Industry
RBI pushes asset reconstruction companies to strengthen KYC compliance
Summary
- RBI’s push is backed by its master circular from 24 April that mandated ARCs to follow these norms as prescribed in its KYC guidelines from 2016.
- ARCs face increased compliance costs and challenges, particularly with retail bad loans, as they adapt to stricter KYC guidelines.
MUMBAI : India’s central bank is intensifying scrutiny on companies that buy bad loans, mandating that they classify borrowers by risk profile and periodically verify KYC (know your customer) data after acquiring bad loans from banks and non-bank financiers.
This move aims to bolster fraud detection and anti-money laundering measures, aligning asset reconstruction companies (ARCs) with the same rigorous standards imposed on banks.
According to two ARC executives aware of the development, the Reserve Bank of India (RBI) has informed them that they need to verify KYC details of borrowers even if they are buying bad loans from lenders who have those details.
Besides, RBI auditors who are examining ARC books have emphasized that merely purchasing KYC-compliant assets is insufficient and regular verification is necessary, one of the executives cited above said on condition of anonymity.
“We have been told to follow similar norms as applicable to banks. ARCs have to put in a lot of effort into this and the cost of compliance would go up as we have to redo the KYC exercise," the first person cited above said. “Given that we largely buy bad loans, most customers would be high-risk and, therefore, their re-verification would have to be more frequent."
The second ARC executive said that mapping KYC would be challenging, especially as ARCs are increasingly buying retail bad loans due to a lack of corporate stress.
“ARCs will now have to push scores of retail borrowers to share their KYC data. Given that they have already defaulted on loans sold to ARCs for recovery, they might not be forthcoming with their KYC data," the executive said, adding that this issue was discussed in a meeting on 17 May between RBI officials and ARC chiefs.
Queries emailed to the RBI remained unanswered till press time.
The business of bad loans
Lenders sell stressed loans to ARCs at a discount, in exchange for either cash or a mix of cash and security receipts, although cash is preferred by lenders. The security receipts are redeemable when the ARC recovers the loan.
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ARCs had assets under management, or outstanding security receipts, of ₹1.4 trillion as on 31 March 2023, according to a report by rating agency Crisil and industry lobby body Assocham released in February. However, the total book value of stressed loans with ARCs stood at ₹8.48 trillion in the same period.
RBI's directive, reinforced by a master circular issued on 24 April, necessitates ARCs to adhere to its 2016 KYC guidelines. These guidelines mandate banks and other lenders to obtain and periodically update customer proof of identity and address, ensuring each account is linked to a genuine customer.
According to KYC norms, as mandated by the central bank, customers should be classified into low, medium, and high-risk categories based on assessment and risk perception. Lenders must periodically update KYC information: at least once every two years for high-risk customers, once every eight years for medium-risk customers, and once every 10 years for low-risk customers from the account opening or last KYC update date.
Industry response and collaboration
The ARC industry is coming together to understand how to comply with these norms.
The Association of Asset Reconstruction Companies in India has started engaging with the regulator and member ARCs. “As per the recent master direction issued by RBI, ARCs are also bound by the KYC norms. It is an important metric and we have been sensitizing our members on this issue," said Hari Hara Mishra, the organization’s chief executive.
Mishra said the association has held an interactive session with external experts on KYC and plans to conduct at least one more. “The association has also been in touch with the RBI for clarifications on certain operational aspects. This will help our member ARCs comply with the changing regulatory landscape while carrying on their business of buying bad loans and making recoveries," he said.
KYC guidelines are an issue that the regulator is not taking lightly. As reported by Mint on 15 February, RBI has been focused on plugging gaps in KYC checks by lenders and other regulated entities, imposing monetary penalties and business restrictions. Recently, RBI proposed stricter KYC guidelines for businesses using payment aggregators for digital payments.
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The regulator is also urging ARCs to improve governance and compliance. Two deputy governors recently highlighted concerns about industry practices in the 17 May meeting cited earlier. Deputy governor Swaminathan J. said onsite examinations revealed instances of ARCs being used to “evergreen distressed assets".
Deputy governor Rajeshwar Rao noted that while ARCs can aid in stressed asset resolutions, there are concerns about them becoming a vehicle for “tainted promoters".
Recently, RBI imposed business curbs on two Edelweiss group entities, including its asset reconstruction company Edelweiss ARC, for regulatory breaches.
The central bank had said that ECL Finance acquired loans from non-lender group entities for ultimate sale to the group ARC, circumventing regulations. “In EARCL (Edelweiss ARC), other violations included not placing the Reserve Bank (of India)’s supervisory letter before the board, non-compliance with loan settlement regulations, and sharing non-public client information with group entities," the regulator had said in a statement announcing the curbs on 29 May.
Both companies have said that RBI’s directions would not have a material impact.
