Asset reconstruction companies (ARCs) are being misused by "tainted" promoters to enter the bankruptcy process after leading their firms to loan defaults, a deputy governor at the Reserve Bank of India said.
Promoters in an Indian market are large shareholders who can influence company policy and, according to regulatory definitions, are prospective owners or directors of the company.
There is a section under the Insolvency and Bankruptcy Code "specifically meant to keep out such promoters, said M. Rajeshwar Rao at the conference on governance in ARCs held early this month, the full version of which was published on Friday.
However, entities often meet this requirement by merely obtaining a declaration signed by the prospective buyer, who does not undertake any independent verification, the deputy governor said.
The RBI has publicly flagged concerns over the functioning of ARCs and has increased the supervision of regulated entities to prevent systemic risks and ensure that regulations are followed.
Earlier this week, the central bank barred two Edelweiss Group companies saying they engaged in "evergreening" of distressed loans - the practice of granting further credit to firms close to default to help them repay existing loans.
Rao said that transactions in ARCs have to be conducted transparently and the manner in which ARCs can resolve an asset needs to be clearly laid down.
"ARCs also need to be conscious of their conduct vis-à-vis the distressed borrowers. Even a single incident of misconduct can potentially snowball into a controversy which the sector should guard against," Rao said.
He stressed the need for strong governance frameworks, robust internal controls, and a strong compliance culture, adding that not all ARCs have implemented the revised guidelines on company boards' composition and functioning.
"... failure to meet regulatory guidelines and wilful violations would invite strict supervisory and enforcement action, if warranted," Rao added.
