Deputy Governor of the Reserve Bank of India, M Rajeshwar Rao, said asset reconstruction companies (ARCs) are being misused by tainted promoters to enter the bankruptcy process after leading their firms to loan defaults.

There is a section under the Insolvency and Bankruptcy Code (IBC), specifically meant to keep out such promoters, the Deputy Governor said at the conference on governance in ARCs held early this month, the full version of which was published by RBI on Friday.

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, he said.

He said that the entities often meet this requirement by merely obtaining a declaration signed by the prospective buyer, who does not undertake any independent verification.

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.

Speaking on governance, he said, that sound and robust governance provides a strong foundation for the ARCs to build a robust business model.

Governance, in this context, transcends mere regulatory compliance; it embodies a philosophy of accountability, transparency, and ethical conduct. In case of distressed assets, where conflicts of interest looms large and fiduciary duties are tested, effective governance can serve to develop confidence in the processes adopted by the ARCs, he mentioned.

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-Ã -vis the distressed borrowers. Even a single incident of misconduct can potentially snowball into a controversy which the sector should guard against,” he added.

He further said that the Sound governance can also act as both a shield and a sword. It shields the stakeholders from conflicts of interest, ensuring that the decisions are guided by prudence and sound business sense.”

“At the same time, it wields the sword of transparency and accountability by holding decision makers accountable for their actions and fostering a culture of ethical leadership,” he added.