the future. All banks can form a consortium thus increasing the discount prices of the bad loans supplied by them to the ARC’s.
Sunk cost fallacy and the Interest Rates
The market valuation of a company reduces if the interest rates are higher given the present value of future returns and vice versa however, venture capitalist who believe in sunk cost fallacy will continue to support such a venture despite there being a stunted growth with respect to the company.
Considering this concept from the perspective of six hats thinking which is used for decision making, the example of a venture capitalist who has invested his money in a startup which is since 5 years trying to gain scales and during the time of investment the interest being high the present value of future cash flows then was low and the startup having not paid heed to the venture capitalist strategic advice can be taken.
From the white hat thinking the current data portrays that the interest rates have been rising with no scope for them to lower thus affecting the future cash flows and with the startup paying no attention towards scales there is a scope for the venture capitalist to move out his investment.
However, the VC ignores the warning signs thus circumventing from the red flags and conveniently avoiding from considering the black hat thinking strategy this focusing more from an emotional perspective of continuing with the startup thus adorning a red hat.
The VC continues with coming up with innovative and creative ideas for the startup to steer ahead towards its success by perceiving from the green hat thinking concept and focusses on the positive side of the entire scenario on the startup. Considering the blue hat if the VC adorns the same, he/she will be able to have knowledge that they are merely wasting their time and money on the startup and in the process enhancing their opportunity costs because the money after disinvestment could be utilized for more profitable investments. And on the current increased interest rates the risk of lower future cash flows could be segregated by adopting a diversified investment strategy into different markets and industries.