RBI Directs ARCs To Stop Bilateral Loan Purchases From Related Entities

The Reserve Bank of India has stopped asset reconstruction companies from purchasing loans bilaterally from related financial companies.

In a notification issued on Friday, the RBI revised its existing guidelines to say that ARCs cannot not acquire loans bilaterally from banks or financial institutions that are sponsors of the ARCs. The asset reconstruction companies have also been barred from buying loans from a bank or financial institution which is either a lender to the ARC or a subscriber to its fund.

Further, ARCs cannot acquire assets from an entity in the same group to which the ARC belongs, the central bank said. “However, they may participate in auctions of the financial assets provided such auctions are conducted in a transparent manner, on arm's length basis and the prices are determined by market forces,” it added.

There have been some instances where an ARC had purchased loan assets from banks, non-banking financial companies and housing finance companies via bilateral deals. Such deals were not explicitly prohibited till now, provided the pricing of such deals was done on an arm's-length basis.

The revised RBI ARC guidelines put an end to that practice.

An ARC can purchase non-performing loans or stressed assets from a lender via bilateral deals or an auction process. The ARC is required to pay 15 percent of the price upfront while the rest can be paid as security receipts. While the auction process should be followed as it is the best method for price discovery of the delinquent assets, it is not mandatory for banks and NBFCs when they sell loans to ARC outside of the group, said an executive at an ARC, on condition of anonymity.

Only public sector banks follow the auction process strictly, given the scare of a possible enquirers from government agencies, this person said.

While financial companies can sell loans to an ARC without conducting an auction, the ARC should be an unrelated entity without common owners to ensure there is an “arm's-length relationship,” said a legal expert speaking on condition of anonymity.