Emphasising that the potential of asset reconstruction companies (ARCs) for resolving stressed assets within the system can only be realised with sound governance and adherence to ethical practices by responsible ownership and professional management, Reserve Bank of India (RBI) says the boards of ARCs should ensure they do the right thing without needing the regulator to point it out to them. "With strong governance, ARCs can not only recover but also revive businesses and rejuvenate the financial system, benefiting both the community and the institution," says Swaminathan J, deputy governor of RBI.
Speaking at a conference of ARCs in Mumbai earlier this month, Mr Swaminathan pointed out that some ARCs, while enjoying the full benefits of the special position granted to them under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act and the regulations, are using innovative ways to structure transactions in a manner to circumvent regulations.
"During the course of our onsite examinations, we have come across instances where ARCs have been used or allowed themselves to be used, if I may say so, as a conduit to evergreen distressed assets. In many cases, there is a lack of transparency and consistency in the issuance and periodic valuation of security receipts (SRs). The practices surrounding the levy of management fees leave much to be desired," he added.
Interestingly, two days ago, RBI imposed business restrictions on two entities of the Edelweiss group, including ECL Finance Ltd (ECL) and Edelweiss Asset Reconstruction Company Ltd (EARCL), for circumventing regulations.
Coming back to Mr Swaminathan's speech where he says RBI observed that a few entities find new ways to achieve their objectives once a particular practice has been identified as a violation or deviation.
The ARC framework is intended to allow loan originators to focus on their core function of lending by removing the sticky stressed assets from their books. It also envisioned the revival of businesses by resolving viable and productive assets.
“A perusal of the scorecard of ARCs during the last two decades throws up a mixed bag. There seem to be more missed opportunities and less than optimal performance by ARCs in fulfilling the principal mandates under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act,” he pointed out.
Mr Swaminathan says, “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. We have also come across instances where ARCs have warehoused the stressed assets while the originator has continued to remain responsible for the collection as well as custody of the security provided by the borrower. ARCs may like to introspect whether they would like them to be a warehousing agency for a fee, which is certainly not in consonance with the underlying intent of the framework.”
He says 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," he added.
At present, there are a total of 27 ARCs registered with the regulator.
The deputy governor acknowledged the unique position of ARCs as special purpose vehicles (SPV) designed to alleviate the burden of high-value non-performing assets (NPAs) from the banking system. By maximising recovery and reconstruction efforts, he says, ARCs enable banks to focus on their core activities, thus ensuring the stability of the financial sector.
The cornerstone of Mr Swaminathan's speech was about setting the right tone from the top. He stressed that the chairperson, board of directors and chief executive officers (CEOs) of ARCs must lead by example, fostering a culture of integrity and ethical conduct. “When leaders prioritise ethical behaviour and compliance, it permeates throughout the organisation, building trust with stakeholders, enhancing reputation, mitigating risks, and contributing to long-term success,” he added.
The deputy governor also called for a shift towards principles-based supervision, focusing on the substance of transactions rather than their legal form. He urged ARCs to adopt a 'regulation plus' approach, ensuring compliance with both the letter and the spirit of the regulations. This approach, he argued, would enhance governance and ensure ARCs fulfil their intended mandates.
Mr Swaminathan outlined several elements crucial for the effective functioning of ARC boards, including competent leadership, diverse expertise, independence, clarity in roles and responsibilities, and diligence. He underscored the importance of having independent directors on boards to provide unbiased perspectives and safeguard against conflicts of interest. Additionally, he emphasised the need for thorough preparation and diligence by board members in reviewing agenda papers and supervisory reports.