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Reserve Bank allows lenders to sell fraud loans to ARCs

According to Reserve Bank of India’s annual report, banks reported frauds worth  ₹3.95 trillion between FY19 and FY21.mintPremium
According to Reserve Bank of India’s annual report, banks reported frauds worth 3.95 trillion between FY19 and FY21.mint

According to data from RBI’s annual report, banks have reported frauds of 3.95 trillion between FY19 and FY21. On Friday, RBI said banks can sell stressed loans in default for more than 60 days or classified as bad loans, including those tagged as fraudulent, subject to conditions.

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The Reserve Bank of India (RBI) on Friday allowed lenders to sell loans tagged as fraud to asset reconstruction companies (ARCs), paving the way for focussed recovery efforts in loans worth trillions of rupees.

According to data from RBI’s annual report, banks have reported frauds of 3.95 trillion between FY19 and FY21. On Friday, RBI said banks can sell stressed loans in default for more than 60 days or classified as bad loans, including those tagged as fraudulent, subject to conditions.

“This shall include loan exposures classified as fraud as on the date of transfer, provided that the responsibilities of the transferor with respect to continuous reporting, monitoring, filing of complaints with law enforcement agencies and proceedings related to such complaints shall also be transferred to the ARC," the central bank said in its master direction on transfer of loan exposures.

Allowing the sale of such loans, RBI also said that transfer of these exposures to an ARC, however, does not absolve the lender from fixing staff accountability as required under the extant instructions on frauds.

According to industry experts, lenders are not allowed to transfer fraudulent loans to asset turnaround companies.

The change in norms announced on Friday would allow not just regular ARCs to buy more assets but also let the National Asset Reconstruction Co. Ltd (NARCL) take part in more asset resolutions, leading to a faster cleanup.

“This opens up significant opportunities not just for banks but also for asset reconstruction companies who could probably buy these assets at a greater discount than regular bad loans," said an ARC executive on condition of anonymity.

Lenders sell stressed loans to ARCs at a discount, either in exchange for cash or a mix of cash and security receipts. These receipts are redeemable as and when the ARC recovers the specific loan. That apart, ARCs charge an asset management fee of 1.5-2% of the asset every year.

Once an account is declared fraud, banks need to set aside 100% of the outstanding loans as provisions, either in one go or over four quarters, according to RBI rules. However, there is always a delay between when the fraud occurs and when it gets reported to the central bank. The average time lag between the occurrence of frauds and the date of detection was 23 months for the frauds reported in FY21.

Concerned about the rising instances of frauds in banks and the delay in these being reported, in 2015, RBI took steps to address the problem. Based on the recommendations of an internal working group, the central bank introduced the practice of red-flagging a loan account as part of a mechanism of early warning system (EWS) aimed at helping banks identify suspicious accounts.

“These signals in a loan account should immediately put the bank on alert regarding a weakness or wrongdoing which may ultimately turn out to be fraudulent. A bank cannot afford to ignore such EWS but must instead use them as a trigger to launch a detailed investigation into a red-flagged account," the central bank had said in 2015.

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