Some ARCs bypassing regulations, lack transparency: RBI deputy governor
Mumbai, May 29, 2024
They are 'using innovative ways to structure transactions', says Swaminathan J
The Reserve Bank of India (RBI) has come down heavily on asset reconstruction companies (ARCs) for violating norms and warned them of regulatory or supervisory action in extreme cases.
In a speech addressed to the board of directors of ARCs, RBI Deputy Governor Swaminathan Janakiraman said that during onsite inspections, it was found that ARCs allowed themselves to be used as a “conduit to evergreen distressed assets”.
“It is also observed that a few entities find new ways of achieving their designs once a particular practice has been called out as a violation or deviation,” Swaminathan said in his speech delivered on May 17 during the inaugural conference of directors on the boards of ARCs organised by the RBI. A copy of the speech was uploaded to the RBI website on Wednesday.
The RBI said that wherever such practices came to notice, it had directed the entities for remediation, including setting aside capital charges on gains.
“In extreme cases, it may call for regulatory or supervisory actions, which, of course, we would like to use only as a last resort,” Swaminathan said.
There are a total of 27 ARCs registered with the regulator.
On Wednesday, the banking regulator barred Edelweiss ARC from acquiring financial assets and security receipts. Edelweiss Group’s non-banking financial arm — ECL Finance — has also been barred from undertaking any structured transactions regarding its wholesale exposures. The RBI cited material concerns arising out of the conduct of the group entities acting in concert.
The RBI urged ARCs to adopt a regulation-plus approach where they not only comply with the letter of the regulation but also its spirit.
The deputy governor also questioned the business model of these firms as they were found mostly doing one-time settlements and rescheduling of debt — actions which banks can also do.
“The ARC framework was intended to allow loan originators to focus on their core function of lending by removing the sticky stressed assets from their books… A review of the data indicates that one-time settlements and rescheduling of debt are the predominant measures of reconstruction employed by ARCs. Arguably, these measures could have been taken by the lenders themselves,” he said.
He said the RBI has come across instances where ARCs have warehoused the stressed assets, while the originator has continued to remain responsible for the collection as well as the custody of the security provided by the borrower.
“ARCs may like to introspect whether they would like to be a warehousing agency for a fee, which is certainly not in consonance with the underlying intent of the framework,” Swaminathan said.
The deputy governor emphasised robust governance practices led by the board as a prerequisite to ensuring that ARCs fulfil their intended mandate.
He cited examples in some ARCs where there were long vacancies in the post of chairperson, along with instances of the Chair of the audit committee of the board also chairing the board meetings, as well as a non-independent director chairing the board meetings, which is contrary to the norms.
“These things only go to show that governance has not been receiving the required attention,” he said.
He also said there are instances where there were not enough independent directors on the board or a sufficient number of independent directors did not attend board meetings.
“Prior preparation and diligence by board members are sine qua non for effective governance and decision-making by the board. I would urge board members to insist on receiving the agenda papers well in advance and thoroughly review them,” he said.
He requested directors to meticulously review RBI supervisory letters and inspection reports, external audit reports, as well as the reports provided by the internal assurance functions, as those would provide valuable insights into the management’s performance.
The deputy governor raised concern about the process followed for the disposal of assets.
He said that at times, the proposals are not even placed before the independent advisory committee, contrary to regulatory instructions.
“Assets are sold to group entities without following the arm’s-length principle and without subjecting them to scrutiny under related party transactions,” he said.
The ‘Swiss challenge’ process for disposing of assets has also come under regulatory scrutiny.
“Another surprising behaviour is the ‘Swiss challenge’, which often goes unchallenged. This has become a routine affair giving rise to suspicion that there may be some implicit understanding among various participants,” he said.
He said such practices are necessitating the supervisors to lift the veil and examine the transactions more closely.
[The Business Standard]
