RBI's Loan Transfer Guidelines Could Change Bad Loan Sales In India

Not only has the door been opened for direct sales of bad loans between banks and stressed asset funds, lenders can now offload loans tagged as "fraud" accounts.

The changes came in as part of guidelines issued on Sept. 24.

The guidelines say that if lenders decide to sell their exposures in a loan account under the June 2019 restructuring guidelines, they may do so to "any class of entities". This could include banks, non-banks, asset reconstruction companies, companies or other buyers.

"The guidelines allow, in spirit, all body corporates to acquire stressed assets," said Eshwar Karra, chief executive officer of Kotak Special Situations Fund. "There's a reference to allow all entities to acquire such loans as long as they are approved by their regulator."

In case the buyer of a stressed loan exposure isn't a designated bank, non-bank or ARC, the lenders selling their exposures must follow certain specific guidelines, the RBI said.

• The buyer must be incorporated in India or registered with a financial sector regulator here.

• The buyer shouldn't be classified as a non-performing asset by any lending institution at the time of transfer.

• The buyer must fully replace all lenders involved in the case.

• Such transactions must take place only on cash basis.

• The buyer shouldn't have funded the bad loan purchase through lenders seeking to sell their exposure.

• Lenders seeking to sell their loans aren't allowed to extend any loan facilities, other than working capital loans, to the company whose loan exposure is being sold for a period of three years from the transfer.

• Similarly, for a period of three years, lenders cannot extend any loan facilities to the buyer of the loan, for the specific purpose of deploying funds to the borrower whose loan account was purchased.

Abizer Diwanji, head of financial services at EY, said the RBI would still need to provide explicit approval for alternative investment funds to buy bad loans.

"As of now, they have asked corporate bodies, such as AIFs, to seek approval from their respective regulator," Diwanji said. "After that the final decision to allow such transactions still remains with the RBI."

Karra of Kotak Special Situations Fund agrees.

"We propose to write to SEBI to give a clarification to the effect that it has no objections in funds purchasing bad loans from banks," Karra said. "Once that comes, we can request RBI to include stressed assets Alternate Investment Funds in their list of permitted entities."

So far, banks have been dependent mostly on ARCs to buy bad debt from them. However, in the last three years, bad loan purchases have dwindled as banks are insisting on deals with a higher proportion of upfront cash as the track record of ARCs in resolving loans has been weak.

According to a senior official at an international distressed asset fund active in India, the new guidelines will remove the "middle-man". This will help in better negotiations with lenders and fewer administrative hiccups in resolution, the official said on the condition of anonymity.

Aroop Sircar, former official at State Bank of India, said the new guidelines make way for banks to have a more diverse set of buyers.

"Banks are the biggest stakeholders here and so more buyers will always be welcome," Sircar said. "There's a lot of interest among stressed asset investors entering India and this opens the door for them to get on the discussion table."

ARCs themselves will lose some of the strategic advantage they have enjoyed so far. But this may prompt them to reinvent themselves to stay relevant in the bad loan market, he said.

An area where ARCs continue to enjoy a strategic advantage is the ability to invoke the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act or Sarfaesi Act.

According to the stressed asset official cited earlier, funds still don't have the ability to move to attach assets in case the resolution process fails. While they can approach the Insolvency & Bankruptcy Code, often the Sarfaesi Act is a quicker solution in smaller-sized assets, the official said.

ARCs though are confident that they will continue to attract partnerships with funds.

"While the new guidelines permit any corporate entity to take exposure in stressed assets under RBI resolution plan, many of these will associate with ARCs in view of their experience and expertise in handling stressed assets, special empowerments and the platform to offer structured solutions," said Hari Hara Mishra, director, UV ARC.

The RBI's guidelines also explicitly allow ARCs to purchase loans declared as fraud by banks. This was previously prohibited by the regulator.

"The transfer of such loan exposures to an ARC, however, does not absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds," the RBI said in its guidelines.

According to Diwanji of EY, this is a crucial step.

"The RBI had blocked such sales in the past because banks would declare an account as fraud and immediately sell it to ARCs to avoid any responsibility. In the current norms, there is room for greater accountability for banks," he said. "Meanwhile, ARCs can aggregate better, despite the fraud tag."

Whether ARCs are able to get good recoveries from such fraud accounts will have to be seen, Diwanji added.

According to the CEO of a large private sector ARC, this move was not something reconstruction companies sought. Rather, the Indian Banks' Association, as part of its bid to create the National Asset Reconstruction Company Ltd, asked for it, the ARC industry official said on condition of anonymity.

The NARCL, dubbed India's version of a bad bank, is set to take over Rs 2 lakh crore of bad loans from banks. Security receipts issued by the NARCL will be guaranteed by the government to the tune of Rs 30,600 crore, Union Finance Minister Nirmala Sitharaman had said earlier this month.