RBI warned Srei group repeatedly, Kanoria says it complied every time

Srei was one of the few top NBFCs in constant 'asset quality review' focus of RBI, even as the regulator never used that term for NBFCs

The Reserve Bank of India (RBI) held “numerous meetings” with the senior management of the Srei group and followed up by letters advising compliance with various supervisory instructions, including improvement in corporate governance, before swinging into action to supersede boards of its two companies on October 4, according to sources close to the development.

In its letters to the group, the regulator raised issues about additional provisioning for divergence, infusion of fresh capital, meeting the qualifying asset criteria for Infrastructure Finance Company (IFC) status. Almost all the letters stressed rectifying corporate governance, sources say, on which the regulator had serious concerns.

Despite irregularities pointed out by the RBI auditors and repeated warnings by the regulator, the group continued with the lapses in its two para banking units—Srei Infrastructure Finance (SIFL) and Srei Equipment Finance (SEFL), a team of supervisors closely scrutinising Srei as part of RBI’s oversight of top few NBFCs, found.

Srei was one of the few top NBFCs that was in constant 'asset quality review' focus of the RBI, even as the regulator never used that term for NBFCs.  

Business Standard reviewed the key red flags raised by the supervisors, which formed the basis of RBI action on the two group companies of Srei. This newspaper sent a detailed questionnaire to Hemant Kanoria, founder of SREI group, listing out the RBI supervisory team's concerns. Kanoria replied to all the points, denying any wrongdoing.  

"The board of directors of both Srei Infra and Srei Equipment consist of highly reputed and experienced professionals, therefore there has been zero non-compliance culture. SREI has won many accolades for its compliance culture. As soon as any point in this regard has been highlighted, it has been responded and complied," Kanoria said in his response.  

The Srei management was “shocked” at the RBI action, but it appears that the case against it had been building up. A promoter entity of Srei filed a writ petition against the regulator in the Bombay High Court on October 6, which the court dismissed. The RBI, thereafter moved the National Company Law Tribunal (NCLT), Kolkata Bench, for initiating insolvency proceedings against SIFL and SEFL, which has been admitted.

Failing financials

Auditors of Srei had for long warned of a steep deterioration in the company's health, which prompted the RBI to closely monitor the group and initiate a special audit in November 2020. The RBI auditors flagged Rs 8,576 crore of related party transactions in the group as of March 31, 2021.

The RBI supervisors found a steady decline in the capital adequacy ratio and net owned fund of the firms in the three years, from the year ending March 31, 2018, to March 31, 2020. SIFL's financial parameters, in particular, were way below the minimum required to keep the IFC status. SEFL also reached a negative capital adequacy ratio by the end of March 2020. (See Table)

"The companies’ assessed financials were on a steady decline and the companies were having negative/ very low assessed net owned funds," the supervisors mentioned in their finding.

Kanoria, however, pointed to the “severe” impact of Covid-19 in the infrastructure sector. “All our clients in construction, mining and infrastructure areas were affected due to lockdowns, migration of workers, substantial bills outstanding from government work, mounting claims from government, non-receipt of money from awards against government departments, and disruption in getting matters settled in courts due to lockdown. All these resulted in substantial dues and therefore, impact on the financials,” he said.

According to sources, the statutory auditors' report on the consolidated financial results of SIFL and SEFL for FY 2020-21 observed that the group’s net worth had eroded and it was not in a position to comply with various regulatory ratios and limits.  

"The auditors had expressed concern that there was a material uncertainty which cast significant doubt about the group’s ability to continue as a “going concern” in the foreseeable future," said a source.

The case against Srei

The board of directors of SEFL and SIFL, at their respective meetings in July 2019, approved the transfer of lending, lease and interest-earning business of SIFL together with associated employees, assets & liabilities as a going concern by way of 'slump exchange' to SEFL.  

A slump exchange is when assets and liabilities are transferred to another company, without individually valuing the assets and liabilities, for a lump-sum consideration. The slump exchange took place through a business transfer agreement (BTA) against fully paid up equity shares subsequently allotted to SIFL on October 1, 2019.  

Subsequently, the audited balance sheets of both SIFL and SEFL for the year ended March 31, 2020, and March 31, 2021, reflected the post-BTA financials. The balance sheet of SIFL came down from Rs 15,577.94 crore as of March 31, 2019 to ₹3,860.62 crore as of March 31, 2020, and that of SEFL increased from Rs 26,607.32 crore to Rs 37,038.74 crore over the same period.

However, the slump exchange went ahead despite a majority of lenders refusing to give a no-objection certificate (NOC) against such a move, the RBI supervisory team mentioned in their report.

In his reply to Business Standard, Kanoria refuted this.  

"The slump exchange transaction was discussed elaborately and all stakeholders gave their approval, as it was in the best interest of both SREI Infra and Srei Equipment," Kanoria said.

"Furthermore, the slump exchange was done to the wholly-owned subsidiary. The approval for slump exchange was given by the shareholders and all other stakeholders, including the lease bankers and a few other bankers too. This was also accordingly considered by RBI in computing their CRAR (capital adequacy ratio) for both the years ending March 20 and 21," Kanoria said.

Both the companies substantially reduced their infrastructure financing loan portfolio to focus gradually on equipment financing, Kanoria said.

One damning charge against the promoters of the group - Hemant and Sunil Kanoria - by the RBI team was that they were both on the board of SEFL as well as SIFL, and either of the two promoter directors was always formally part of statutory committees of the companies.  

Any of them at every point was part of the Audit Committee, Nomination and Remuneration Committee, Stakeholders Relationship Committee, Corporate Social Responsibility Committee, Executive Committee of Directors, Asset Liability Management and Treasury Committee, Risk Committee, Credit and Investment Committee.  

"Hence, the lending decisions of both NBFCs were directed by the same persons," the supervisory charge notes.

Responding to this, Kanoria said both the companies were professionally run and supervised by a competent board. "SREI Equipment was promoted by BNP Paribas and Srei Infra together in 2007 as a 50:50 joint venture company, having its chairman from BNP. Srei Infra and Srei Equipment, both were never run day-to-day by promoters. All credit decisions were taken by committees who have been represented by competent professionals," Kanoria said.

However, the RBI supervisors found that credit facilities sanctioned to some accounts were disproportionate to the balance sheet size of the borrowers, and importantly, “almost 33 per cent of the lending from the companies have been to the related, connected parties and group entities, without observing any arm’s length principle in lending.”  

But according to Kanoria, all large credit decisions were properly evaluated following laid down processes. “The lending to borrowers classified as related or connected has been within the credit parameters with adequate security,” he said.

The RBI supervisors noted that term loans of sizeable amounts were sanctioned to borrowers who had weak financials. Long moratorium loans of 10-12 years were sanctioned by the company at 1 per cent return on interest (ROI), payable on a cash basis every year, whereas the accrued interest was calculated at 11-12 per cent per annum and was payable after 10-12 years.

“Such long moratorium loans adversely affected the liquidity position and also contributed to the present default situation facing these companies," the RBI supervisors observed.  

"In the infrastructure sector, the lending has to be based on the future cash flows, long moratorium loans with proper security. However, the credit risks are imminent in any business, so there are some bad debts also," Kanoria countered.

The supervisors also red-flagged the group indulging in widespread 'evergreening'.

"Existing accounts were being closed by sanction of new loans, often to group entities of the borrower. In some cases, loans were sanctioned to new loan accounts opened in changed names of existing NPA borrowers, which were then used through circuitous means to close the earlier NPA accounts,” a key observation by the supervisors read.

“The accounts thus opened in new names were kept standard. Thus the evergreening of accounts was done through round-tripping of funds through group companies, by accounting for unrealised ‘cheques in hand’ for a long period, by misuse of internal accounts, etc.,” the supervisors said.

Hemant Kanoria countered this, saying his firms had formidable recovery skills. “In the last 32 years as an NBFC, the structure of financing has been made on decisions of security, future cash flows and other credit parameters, therefore Srei has been at the vanguard of recovery and well recognized for its skill sets for recovery and structured financing or refinancing," he said in his response.

Hemant Kanoria responds to RBI red-flags in Srei

1. Slump exchange of SIFL with SEFL, without NOC from lenders

Reply: Slump exchange was discussed elaborately and approval was given by the shareholders and all other stakeholders including lease bankers and few other bankers  

2. Financials had deteriorated rapidly, raising doubt on going concern

Reply: Impact of Covid-19 was severe. Clients affected, govt kept bills unpaid, demand for claims mounted, legal matters remained unsettled due to lockdown.

3. Promoters were on every committee, and may have affected credit decisions

Reply: Credit decisions taken by committees run by professionals

4. Almost 33% of credit given to related parties and group entities

Reply: All credit decisions evaluated, guarantees taken, and were within credit parameters

5. Widespread evergreening of loans

Reply: Srei has credit recovery skills, and all loans given after taking adequate security

6. Compliance issues were not adhered to

Reply: Compliance adhered to as soon as issues raised

7. Long moratorium loans sanctioned to companies with weak financials

Reply: Infra lending is based on future cash flows, some bad debts happen.