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Mumbai: The Reserve Bank of India (RBI) has warned banks to be cautious about the entities to which they sell assets acquired on account of loan defaults, two persons with direct knowledge of the development said.

The note, sent earlier this month, was more an informal warning rather than an official guideline, said the two, who asked not to be identified.

RBI’s warning may have been prompted by fears that promoters of companies acquired by banks after they failed to repay loans may be using shell entities, in India and elsewhere, to buy back these assets at much lower prices, one of the two persons said.

If that is the case, it would also allow unaccounted-for or black money stashed by Indian businessmen overseas to come back into India.

“Bankers have been asking specialists to come and work with them to establish that there is no connection between the new buyers and the current promoters of the company," said the first person cited above, a senior official at a stressed-asset management firm. The official requested anonymity as these discussions are confidential.

The cautionary note from RBI comes against the backdrop of banks taking over and selling assets where promoters have failed to repay loans. These conversions are happening under the strategic debt restructuring (SDR) scheme which RBI introduced as a tool to help banks resolve their bad-loan problem.

According to SDR rules, banks can convert loans to a majority equity stake in the borrower and find a buyer within 18 months. The rules further stipulated that banks would have to establish that the buyer does not belong to the existing promoter group.

RBI has now re-emphasized this point to bankers and asked them to ensure there are no back-door connections between the existing promoters and the buyers.

“The demand for such enhanced due diligence has come up since prospective buyers in a number of cases are coming from relatively unknown backgrounds and banks need to be sure that there is no foul play," added the first person.

Such relationships, if discovered, could end the deal.

Since June 2015, when SDR rules were introduced, lenders have converted debt to equity in a number of firms including Electrosteel Steels Ltd, Ankit Metal and Power Ltd, Rohit Ferro-Tech Ltd, IVRCL Ltd, Gammon India Ltd, Monnet Ispat and Energy Ltd, VISA Steel Ltd, Lanco Teesta Hydro Power Pvt. Ltd, Jyoti Structures Ltd and Alok Industries Ltd.

Of these, the only known case where lenders are closing in on a sale is Electrosteel Steels.

On 17 February, Mint reported that banks had decided to go ahead and sell their majority stake in Electrosteel Steels to London-based investment firm First International Group Plc. (FIG). According to regulatory filings in the UK, FIG is in security and commodity contracts dealing activities and has no interest in steel.

Lenders have been asking large audit and consulting firms with a proven track record in due diligence to help, said the second person cited above, who works at an international consulting firm.

“The RBI’s directive is for any kind of sales—whether it is selling of equity in a defaulting firm or even sale of assets in an infrastructure company. However, lenders are more concerned about the deals being worked out under the SDR route right now, since they are on a strict timeline," the second person said.

An RBI spokesperson did not respond to an e-mail seeking comment.

In the case of Electrosteel, at a meeting in the last week of January, banks looked at offers from two potential buyers—FIG and Tata Steel Ltd—and decided to go with the UK-based investor’s offer.

As part of its offer, FIG proposed a loan waiver of 2,559 crore and conversion of 4,700 crore of debt into cumulative redeemable preference shares (CRPS). Tata Steel proposed a waiver of 6,000 crore and also asked for the conversion of 750 crore worth of debt to equity and 3,500 crore of debt to cumulative redeemable preference shares.

Lenders chose to go with the offer made by FIG even though Tata Steel may have been a better strategic fit.

“Large facilities typically have complex operations and therefore it would make sense if the buyer has a successful track record in the same sector," said Jayanta Roy, senior vice-president, Icra Ltd.

FIG chief executive officer Rupin Vadera did not respond to an email and calls seeking the reason for his firm’s interest in Electrosteel Steels.

“We are not in a position to comment (on this deal)," said Madhavi Vadera, a director at FIG.

Electrosteel Steels did not respond to an e-mail seeking comment.

To be sure, bankers are already conducting due diligence on buyers through consulting firms and even companies that specialize in forensic audits. However, both people cited above said the scope of due diligence is now being widened after RBI’s warning.

The Indian banking sector is in the midst of one of the biggest clean-ups of bad loans in recent times. RBI governor Raghuram Rajan has given banks until March 2017 to clean-up their books.

As part of this clean-up, RBI has asked banks to recognize stressed assets early and come up with a plan for resolution and recovery. The clean-up has meant a surge in bad loans at banks which, in turn, are putting pressure on promoters to sell assets to reduce debt.

Gross non-performing assets (NPAs) of 39 listed banks surged to 4.38 trillion in the quarter ended 31 December 2015, from 3.4 trillion at the end of the September quarter, according to data collated by corporate database provider Capitaline.

As of 30 September, stressed loans—the sum of gross NPAs and restructured loans—stood at 11.3% of total advances, according to the December edition of the Financial Stability Report released by RBI.

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