Editorial published in The Economic Times on 19th July 2011
32 Years of Nationalization and 20 years of Free Economy
The Reserve Bank of India's (RBI) inspection report on Arcil, the earliest asset reconstruction company set up to buy distressed loans of banks and other financial institutions, is a wake-up call for the banking sector regulator. It points to a number of deficiencies in the asset-reconstruction business and in Arcil's functioning in particular. First, there is the issue of poor corporate governance that enabled major shareholders to collude in offloading their bad loans to Arcil.
State Bank of India , IDBI Bank and ICICI Bank together own more than 50% of Arcil's equity and they apparently used this clout to enter into questionable deals that furthered their own interests at the cost of Arcil. Second, is the technical issue of Arcil's business model for acquiring and subsequently realising non-performing loans (NPLs).
Typically, NPLs are acquired by Arcil under a trust structure and security receipts representing interest in underlying assets issued to Qualified Institutional Buyers, with Arcil acting as the trustee. The proceeds from these receipts are then utilised to pay sellers of NPLs.
Since the sellers are also banks or financial institutions the model is akin to a cosy deal between banks and the asset reconstruction company, reminiscent of the incestuous relationship between financial players that was a hallmark of the 2008 financial crisis. In effect, banks get NPLs off their books by selling to a trust while the latter in turn is funded by the banks.
So instead of impaired loans they now hold security receipts representing the same impaired assets. The third, critical deficiency that the RBI report suggests, if not in so many words, that Arcil seems no better equipped to recover the NPLs than the banks themselves.
The Securitisation Act 2002, was expected to strengthen the hands of banks, financial institutions and other specialised agencies like Arcil by providing a legal framework for securitisation and for enforcement of security. But a quick resolution is still nowhere on the cards. That is what we need to address, both to ensure wilful defaulters don't hold the system to ransom and to turn around locked-in capital in a capital scarce economy.
State Bank of India , IDBI Bank and ICICI Bank together own more than 50% of Arcil's equity and they apparently used this clout to enter into questionable deals that furthered their own interests at the cost of Arcil. Second, is the technical issue of Arcil's business model for acquiring and subsequently realising non-performing loans (NPLs).
Typically, NPLs are acquired by Arcil under a trust structure and security receipts representing interest in underlying assets issued to Qualified Institutional Buyers, with Arcil acting as the trustee. The proceeds from these receipts are then utilised to pay sellers of NPLs.
Since the sellers are also banks or financial institutions the model is akin to a cosy deal between banks and the asset reconstruction company, reminiscent of the incestuous relationship between financial players that was a hallmark of the 2008 financial crisis. In effect, banks get NPLs off their books by selling to a trust while the latter in turn is funded by the banks.
So instead of impaired loans they now hold security receipts representing the same impaired assets. The third, critical deficiency that the RBI report suggests, if not in so many words, that Arcil seems no better equipped to recover the NPLs than the banks themselves.
The Securitisation Act 2002, was expected to strengthen the hands of banks, financial institutions and other specialised agencies like Arcil by providing a legal framework for securitisation and for enforcement of security. But a quick resolution is still nowhere on the cards. That is what we need to address, both to ensure wilful defaulters don't hold the system to ransom and to turn around locked-in capital in a capital scarce economy.
Arcil under stress from large lenders like SBI, ICICI Bank, PNB and IDBI Bank, says Reserve Bank of India-Economic Times-18th July 2011
The regulator's remark in the inspection report of Arcil puts a question mark on deals that banks cut with the asset reconstruction company to palm off their bad loans. The report has also pointed out a string of accounting and transaction irregularities in Arcil, whose main shareholders include SBI, ICICI Bank, PNB and IDBI Bank.
While the report does not highlight specific cases where these large institutions have used their influence, it categorically states: "The directors representing the sponsor institutions—SBI, ICICI Bank, IDBI Bank and PNB—were functioning as pressure groups to further sponsors' agenda; these directors were of late holding separate meetings and forwarding their brief to the company, which the company was supposed to place as agenda for discussion in the meetings of the board." The RBI said they were "controlling the functioning of the company in an indirect manner".
When contacted by ET, spokespersons and senior officials from ICICI Bank, IDBI Bank and SBI declined to comment. Banks sell bad loans to asset reconstruction companies like Arcil in exchange for cash or security receipts issued by the latter. So far, Arcil has acquired stressed assets with principal value of around Rs 24,000 crore from various banks, of which the highest—Rs 9,000 crore—is from the secondlargest lender by value, ICICI Bank.
The RBI said Arcil also inflated its earnings.
"The accounting policies of the company were modified very frequently during the period with the approval of the board and the latest change has resulted in inflating the profit of the company by Rs 84.48 crore as on March 31, 2010," it said. "Even the existing policies which provided for recognition of income on accrual basis and its reversal only if the same is not realised for more than two years were not in conformity with RBI guidelines which require the reversal of such income if it remains due for more than 180 days."
Arcil, in its response to ET, said, "The RBI has forwarded their initial observations to Arcil and sought our comments or response on the same." The matter is presently under discussion and Arcil will be shortly submitting its responses to RBI. It is, therefore, too early to arrive at any conclusion at this stage.
Further, these are regulatory matters and confidential in nature and Arcil is, therefore, not in a position to comment on specifics," Arcil added. The central bank believes the practices of Arcil and some of its shareholders in exploiting their position may erode credibility.
"This is a very serious issue having a bearing on the credibility of the accounting systems being followed by the company and its implications for protection of interest of the other stakeholders," the report said. The asset reconstruction firm is also charged of violating many prudential guidelines, including the powers assigned to recovery agents.
"The resolution procedure to be adopted by portfolio recovery agents was left to them and agents could obtain recoveries by way of settlement with the borrowers and/or sale of underlying assets," the report said adding the "strategy to be adopted being left to recovery agents. This was a gross violation".
Transactions with the state-run Indian Overseas Bank and ICICI Bank also find a mention in the central bank's report. In a portfolio acquired from Indian Overseas Bank, the due diligence was done in only 50 cases out of 1,40,000 cases, which was much 'lower than the contemplated ratio as per the policy guidelines evolved by the company', said the report.
On ICICI Bank, the RBI observed: "The company had purchased collection rights of the non-performing assets belonging to ICICI Bank by paying an amount upfront and assuring the bank of recovery of a particular amount which was not in conformity with the provisions of the SARFAESI Act." Arcil had also misled its own board and the accounting was dubious, says the central bank report.
"In a few cases, the information placed before the board was not factually correct," it said referring to instances where non-banking finance companies were referred to as qualified institutional buyers and in purchases of retail portfolio. The report also said, "Some large value accounts acquired 3-4 years back but in which there was no or minimal recovery till date were being treated by the company as resolved."
Arcil had stepped beyond its objective by even turning into a real estate developer in some cases, which is not its business. "In some cases, the company had actively involved itself in development of land forming part of secured assets of borrowers," the report said.
"Its active involvement may have indirect implication for compliance with regulatory guidelines."
"In a few cases, the information placed before the board was not factually correct," it said referring to instances where non-banking finance companies were referred to as qualified institutional buyers and in purchases of retail portfolio. The report also said, "Some large value accounts acquired 3-4 years back but in which there was no or minimal recovery till date were being treated by the company as resolved."
Arcil had stepped beyond its objective by even turning into a real estate developer in some cases, which is not its business. "In some cases, the company had actively involved itself in development of land forming part of secured assets of borrowers," the report said.
"Its active involvement may have indirect implication for compliance with regulatory guidelines."
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