Asset reconstruction companies (ARCs) were designed to clean up the banking sector by resolving non-performing assets (NPAs). Consequently, people outside the banking, finance and investment world had nothing to do with them nor had they heard much about them. A spate of defaults among realty developers after 2018 is forcing people to wake up to these entities whose dodgy operations have been under the regulator’s radar for the past couple of years.
Also, in May this year, in a rare move, RBI deputy governor Swaminathan J also went public with the regulator’s concerns about ARCs acting as a conduit for ever-greening bad loans (https://www.bis.org/review/r240529b.htm) of companies by entering into a series of structured transactions to circumvent RBI regulations.
Mr Swaminathan also questioned the business model of ARCs, saying that most were only doing one-time settlements and rescheduling of debt — actions which can easily be done by banks themselves. What is worse, ARCs were found to be warehousing bad debt, to allow banks to show cleaner books, while they continued to remain responsible for loan recovery and also held on to collateral security.
The deputy governor’s speech alluded to deals where assets are sold to group entities without placing proposals before independent committees or subjecting them to scrutiny under related-party transactions. Valuation of security receipts (SRs) was dodgy; more importantly, incorrect information was reported to the central repository for information on large credits system (CRILC).
RBI followed this up with a set of stringent new regulations that will come into force in January 2025. The breadth of concerns raised by Mr Swaminathan makes you wonder about the legitimacy of the very business model of ARCs. Ironically, RBI’s crackdown and stringent new rules have come at a time when the ARC business has already taken a beating and many of the 27 registered ARCs have begun to shut shop. But all this is cold comfort for retail investors and home-owners who continue to lose out due to the collusive deals between companies and ARCs, especially in the insolvency process. Consider these examples:
According to a media report, the Securities and Exchange Board of India (SEBI) is investigating a whistle-blower complaint about Dewan Housing Finance Ltd (DHFL) which was acquired by the Piramal group. Apparently, DHFL loans were sold at steep discounts to an unlisted group entity. These were later repurchased by the original borrowers at significantly higher rates, allowing the unlisted entity to profit at the cost of investors of the listed company that acquired DHFL. An ARC is understood to have facilitated this shady deal. This is a double whammy for investors as a class, because one set of investors already lost heavily when the Piramals acquired DHFL through the insolvency process. DHFL, with admitted outstanding loans of over Rs90,000 crore, was thus acquired for a little over Rs32,000 crore. Various categories of retail investors suffered badly in this deal.
The second case involves a loan of Rs2,000-crore made by the same DHFL to ABC Ltd (name changed) before it collapsed. The loan was classified as ‘fraudulent’ in a forensic audit by Grant Thornton. After acquisition by the Piramal group, DHFL was renamed Piramal Capital and Housing Finance Limited (PCHFL). Meanwhile, ABC, the borrower, also went belly-up and was admitted to the bankruptcy process. PCHFL had now assigned this fraudulent loan to XYZ Asset Reconstruction Company (XYZ-ARC), set up by a controversial developer, who has done a good deal of jail time. XYZ-ARC portrayed itself as a financial creditor and participated in the ABC resolution process, making a claim against the fraudulent loan. What is worse, it was admitted to the committee of creditors (CoC) and got 80% voting rights. This legitimised a fraudulent loan at the cost of the home-buyers who have lower rights. According to ABC home-buyer, this is typical of the convenient arrangements between various realty companies to get fraudulent loans laundered through the bankruptcy process. Retail investors and home-buyers with less clout and knowledge are again the losers, while the regulators sleep.
The third is a case of unexpected consequences. An activist I know lives in a tenanted building in Mumbai. A charitable trust that owned the building had sold it to a very well-known realty company with the specific understanding that it would be re-developed. The tenants had approved the deal on the understanding that they would get new apartments on redevelopment. When there was no progress for a long time, the activist began an investigation which revealed that the builder, who acquired the property, is in financial difficulties. A leading bank to which he owes money has sold his loans to an ARC– including the one that acquired the trust land. This has left the tenants in limbo, since they are unclear about the fate of their agreement and its resolution. This has no solutions under the Real Estate Regulation Act either.
All three examples show how ordinary people have ended up at the losing end of bankruptcy resolutions, where ARCs have played a shady role. What is the regulator doing about it? Over the past three years, RBI has been working to fix systemic flaws in the functioning of ARCs but it doesn’t help home-buyers.
In October 2022, RBI (https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12399) mandated a more robust capital structure with specified investment in security receipts, better transparency and governance for ARCs. This was a year after Paras Kuhad, a former additional solicitor general, had accused Edelweiss ARC of fund diversion and other irregularities. Mr Kuhad alleged that Edelweiss group and its Canadian partner, CDPQ, misused funds and violated norms in their ARC operations. He raised these concerns with the prime minister's office (PMO) and RBI, prompting the ministry of corporate affairs (MCA) to initiate a probe. Edelweiss had then denied the allegations.
For another two years, RBI engaged with the Edelweiss ARC and the crackdown in May 2024 happened only because the ARC’s senior management did not take ‘meaningful’ remedial action, but found new ways to circumvent regulations. Perhaps this brazen attitude led to the stringent new rules and directives issued in October 2024 which will be effective from January 2025.
These rules make it mandatory for ARCs to join at least one credit information company (CIC) and prescribe standard operating procedures (SOPs), such as proper maintenance of customer information, centralisation of repayment data, ensuring that no repayment, including the last one, is ‘left unreported’, appointment of a nodal officer and the obligation to prioritise grievance redress.
The stricter rules are also in preparation for a flood of retail and micro-loan defaults that are already finding their way to ARCs from banks. The rating agency CRISIL has reported that sale of retail stressed assets is already high. At the same time, there is a slowdown in the growth of bad loans, because of the massive write-offs and clean-up at public sector banks (PSBs), over the years. The formation of the State-owned National Asset Reconstruction Company Ltd (NARCL), whose security receipts carry a government guarantee, is more attractive to lenders looking to flog bad loans.
This combination of factors has already hit the ARC business with several of the 27 registered ARCs looking to exit or shut down. Among those exiting are: Aditya Birla Asset Reconstruction Company (ABARC), India Resurgence Asset Reconstruction Company, Arcion Revitalisation Pvt Ltd and Lone Star India Asset Reconstruction Pvt Ltd.
Tighter regulation, more transparency and competition from a State-owned entity, which may be less amenable to indulge in dodgy deals, is all good for the system. But hapless retail investors and home–buyers, who are badly burnt, pay the price, in the interim.
Comments
covaimthangavel
2 weeks ago
Lots of bank NPA properties sold lower than 80% market price. Means money were lotted by some persons
ARCs dealing with bad loans undertake lot of unholy activities just like any other business entity including banks. But these entities are very much needed by the banking system.
An effective supervisory structure is the need of the hour, rather than killing them highlighting a few stray cases.
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An effective supervisory structure is the need of the hour, rather than killing them highlighting a few stray cases.