Banks can’t fund sale of their NPAs to bad loan recovery cos

Mumbai: The RBI has barred

asset reconstruction companies

(

ARCs

) from buying bad loans through deals where there is scope for banks or lenders to fund the purchase.

The

central bank

has done this by disallowing purchase of non-performing assets by ARCs through bilateral deals where the lender is a sponsor, financier or a group company.

In a circular issued on Friday, the RBI said ARCs will not acquire financial assets from the earlier mentioned cases whatever may be the consideration. However, ARCs can participate in the auction of financial assets by lenders provided these are conducted in a fair and transparent manner and pricing is decided by market forces. ARCs buy bad loans from lenders and make recoveries by either selling assets or getting the business back on rails.

The central bank appears to be sending a message that lenders cannot engage in financial engineering to clean up their books by using their liquidity to fund an ARC, which will take over the bad loans from banks’ books.

The RBI directions come just before the fourth quarter, when banks increase the pace of bad loan sales in order to come out with good numbers at the end of the year.

Bankers say that besides cleaning up books, selling

NPAs

helps lenders conserve management time. Given that the time for resolution of stressed assets under the insolvency code has exceeded two years, a lot of management time is occupied in attending meetings concerning the default. Selling the loan enables banks to move on. Also, bankers can incorporate a clause where the ARC shares any upside from future recovery.

Earlier, banks would sell their bad loans to ARCs and fund the same by purchasing security receipts from them. A security receipt is the equivalent of a mutual fund unit except that instead of equities, the underlying assets are bad loans. The RBI stopped the security receipt route and insisted that ARCs pay cash for bad loans.

According to data published by the RBI in July, bad loan recoveries from ARCs are just a tenth of what was sold to them by banks. ARCs recovered a maximum of 9.5% of the security receipts they held at the end of FY18. This number halved from a maximum recovery of 18.7% made at the end of FY17. “The recovery rate specifically shows a precipitous decline for assets that originated after 2014,” the RBI had said in its financial stability report released earlier this year.