RBI cracks down on Edelweiss ARC & ECL Finance

The Reserve Bank of India (RBI) has announced that it had imposed stringent restrictions on two Edelweiss Group companies, Edelweiss Asset Reconstruction Co Ltd. (EARCL) and non-bank firm ECL Finance (ECL) from acquiring financial assets or undertaking structured transactions, for their involvement in “evergreening” distressed loans.

This comes within a week of asking asset reconstruction companies to behave in their business practices

The RBI has barred both companies from acquiring new loans and financial assets as it has found them “acting in concert by entering into a series of structured transactions for evergreening stressed exposures of ECL, using the platform of EARCL and connected AIFs, thereby circumventing applicable regulations,” the regulator said in a statement.

Evergreening is a process that aims to hide the exact amount of non-performing loans on a company’s balance sheet by issuing new loans to stressed borrowers in order to repay current debts. Because these tactics have the possibility to conceal financial instability inside companies, the RBI has already issued warnings against them. According to the RBI, both companies took part in a number of planned transactions to renew ECL’s problematic loans.

The central bank observed that by using the EARCL platform and related alternative investment funds, these businesses were able to get beyond legal restrictions. By shifting loans from non-lender firms inside the group to the group’s asset reconstruction company, ECL specifically permitted itself to operate as a conduit, allowing the group to get around regulatory restrictions.

RBI Imposes Business Restrictions on Edelweiss Amid Regulatory Crackdown

On Wednesday, the RBI directed EARCL “to cease and desist from the acquisition of financial assets, including security receipts (SRs) and reorganising existing SRs into senior and subordinate tranches, with immediate effect,” the direction to the group firm ECL Finance is “to cease and desist, with immediate effect, from undertaking any structured transactions in respect of its wholesale exposures, other than repayment and/or closure of accounts in its normal course of business.”

Asset reconstruction businesses are only allowed to purchase financial assets from banks and other financial institutions, under RBI regulations. The central bank discovered that EARCL and ECL Finance had handled their distressed loans improperly by breaking these rules.EARCL responded to the RBI’s instruction by saying it is now going over the guidelines and has plans to deal with the regulatory remarks.

ECL Finance stated that it is following the advice and hopes to have the problems fixed in the three weeks that the central bank has given. In addition, disparities in the security receipt valuation for ECL and EARCL were observed by the central bank. The RBI chastised the group for looking for novel methods to get around rules rather than taking significant corrective action.

Asset reconstruction companies (ARCs) provide security receipts as payment for the distressed assets they buy from banks and non-bank financial institutions. Rakshesh Shah, the founder and chairman of the Edelweiss group, was not reached by phone or text message, and no one answered.

The regulator stated that incorrect SR valuation was also observed in both EARCL and ECL. In addition, supervisory observations in ECL included incorrectly providing lenders with information about its eligible book debts to calculate drawing power, failure to comply with loan-to-value standards for lending against shares, filing inaccurate reports to the Central Repository for Information on Large Credits system, and failing to follow KYC guidelines.

The RBI in its order said “instead of taking meaningful remedial action to rectify the said deficiencies, it was observed that the group entities were resorting to new ways to circumvent regulations. Over the last few months, the Reserve Bank has been engaging with the senior management of these entities and their statutory auditors, but no meaningful corrective action has been evidenced so far, necessitating the imposition of business restrictions.”

According to ECL, it has been assuming debts from the group’s non-lender subsidiaries in order to sell to EARCL, allowing itself to be used as a conduit to circumvent regulations that permit ARCs to acquire financial assets only from banks and financial institutions.

The entities’ need to guarantee that the requirements are followed “in letter and spirit at all times” was emphasized by the central bank. Despite these regulatory measures, ECL Finance asserted that the order will not substantially affect its business operations. In the same vein, EARCL said that business as normal will resume with its resolution and recovery activities. The RBI’s decision reflects its heightened oversight of regulated enterprises to avert systemic risks and ensure compliance with regulations.

In a recent statement, RBI Deputy Governor Swaminathan J. highlighted larger regulatory issues in the industry by pointing out that certain asset reconstruction businesses were helping the evergreening of troubled assets.

Since January, Edelweiss has been subject to severe punitive regulatory proceedings. The RBI requested that payments giant Paytm Payments Bank almost completely down its doors on March 15. Then, in March, it took a serious hit to the IIFL Group, demanding that its gold loan division cease onboarding new borrowers right once. JM Financial was the next target of regulatory action, as JM Financial Products was prohibited from executing any kind of financing including shares and debentures.

The greatest of all was the imposition of more stringent regulations on Kotak Mahindra Bank, the fourth-largest private sector lender, which prohibited the onboarding of new credit card clients and ordered the bank to cease all online and mobile banking activities for new customers. All these actions were carried out after these entities continued to flout regulatory demands for almost two years on the trot.

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