Description
This is a document about the impact of securitization on IPA of banks.
The Impact of Securitization on NPA of Banks in India
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Table of Contents
TABLE OF CONTENTS
I
EXECUTIVE SUMMARY
VII
OBJECTIVES OF THE STUDY
VIII
ACKNOWLEDGEMENTS
IX
CHAPTER ONE - THE CONCEPT OF SECURITISATION
FEATURES OF SECURITISATION 1. Marketability 2. 3. 4. 5. 6. Merchantable quality Wide Distribution Homogeneity Special purpose vehicle Assets that can be securitised
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5 5 6 7 7 8 8 10 10 13 14 14
PROCESS OF SECURITISATION TERMS USED IN A SECURITISATION TRANSACTION BENEFITS FROM SECURITISATION OF ASSETS RISKS FACED, THREATS INVOLVED IF SECURITISATION IS NOT CARRIED OUT
PRUDENTIALLY
SECURITISATION IN INDIA
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CHAPTER TWO - NEED FOR SECURITISATION ACT
NPAS IN THE BANKING SECTOR DEFINITION OF NON-PERFORMING ASSET NPA STATISTICS 1. Impact on Profitability 2. Impact on Liquidity of the Nationalised Banks 3. Impact on Outlook of Bankers towards Credit Delivery INITIATIVES OF GOVERNMENT AND RBI FOR REDUCTION OF NPAS 1. 2. 3. 4. 5. 6. 7. 8. 9. Compromise settlement schemes Lok Adalats Debt Recovery Tribunals Circulation of information on defaulters Recovery action against large NPAs Corporate Debt Restructuring (CDR) Credit Information Bureau Proposed guidelines on willful defaults/diversion of funds Corporate Governance
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18 20 20 24 29 29 31 31 32 32 33 34 34 35 35 35 36 36 36 36 37 37 37 38 39
PROBLEMS WITH PREVIOUS METHODS 1. Inadequate security & Erosion in value of security 2. Political interference 3. Slow legal procedures 4. Swamping of DRTs with cases 5. Misuse of BIFR / SICA 6. Transfer of property Act, English mortgage CAUSES OF NPAS CONCLUSION
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CHAPTER THREE - SECURITISATION ACT – A NEW LANDMARK IN THE INDIAN FINANCIAL SECTOR
SCOPE & OBJECTIVES OF THE ACT SOME IMPORTANT DEFINITIONS REGISTRATION OF SECURITISATION OR RECONSTRUCTION COMPANY 1. Requirements for registration of securitisation company 2. Operational Rules for Already Existing ARCs/SCs 3. Procedure for Registration Approval of RBI for Change in Management Business that can be carried out Powers of RBI Cancellation of registration Other companies/entities can carry out securitisation ACQUIRING FINANCIAL ASSETS FROM BANK / FI 1. Modes of acquiring financial asset 2. Is it transfer of actionable claim? 3. Registration of agreement 4. Stamp Duty Payable Company enters into shoes of Bank/Fl after acquiring asset Notice to borrower/Registrar Effect of the notice Arbitration Mandatory Protection to secured creditor for acts in good faith CENTRAL REGISTRY 1. Maintenance of Central Register 2. Satisfaction or payment of security interest 3. Inspection of Central Register 4. 5. 6. Penalty for default Provisions to apply only after Central Registry is setup All security interest created to be registered? 5. 6. 7. 8. 9. 4. 5. 6. 7. 8.
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41 44 51 51 52 52 53 53 54 54 55 56 56 57 57 58 59 59 60 60 61 62 62 63 63 64 65 65 66 66
ENFORCEMENT OF SECURITY INTEREST 1. Requirements of notice
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2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Mode of Serving Notice Provision when joint financing is involved Measures that can be taken Cost and expenses can be recovered from borrower Excess amount to be refunded to borrower Secured creditor can proceed against borrower for balance amount How the secured creditor can exercise his right Restrictions on borrower after receipt of notice Effect of transfer of asset to third person Significance OF ‘AS IF TRANSFER IS MADE BY OWNER OF ASSET’
66 67 68 69 70 70 71 71 71 71 72 73 73 73 74 75 75 75 76 77 77 93 93 93 94 94 94 94 95
Payment of amount by Borrower any taking back possession Time limit for taking action after serving of notice Jurisdiction of civil court barred Protection to secured creditor for acts in good faith Can Secured Creditor take action if matter is with DRT / Civil Court? TAKING OVER OF ASSETS 1. Assistance of Magistrate to take over possession 2. Change of directors/appointment of administrator 3. Effect of the notice Effect of takeover of management Guidelines for exercise of power APPEALS AND PENALTIES 1. Appeal against action of secured creditor 2. Appeal to DRT 3. Appeal to Appellate Tribunal 4. Right of Borrower to Receive Compensation and Costs for Wrongful Action 5. Reliefs that can be granted 6. Only compensation, no damages 7. Punishment 4. 5.
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CHAPTER FOUR - PUNJAB NATIONAL BANK – A CASE STUDY
RESEARCH METHODOLOGY COLLECTION OF DATA Primary Sources Secondary Sources ABOUT PUNJAB NATIONAL BANK INTERPRETATION OF DATA Process of recovery under enforcement of security interest Example of recovery through enforcement of security interest
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97 97 97 97 97 102 102 104
CHAPTER FIVE - BENEFITS, PROBLEMS AND RECOMMENDATIONS
BENEFITS OF THE ACT PROBLEMS ENVISAGED RECOMMENDATIONS
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109 110 115
ANNEXURE
QUESTIONNAIRE Part A Part B POSSESSION NOTICE [RULE 8(1)] RBI NORMS FOR CLASSIFICATION OF NPAS BIBLIOGRAPHY Books Reports Newspapers and Magazines
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118 118 118 120 122 126 126 126 126
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Executive Summary
The project report is divided into five main chapters. In the first chapter, the concept of Securitisation has been dealt with. This chapter explains the salient features, the process and the parties involved in a Securitisation transaction. It explains the major benefits of securitisation and the risks involved. It shows the various stages through which the development of Securitisation in India has gone through. In the second chapter, the reasons behind the need for the present act are analysed. The huge mountain of NPAs in the banking sector, and the inability to find an appropriate method to curb their rise, contributed to this need. The problems with the previous methods of loan recovery are explained, and a case for the new act prepared. In the third chapter, the provisions of the ‘The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002’ are detailed. It includes the scope and objectives of the act, a number of important definitions and procedures for regulation of securitisation companies, enforcement of security interest by banks and for taking over assets without the intervention of courts. In the fourth chapter, an attempt has been made to understand the impact of the current legislation on the NPAs of banks with regards to its effectiveness in enabling recovery of NPAs. This is done by taking the example of Punjab National Bank as a case study. The procedure followed by the bank for the successful recovery from Silverline Technologies is used to form the ideal procedure to be followed by banks. In the final chapter, the benefits of the current act, as discussed by the bankers, as well ass problems which need to be solved are outlined. Based on the
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discussion of these problems, a number of recommendations have been formulated, which can make this Act a strong instrument for the improvement of the banking sector?s financial condition.
Objectives of the Study
My main objectives in undertaking this project report are as follows: ? To understand the working of banks with regards to loan appraisal and recovery ? ? To understand the problems faced by banks in the loan recovery process To analyze the impact of „The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002? on the NPAs of banks
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Acknowledgements
Any project report cannot be completed without the help and co-operation of a number of people, who equally contribute to its successful completion. I would like to offer my sincere gratitude to these people. Firstly, my wholehearted gratitude goes to Professor Sanjay Kaila, my mentor, and project guide, without whose help and frank opinion, this project would not have been possible. He motivated me to undertake this detailed study and helped me with all my queries. Thanks a lot, Sir! I would also like to thank Professor Sapna Mallaya, who has taught me the financial concepts. Last, but not the least, I would like to thank the following people at Punjab National Bank for providing their precious time to discuss my project, and providing the information for my case study: ? ? ? Mr. Anil Bhan, Chief Manager, Credit Risk Management Department Mr. Avinash Vaidya, Senior Manager, Credit Risk Management Department Mr. T. V. K. Subramanian, Senior Manager, Credit Risk Management Department ? Mrs. Padmaprabha, Senior Manager, Credit Risk Management Department
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Chapter One
The Concept of Securitisation
Concept of Securitisation
Concept of Securitisation
Normally, a lender (financier) finances loans to borrowers and gets repayment with interest over a period. The lender would collect the periodic installments and use them to finance new loans. This limits his capacity to give fresh loans, as he has to wait until he recovers the installments along with interest. Instead of waiting for a long time, he can pool the loans together and sell his right to receive future payments from the borrowers of these loans. This is termed as securitisation of loans. The original lender will receive consideration for the same upfront, i.e. immediately, by securitizing his loans portfolio. Of course he will receive the amount at a discounted value. He can then use the proceeds to further develop his business, which is of giving loans. These „securitised loans? will be purchased by mutual funds, provident funds and insurance companies, which have funds but do not have a mechanism to assess, grant and recover loans. Thus corporate bodies like finance companies having expertise in assessing, granting and recovering loans get the funds from corporate bodies like mutual funds, provident funds and insurance companies which have funds but do not have expertise in loan assessment and disbursal. However, securitisation is a wider term, which can include all future cash flows. Assets which can be securitised and the types of securitisation are discussed later.
Legal definition
“Securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise.
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Concept of Securitisation
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Meaning of security: In connection with securitisation, the word "security" does not mean what it traditionally might have meant under corporate laws or commerce: a secured instrument. The word "security" here means a financial claim which is generally manifested in form of a document, its essential feature being marketability. To ensure marketability, the instrument must have general acceptability as a store of value. Hence, either it is generally rated by credit rating agencies, or it is secured by charge over substantial assets. Further, to ensure liquidity, the instrument is generally made in homogenous lots.
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Securitisation is the process of commoditisation: The basic idea is to take the outcome of this process into the market, the capital market. Thus, the result of every securitisation process, whatever might be the area to which it is applied, is to create certain instruments which can be placed in the market.
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Securitisation is the process of integration and differentiation: The entity that securitises its assets first pools them together into a common hotchpot (assuming it is not one asset but several assets, as is normally the case). Thus the process of integration. Then, the pool itself is broken into instruments of fixed denomination. This is the process of differentiation.
?
Securitisation is the process of de-construction of an entity: If one envisages an entity's assets as being composed of claims to various cash flows, the process of securitisation would split apart these cash flows into different buckets, classify them, and sell these classified parts to different investors as per their needs. Thus, securitisation breaks the entity into various sub-sets.
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Concept of Securitisation
Example to understand the concept
The simplest way to understand the concept of securitisation is to take an example. Let us say, I want to own a car to run it for hire. I could take a loan with which I could buy the car. The loan is my obligation and the car is my asset, and both are affected by my other assets and other obligations. This is the case of simple financing. On the other hand, if I were to analytically envisage the car, my asset in the instant case, as claim to value over a period of time, that is, ability to generate a series of hire rentals over a period of time, I might sell a part of the cash flow by way of hire rentals for a stipulated time and thereby raise enough money to buy the car. The investor is happier now, because he has a claim for a cash flow which is not affected by my other obligations; I am happier because I have the cake and eat it also, and also, because the obligation to repay the financier is taken care of by the cash flows from the car itself. This is a win-win situation for both the financier and for me.
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Concept of Securitisation
Features of securitisation
A securitised instrument, as compared to a direct claim on the issuer, will generally have the following features:
1. Marketability
The very purpose of securitisation is to ensure marketability to financial claims. Hence, the instrument is structured so as to be marketable. This is one of the most important features of a securitised instrument, and the others that follow are mostly imported only to ensure this one. The concept of marketability involves two postulates: (a) the legal and systemic possibility of marketing the instrument; (b) the existence of a market for the instrument. As far as the legal possibility of marketing the instrument is concerned, traditional mercantile law took a contemporaneous view of marketable documents. In most jurisdictions of the world, laws dealing with marketable instruments (also referred to as negotiable instruments) were mostly limited in application to what were then in circulation as such. Besides, the corporate laws mostly defined and sought to regulate issuance of very usual corporate financial claims, such as shares, bonds and debentures. For any codified law, this is not unexpected, since laws do not lead commerce: most often, they follow, as the concern of the law-maker is mostly regulatory and not promotional. Hence, in most jurisdictions of the world, well-coded laws exist to enable and regulate the issuance of traditional forms of securitised claims, such as shares, bonds, debentures and trade paper (negotiable instruments). Most countries lack in legal systems pertaining to other securitised products, of recent or exotic origin, such as securitisation of receivables. On a policy plane, it is incumbent on the part of the regulator to view any securitised instrument with the same concern as in case of traditional instruments, for reasons of investor protection.
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Concept of Securitisation
However, it needs to be noted that where a law does not exist to regulate issuance of a securitised instrument, it is naive to believe that the law does not permit such issuance. As regulation is a design by humanity itself, it would be ridiculous to presume that everything that is not regulated is not even allowed. Regulation is an exception and freedom is the rule. The second issue is one of having or creating a market for the instrument. Securitisation is a fallacy unless the securitised product is marketable. The very purpose of securitisation will be defeated if the instrument is loaded on to a few professional investors without any possibility of having a liquid market therein. Liquidity to a securitised instrument is afforded either by introducing it into an organised market (such as securities exchanges) or by one or more agencies acting as market makers in it, that is, agreeing to buy and sell the instrument at either pre-determined or market-determined prices.
2. Merchantable quality
To be market-acceptable, a securitised product has to have a merchantable quality. The concept of merchantable quality in case of physical goods is something which is acceptable to merchants in normal trade. When applied to financial products, it would mean the financial commitments embodied in the instruments are secured to the investors' satisfaction. "To the investors' satisfaction" is a relative term, and therefore, the originator of the securitised instrument secures the instrument based on the needs of the investors. The general rule is: the broader the base of the investors, the less is the investors' ability to absorb the risk, and hence, the more the need to securitise. For widely distributed securitised instruments, evaluation of the quality, and its certification by an independent expert, viz., rating is common. The rating serves for the benefit of the lay investor, who is otherwise not expected to be in a position to appraise the degree of risk involved.
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Concept of Securitisation
In case of securitisation of receivables, the concept of quality undergoes drastic change making rating is a universal requirement for securitisations. As already discussed, securitisation is a case where a claim on the debtors of the originator is being bought by the investors. Hence, the quality of the claim of the debtors assumes significance, which at times enables to investors to rely purely on the credit-rating of debtors (or a portfolio of debtors) and so, make the instrument totally independent of the originators' own rating.
3. Wide Distribution
The basic purpose of securitisation is to distribute the product. The extent of distribution which the originator would like to achieve is based on a comparative analysis of the costs and the benefits achieved thereby. Wider distribution leads to a cost-benefit in the sense that the issuer is able to market the product with lower return, and hence, lower financial cost to himself. But wide investor base involves costs of distribution and servicing. In practice, securitisation issues are still difficult for retail investors to understand. Hence, most securitisations have been privately placed with professional investors. However, it is likely that in to come, retail investors could be attracted into securitised products.
4. Homogeneity
To serve as a marketable instrument, the instrument should be packaged as into homogenous lots. Homogeneity, like the above features, is a function of retail marketing. Most securitised instruments are broken into lots affordable to the marginal investor, and hence, the minimum denomination becomes relative to the needs of the smallest investor. Shares in companies may be broken into slices as small as Re. 1 each, but debentures and bonds are sliced into Rs. 100 each to Rs. 1000 each. Designed for larger investors, commercial paper may be in denominations as high as Rs. 5 Lac. Other securitisation applications may also follow this logic. The need to break the whole lot to be securitised into several
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Concept of Securitisation
homogenous lots makes securitisation an exercise of integration and differentiation: integration of those several assets into one lump, and then the latter's differentiation into uniform marketable lots. This often invites the next feature: an intermediary to achieve this process.
5. Special purpose vehicle
In case the securitisation involves any asset or claim which needs to be integrated and differentiated, that is, unless it is a direct and unsecured claim on the issuer, the issuer will need an intermediary agency to act as a repository of the asset or claim which is being securitised. Let us take the easiest example of a secured debenture, in essence, a secured loan from several investors. Here, security charge over the issuer's several assets needs to be integrated, and thereafter broken into marketable lots. For this purpose, the issuer will bring in an intermediary agency whose basic function is to hold the security charge on behalf of the investors, and then issue certificates to the investors of beneficial interest in the charge held by the intermediary. So, whereas the charge continues to be held by the intermediary, beneficial interest therein becomes a marketable security. The same process is involved in securitisation of receivables, where the special purpose intermediary holds the receivables with itself, and issues beneficial interest certificates to the investors.
6. Assets that can be securitised
Basically, all assets which generate a cash flow can be securitised e.g. mortgage loans, housing loans, automobile loans, credit card receivables, trade receivables, consumer loans, lease finance, etc. a perfectly and normal financial asset is usually securitised. A difference is usually made between asset securitisation and mortgage securitisation.
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Concept of Securitisation
Process of Securitisation
Owner (Originator)
Original Loan
Obligor(s)
Consideration
Financial assets such as loans etc., which are securitised Repayment of Loan
Servicer Special purpose Vehicle / Entity
Credit Enhancement
Collections
Consideration Redemption of securities Investors
Securities such as PTCs and/or debt-securities
1. Obligor is an entity which has received a loan giving rise to the financial asset that is securitised by the Originator. 2. Servicer can be Originator also 3. Credit enhancement may be provided by the Originator or any other third party.
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Concept of Securitisation
Process of securitisation
1. The lender (originator) provides various types of loans to borrowers (obligor). 2. Out of these loans, the originator pools certain loans together and sells these to a securitisation company (SPV). 3. The securitisation company makes payment (consideration) to the originator for the loans purchased. 4. These loans are converted into a pool of securities by the securitisation company for the purpose of issuing Pass Through or Pay Through Certificates (PTCs) 5. These PTCs are then rated by Credit Rating Agencies (e.g. CRISIL). 6. The PTCs are sold to individual investors (QIBs) 7. The recovery from original borrower are obtained by original lender (in case of Pass Through Certificates) and by securitisation company (in case of Pay Through Certificates). If collection is made by original lender, he is under obligation to pass on the money to the securitisation company. 8. The securitisation company then, makes payment to the investors.
Terms used in a securitisation transaction
1. The entity that securitises its assets is called the originator: the name signifies the fact that the entity was responsible for originating the claims that are to be ultimately securitised. 2. There is no distinctive name for the investors who invest their money in the instrument: therefore, they might simply be called investors. However, the
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Concept of Securitisation
Act provides for the offer of securities to ‘Qualified Institutional Buyers (QIBs)’ only. No public participation is allowed. QIBs include financial institutions, insurance companies, banks, state financial corporations, state industrial development corporations, trustees or any asset management companies making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund or foreign institutional investors registered under the Securities and Exchange Board of India Act, 1992. 3. The claims that the originator securitise could either be existing claims, or existing assets (in form of claims), or expected claims over time. In other words, the securitised assets could be either existing receivables, or receivables to arise in future. The latter, for the sake of distinction, is sometimes called future flows securitisation, in which case the former is a case of asset-backed securitisation. 4. In US markets, another distinction is mostly common: between mortgagebacked securities and asset-backed securities. This only is to indicate the distinct application: the former relates to the market for securities based on mortgage receivables, which in the USA forms a substantial part of total securitisation markets, and securitisation of other receivables. 5. Since it is important for the entire exercise to be a case of transfer of receivables by the originator, not a borrowing on the security of the receivables, there is a legal transfer of the receivables to a separate entity. In legal parlance, transfer of receivables is called assignment of receivables. It is also necessary to ensure that the transfer of receivables is respected by the legal system as a genuine transfer, and not as a mere eyewash where the reality is only a mode of borrowing. In other words, the transfer of receivables has to be a true sale of the receivables, and not merely a financing against the security of the receivables.
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Concept of Securitisation
6. Since securitisation involves a transfer of receivables from the originator, it would be inconvenient, to the extent of being impossible, to transfer such receivables to the investors directly, since the receivables are as diverse as the investors themselves are. Besides, the base of investors could keep changing as the resulting security is essentially a marketable security. Therefore, it is necessary to bring in an intermediary that would hold the receivables on behalf of the end investors. This entity is created solely for the purpose of the transaction: therefore, it is called a special purpose vehicle (SPV) or a special purpose entity (SPE) or, if such entity is a company, special purpose company (SPC). The function of the SPV in a securitisation transaction could stretch from being a pure conduit or intermediary vehicle, to a more active role in reinvesting or reshaping the cash flows arising from the assets transferred to it. Therefore, the originator transfers the assets to the SPV, which holds the assets on behalf of the investors, and issues to the investors its own securities. Therefore, the SPV is also called the issuer. In the Act an independent ‘Securitisation Company’ or ‘Asset Reconstruction Company’ is envisaged. 7. There is no uniform name for the securities issued by the SPV as such securities take different forms. These securities could either represent a direct claim of the investors on all that the SPV collects from the receivables transferred to it: in this case, the securities are called pass through certificates or beneficial interest certificates as they imply certificates of proportional beneficial interest in the assets held by the SPV. Alternatively, the SPV might be re-configuring the cashflows by reinvesting it, so as to pay to the investors on fixed dates, not matching with the dates on which the transferred receivables are collected by the SPV. In this case, the securities held by the investors are called pay through certificates. The securities
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Concept of Securitisation
issued by the SPV could also be named based on their risk or other features, such as senior notes or junior notes, floating rate notes, etc. 8. Another word commonly used in securitisation exercises is bankruptcy remote transfer. What it means is that the transfer of the assets by the originator to the SPV is such that even if the originator were to go bankrupt, or get into other financial difficulties, the rights of the investors on the assets held by the SPV is not affected. In other words, the investors would continue to have a paramount interest in the assets irrespective of the difficulties, distress or bankruptcy of the originator.
Benefits from Securitisation of Assets
Securitisation is designed to offer a number of advantages to the seller, investor and debt markets. 1. For seller or originator: Securitisation mainly results in receivables being replaced by cash thereby improving the liquidity position. It removes the assets from the balance sheet of the originator, thus liberating capital for other uses, and enabling restructuring of the balance sheet by reducing large exposures or sectoral concentration. It facilitates better asset liability management by reducing market risks resulting from interest rate mismatches. The process also enables the issuer to recycle assets more frequently and thereby improve earning. Finally, transparency may be improved since securitisation results in identifiable assets in the balance sheet. 2. For investor: Securitisation essentially provides an avenue for relatively riskfree investment. The credit enhancement provides an opportunity to investors to acquire good quality assets and to diversify their portfolios.
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Concept of Securitisation
3. From the point of view of the financial system as a whole: Securitisation increases the number of debt instruments in the market, and provides additional liquidity in the market. It also facilitates unbundling, better allocation and management of project risks. It could widen the market by attracting new players on account of superior quality assets being available. 4. It also provides opportunity for matching cash flows and managing ALM since a securitised instrument carries regular monthly cash flows and has varying maturities. The prevalence of secondary markets would offer liquidity.
Risks faced, Threats Involved if Securitisation is not carried out prudentially
If not carried out prudentially, Securitisation can leave risks with the originating bank without allocating capital to back them. While all banking activity entails operational and legal risks, these may be greater, the more complex the activity. It is felt that the main risk a bank may face in a securitisation scheme arises if a true sale has not been achieved and the selling bank is forced to recognise some or all of the losses if the assets subsequently cease to perform. Also, funding risks and constraints on liquidity may arise if assets designed to be securitised have been originated, but because of disturbances in the market, the securities cannot be placed. There is also a view that there is at least a potential conflict of interest if a bank originates, sells, services and underwrites the same issue of securities.
Securitisation in India
Available data indicates that ICICI had securitised assets to the tune of Rs.2,750 crore in its books as at end March 1999. Assets to the tune of Rs.1,200 crore was in the process of being bought over up to end of FY-1998'99.. CRISIL is
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Concept of Securitisation
reported to have rated about Rs. 1,200 crore of securitised transactions up to 1998. In addition, there have been several unrated transactions. The first widely reported securitisation deal in India dates back to 1990 when Citibank securitised auto loans and placed a paper with GIC mutual fund. Since then, a variety of deals have been undertaken. Asset classes chosen have concentrated mostly on auto and hire purchase receivables of NBFCs. According to some estimates, 35 per cent of all securitisation deals between 1992 and 1998 related to hire purchase receivables of trucks and the rest towards other auto/transport segment receivables. Apart from these, some innovative deals have also been struck. Earlier, in 199495, SBI Cap structured an innovative deal where a pool of future cash flows of high value customers of Rajasthan State Industrial and Development Corporation was securitised. An oil monetisation deal has been structured where the future flows of oil receivables accruing to a company was securitised. Real estate developers have securitised receivables arising out of installment sales. The recent securitisation deal of Larsen & Toubro has opened a new vista for financing power projects. The deal was a securitisation of lease receivables even before the plant was completed. Thus, this securitisation deal financed even the asset creation. National Housing Bank (NHB) has made efforts to structure the pilot issue of mortgage backed securities (MBS) within the existing legal, fiscal and regulatory framework. Under the proposed transaction, mortgage debt shall be
transferred/assigned/sold to NHB by Housing Finance Companies (HFC) (originator) pursuant to an agreement/contract in the 'debt simplicitor form'. NHB will act as an issuer of pass through certificates (PTCs) and as a trustee on behalf of the investors. There is a view that there will be a conflict of interest if NHB, a regulator also acts as a trustee. However, as stated in the RBI discussion paper on universal banking, the ownership, regulatory and supervisory
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Concept of Securitisation
framework of the development financial institutions are under review. Based on the Indian experience before the Act has been passed, the following features of securitisation appear noteworthy. 1. Most deals have involved the transfer of beneficial interest on the asset and not the legal title. 2. Most transactions have followed the pass-through mechanism. 3. In fact, many transactions have followed the escrow mechanism where receivables are transferred to an escrow account for payment to the buyer. 4. According to Duff & Phelps India, a rating agency, past deals have mostly been direct purchases of receivables by institutions and bigger NBFCs. 5. Routing the transaction through a Special Purpose Vehicle is yet to gain popularity. 6. There appears to be no secondary market for securitised debt. 7. The market is unregulated and lacks transparency in terms of volume, price, parties to the transaction, etc. 8. The settlement procedures are not clear. 9. There are no standard accounting and valuation norms.
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Chapter Two
Need for Securitisation Act
Need for the Securitisation Act
NPAs in the banking sector
Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures taken under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports have been neutralised by the ill effects of this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by Nationalised Banks, followed by the SBI group, and the all India Financial Institutions. NPA is a brought forward legacy accumulated over the past three decades, when prudent norms of banking were forsaken basking by the halo of security provided by government ownership. It is not wrong to have pursued social goals, but this does not justify relegating banking goals and fiscal discipline to the background. But despite this extravagance the malaise remained invisible to the public eyes due to the practice of not following transparent accounting standards, but keeping the balance sheets opaque. This artificially conveyed picture of 'all is well' with PSBs suddenly came to an end when the lid was open with the introduction of the prudential norms of banking in the year 1992-93, bringing total transparency in disclosure norms and 'cleansing' the balance sheets of commercial banks for the first time in the country.
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Need for the Securitisation Act
How RBI Describes this New Development in its Web Site In the peak crisis period in early Nineties, when the first Series of Banking Reforms were introduced, the working position of the State-owned banks exhibited the severest strain. Commenting on this situation the Reserve Bank of India in its web-site has pointed out as under: "Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twentyseven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed." Consequently PSBs in the post reform period came to be classified under three categories as ?
healthy banks (those that are currently showing profits and hold no accumulated losses in their balance sheet)
?
banks showing currently profits, but still continuing to have accumulated losses of prior years carried forward in their balance sheets
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Banks which are still in the red, i.e. showing losses in the past and in the present.
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Need for the Securitisation Act
Definition of Non-performing Asset
"Non-performing asset" means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or under guidelines relating to assets classifications issued by the Reserve Bank. RBI Guidelines for classification of NPAs have been provided in Annexure 3.
NPA statistics
As at 31.03.2002 the aggregate gross NPA of all scheduled commercial banks amounted to Rs.70,904 Crore. Table No. I gives the figures of gross and net NPA for the last five years. It shows an increase of Rs. 7,163 Crore or more than 11% in the last financial year, indicating that fresh accretion to NPA is more than the recoveries that were effected, thus signifying a losing battle in containing this menace. Table No. I - NPA Statistics -All Scheduled Commercial Banks
Year
Total Gross Net Net NPA Advances NPA Advances 50,815 58,722 60,408 3,25,522 3,67,012 4,44,292 25,734 27,892 30,211
%-age Gross NPA to total advances 14.4 14.7 12.7
%-age Net NPA to net advances 7.3 7.6 6.8
1997-98 3,52,697 1998-99 3,99,496 19992000 20002001 20012002 4,75,113
5,58,766 6,80,958
63,741 70,904
5,26,329 6,45,859
32,632 35,546
11.4 10.4
6.2 5.5
(Amount in Crores, Source: RBI Report)
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Need for the Securitisation Act
The apparent reduction of gross NPA from 14.4% to 10.4% between 1998 and 2002 provides little comfort, since this accomplishment is on account of credit growth, which was higher than the growth of Gross NPA and not through appreciable recovery of NPA. There is neither reduction nor even containment of the threat. The gross NPA for Public Sector Banks (PSBs) as at 31.03.2002 are 11.1% are higher than the figures for All Scheduled Commercial Banks at 10.4%. Comparative figures for PSBs, SBI Group and Nationalised Banks are as under. Table - 2: NPA of PSBs (Amount in Crores)
Year
Total Gross NPA Net NPA Advances
%-age of Gross NPA to total advances 17.8 % 16.0 % 15.9 % 14.00 % 12.39 % 11.1%
%-age of Net NPA to net advances 9.2 % 8.2 % 8.1 % 7.9% 6.74% 5.8%
1996-97 1997-98 1998-99 1999-2000 2000-2001 2001-2002
2,44,214 2,84,971 3,25,328 3,80,077 4,42,134 5,09,368
43,577 45,563 51,710 53,033 54,773 56,507
20,285 21,232 24,211 26,188 27,967 27,958
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Need for the Securitisation Act
Table -3: NPA of State Bank Group (Amount in Crores)
Year 1997-98 1998-99 19992000 20002001
Total Advances 113360 118959 129253 150390
Gross NPA 15522 18641 19773 20586
Net NPA 6829 7764 7411 8125
%-age of Gross NPA to total advances 14.57% 15.67 % 14.08 % 12.73 %
%-age of Net NPA to net advances 6.98 % 7.74 % 6.77 % 6.26 %
Table -4: NPA of Nationalised Banks (Amount in Crores)
Year
Total Advances
Gross NPA
Net NPA
%-age of Gross NPA to total advances 16.88 16.02 13.99 12.19
%-age of Net NPA to net advances 8.91 8.35 7.80 7.01
1997-98 1998-99 1999-2000 2000-2001
166222 188926 224818 264237
30130 33069 33521 34609
14441 15759 17399 16096
Further it is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of 'ever-greening' of advances, through subtle techniques. As per report appearing in a national daily the banking industry has under-estimated its non-performing assets (NPAs) by whopping Rs. 3,862.10 Crore as on March 1997. The industry is also estimated
22
Need for the Securitisation Act
to have under-provided to the extent of Rs 1,412.29 Crore. The worst "offender" is the public sector banking industry. Nineteen nationalised banks along with the State Bank of India and its seven associate banks have underestimated their NPAs by Rs 3,029.29 Crore. Financial institutions have not far lagged behind. NPAs of ten leading institutions have reported a rise of 11.89 per cent, or Rs 1,929 Crore, to Rs 18,146 Crore during the year ended March 2000 from Rs 16,217 Crore last year. The NPA statistics of the three leading Financial Institutions for the last two years are given in Table-5 IDBI tops the list by notching up bad loans worth Rs 7665 Crore by March 2000. In fact, its NPAs have gone up by Rs 1,185 Crore from Rs 6,490 Crore in the previous year. IFCI followed with NPAs of Rs 4,103 Crore, but it reported fall of Rs 134 Crore from the previous year's level of Rs 4,237 Crore. ICICI's NPAs went up to Rs 3,959 Crore from Rs 3,623 Crore in the previous year. Table 5- NPA Statistics of the three Major Term Lending Institutions as at 31.03.2001.
Name Total Loans Total Loans NPA NPA -% age NPA NPA -% age of FI 31.3.2000 31.3.2001 31.3.2000 31.3.2000 31.3.2001 31.3.2001 IDBI ICICI IFCI 57099 52341 19841 56477 57507 18715 7665 3959 4103 13.4 7.6 20.7 8363 2782 3897 13.9 5.2 20.8
(Amount in Crores)
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Need for the Securitisation Act
Adverse effects of NPAs on banks
NPA has affected the profitability, liquidity and competitive functioning of PSBs and finally the psychology of the bankers in respect of their disposition towards credit delivery and credit expansion.
1. Impact on Profitability
"The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks, but at the same time banks are required to make provisions for such NPAs from their current profits. NPAs have a deleterious effect on the return on assets in several ways ? ? ?
They erode current profits through provisioning requirements They result in reduced interest income They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future, and
?
They limit recycling of funds, set in asset-liability mismatches, etc
There is at times a tendency among some of the banks to understate the level of NPAs in order to reduce the provisioning and boost up bottom lines. It would only postpone the process. In the context of crippling effect on a bank's operations in all spheres, asset quality has been placed as one of the most important parameters in the measurement of a bank's performance under the CAMELS supervisory rating system of RBI.
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Need for the Securitisation Act
Between 01.04.93 to 31.03.2001, Commercial banks incurred a total amount of Rs.31251 Crores towards provisioning NPA. This has brought Net NPA to Rs.32632 Crores or 6.2% of net advances. To this extent, the problem is contained, but at what cost? This costly remedy is made at the sacrifice of building healthy reserves for future capital adequacy. The enormous provisioning of NPA together with the holding cost of such nonproductive assets over the years has acted as a severe drain on the profitability of the PSBs. In turn PSBs are seen as poor performers and unable to approach the market for raising additional capital. Equity issues of nationalised banks that have already tapped the market are now quoted at a discount in the secondary market. Other banks hesitate to approach the market to raise new issues. This has alternatively forced PSBs to borrow heavily from the debt market to build Tier II Capital to meet capital adequacy norms putting severe pressure on their profit margins, else they are to seek the bounty of the Central Government for repeated Recapitalisation. Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of funds at 6% plus 1% service charge) the net NPA of Rs.32632 Crores absorbs a recurring holding cost of Rs.2300 Crores annually. Considering the average provisions made for the last 8 years, which works out to average of Rs.3300 crores from annum, a sizeable portion of the interest income is absorbed in servicing NPA. NPA is not merely non-remunerative. It is also cost absorbing and profit eroding. In the context of severe competition in the banking industry, the weak banks are at disadvantage for leveraging the rate of interest in the deregulated market and securing remunerative business growth. The options for these banks are lost. "The spread is the bread for the banks". This is the margin between the cost of resources employed and the return therefrom. In other words it is gap between the return on funds deployed (Interest earned on credit and investments) and
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Need for the Securitisation Act
cost of funds employed (Interest paid on deposits). When the interest rates were directed by RBI, as heretofore, there was no option for banks. But today in the deregulated market the banks decide their lending rates and borrowing rates. In the competitive money and capital Markets, inability to offer competitive market rates adds to the disadvantage of marketing and building new business. In the face of the deregulated banking industry, an ideal competitive working is reached, when the banks are able to earn adequate amount of non-interest income to cover their entire operating expenses i.e. a positive burden. In that event the spread factor i.e. the difference between the gross interest income and interest cost will constitute its operating profits. Theoretically even if the bank keeps 0% spread, it will still break even in terms of operating profit and not return an operating loss. The net profit is the amount of the operating profit minus the amount of provisions to be made including for taxation. On account of the burden of heavy NPA, many nationalised banks have little option and they are unable to lower lending rates competitively, as a wider spread is necessitated to cover cost of NPA in the face of lower income from off balance sheet business yielding non-interest income. The following working results of Corporation bank an identified well managed nationalised banks for the last two years and for the first nine months of the current financial year, will be revealing to prove this statement-
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Need for the Securitisation Act
Table - 6 (part-1) - Performance of Corporation Bank (Amount in Crores)
Performance indicator Earnings interest Non-
Year ended Year ended Mar. 9 months Mar. 2000 2001 Apr.Decr.2001 270.81 292.09 341.36 - 49.27 285.85 280.52 5.33
Operating expenses 303.99 Difference - 33.18
Non-interest income fully absorbs the operating expenses of this bank in the current financial year for the first 9 months. In the last two financial years, though such income has substantially covered the operating expenses (between 80 to 90%) there is still a deficit left. Now what are the interest earnings and expenses of Corporation Bank during this period? Table - 6 (part-2) Corporation Bank - Interest Earnings and Expense (Amount in Crores)
Performance indicator Earnings - Interest Income Exp.- Interest expenses Interest spread Operating Profit Provisions Net Profit
Year ended Mar. 2000 1604.39 1146.09 458.30 425.12 192.68 232.44
Year ended 9 months Mar. 2001 Apr.Decr.2001 1804.54 1223.21 581.33 482.21 270.22 261.84 1458.33 981.45 476.88 532.06 219.48 262.73
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Need for the Securitisation Act
The strength of Corporation Bank is identified by the following positive features: 1. It's sizeable earnings under of non-interest income substantially/totally meets its non-interest expenses. 2. Its obligation for provisioning requirements is within bounds. (Net NPA/Net Advances is 1.92%) It is worthwhile to compare the aggregate figures of the 19 Nationalised banks for the year ended March 2001, as published by RBI in its Report on trends and progress of banking in India. Table 7- Nationalised banks operational statistics (Amount in Crores)
Performance indicator Earnings - Non-interest Operating expenses Difference Earnings - interest income Exp.-Interest expenses Interest spread Intt. On Recap bonds Operating Profit Provisions Net Profit
Year ended Mar. 2000 6662.42 14251.87 - 7589.45 50234.01 35477.41 14756.60 1797.88 5405.27 4766.15 639.12
Year ended Mar. 2001 7159.41 17283.55 - 10124.14 56967.11 38789.64 18177.47 1795.48 6257.85 5958.24 299.61
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Need for the Securitisation Act
Interest on Recapitalisation Bonds is a income earned from the Government, who had issued the Recapitalisation Bonds to the weak banks to sustain their capital adequacy under a bail out package. The statistics above show the other weaknesses of the nationalised banks in addition to the heavy burden they have to bear for servicing NPA by way of provisioning and holding cost as under: ? Their operating expenses are higher due to surplus manpower employed. Wage costs to total assets is much higher to PSBs compared to new private banks or foreign banks. ? Their earnings from sources other than interest income are meagre. This is due to failure to develop off balance sheet business through innovative banking products.
2. Impact on Liquidity of the Nationalised Banks
Though nationalised banks (except Indian Bank) are able to meet norms of Capital Adequacy, as per RBI guidelines, the fact that their net NPA in the average is as much as 7% is a potential threat for them. RBI has indicated the ideal position as Zero percent Net NPA. Even granting 3% net NPA within limits of tolerance the nationalised banks are holding an uncomfortable burden at 7.1% as at March 2001. They have not been able to build additional capital needed for business expansion through internal generations or by tapping the equity market, but have resorted to II-Tier capital in the debt market or looking to recapitalistion by Government of India.
3. Impact on Outlook of Bankers towards Credit Delivery
The fear of NPA permeates the psychology of bank managers in the PSBs in entertaining new projects for credit expansion. In the world of banking the concepts of business and risks are inseparable. Business is an exercise of balancing between risk and reward. Accept justifiable risks and implement de-
29
Need for the Securitisation Act
risking steps. Without accepting risk, there can be no reward. The psychology of the banks today is to insulate themselves with zero percent risk and turn lukewarm to fresh credit. This has affected adversely credit growth compared to growth of deposits, resulting in a low C/D Ratio around 50 to 54% for the industry. The fear psychosis also leads to excessive security-consciousness in the approach towards lending to the small and medium sized credit customers. There is insistence on provision of collateral security, sometimes up to 200% value of the advance, and consequently due to a feeling of assumed protection on account of holding adequate security (albeit over-confidence), a tendency towards laxity in the standards of credit appraisal comes to the fore. It is well known that the existence of collateral security at best may convert the credit extended to productive sectors into an investment against real estate, but will not prevent the account turning into NPA. Further blocked assets and real estate represent the most illiquid security and NPA in such advances has the tendency to persist for a long duration. Nationalised banks have reached a dead-end of the tunnel and their future prosperity depends on an urgent solution threat. for handling this hovering
30
Need for the Securitisation Act
What does the RBI Governor feel about the banks’ problems? "As regards internal factors leading to NPAs, the onus rests with the banks themselves. This calls for organisational restructuring, improvement in managerial efficiency, skill upgradation for proper assessment of
creditworthiness and a change in the attitude of the banks towards legal action which is traditionally viewed as a measure of the last resort. These are the elements on the agenda of the second phase of reforms”. Dr.Bimal Jalan, Governor, RBI (In a speech titled "Banking and Finance in the New Millennium." at 22nd Bank Economists Conference, New Delhi,15th February, 2001)
Initiatives of Government and RBI for Reduction of NPAs
1. Compromise settlement schemes
The RBI / Government of India have been constantly goading the banks to take steps for arresting the incidence of fresh NPAs and have also been creating legal and regulatory environment to facilitate the recovery of existing NPAs of banks. More significant of them, I would like to recapitulate at this stage.
?
The broad framework for compromise or negotiated settlement of NPAs advised by RBI in July 1995 continues to be in place. Banks are free to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements with the approval of their Boards, particularly for old and unresolved cases falling under the NPA category. The policy framework suggested by RBI provides for setting up of an independent Settlement Advisory Committees headed by a retired Judge of the High Court to scrutinise and recommend compromise proposals
31
Need for the Securitisation Act ?
Specific guidelines were issued in May 1999 to public sector banks for one time non discretionary and non discriminatory settlement of NPAs of small sector. The scheme was operative up to September 30, 2000. [Public sector banks recovered Rs. 668 crore through compromise settlement under this scheme.]
?
Guidelines were modified in July 2000 for recovery of the stock of NPAs of Rs. 5 crore and less as on 31 March 1997. [The above guidelines which were valid up to June 30, 2001 helped the public sector banks to recover Rs. 2600 crore by September 2001]
?
An OTS Scheme covering advances of Rs.25000 and below continues to be in operation and guidelines in pursuance to the budget announcement of the Hon'ble Finance Minister providing for OTS for advances up to Rs.50,000 in respect of NPAs of small/marginal farmers are being drawn up.
2. Lok Adalats
Lok Adalats help banks to settle disputes involving accounts in "doubtful" and "loss" category, with outstanding balance of Rs.5 lakh for compromise settlement under Lok Adalats. Debt Recovery Tribunals have now been empowered to organize Lok Adalats to decide on cases of NPAs of Rs.10 lakhs and above. The public sector banks had recovered Rs.40.38 crore as on September 30, 2001, through the forum of Lok Adalat. The progress through this channel is expected to pick up in the coming years particularly looking at the recent initiatives taken by some of the public sector banks and DRTs in Mumbai.
3. Debt Recovery Tribunals
The Recovery of Debts due to Banks and Financial Institutions (amendment) Act, passed in March 2000 has helped in strengthening the functioning of DRTs. Provisions for placement of more than one Recovery Officer, power to attach
32
Need for the Securitisation Act
defendant's property/assets before judgement, penal provisions for disobedience of Tribunal's order or for breach of any terms of the order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in the times to come. Though there are 22 DRTs set up at major centres in the country with Appellate Tribunals located in five centres viz. Allahabad, Mumbai, Delhi, Calcutta and Chennai, they could decide only 9814 cases for Rs.6264.71 crore pertaining to public sector banks since inception of DRT mechanism and till September 30, 2001.The amount recovered in respect of these cases amounted to only Rs.1864.30 crore. Looking at the huge task on hand, with as many as 33049 cases involving Rs.42988.84 crore pending before them as on September 30, 2001, I would like the banks to institute appropriate documentation system and render all possible assistance to the DRTs for speeding up decisions and recovery of some of the well collateralised NPAs involving large amounts. I may add that familiarisation programmes have been offered in NIBM at periodical intervals to the presiding officers of DRTs in understanding the complexities of documentation and operational features and other legalities applicable of Indian banking system. RBI on its part has suggested to the Government to consider enactment of appropriate penal provisions against obstruction by borrowers in possession of attached properties by DRT receivers, and notify borrowers who default to honour the decrees passed against them.
4. Circulation of information on defaulters
The RBI has put in place a system for periodical circulation of details of willful defaults of borrowers of banks and financial institutions. This serves as a caution list while considering requests for new or additional credit limits from defaulting
33
Need for the Securitisation Act
borrowing units and also from the directors /proprietors / partners of these entities. RBI also publishes a list of borrowers (with outstanding aggregating Rs. 1 crore and above) against whom suits have been filed by banks and FIs for recovery of their funds, as on 31st March every year. It is our experience that these measures had not contributed to any perceptible recoveries from the defaulting entities. However, they serve as negative basket of steps shutting off fresh loans to these defaulters. I strongly believe that a real breakthrough can come only if there is a change in the repayment psyche of the Indian borrowers.
5. Recovery action against large NPAs
After a review of pendency in regard to NPAs by the Hon'ble Finance Minister, RBI had advised the public sector banks to examine all cases of willful default of Rs 1 crore and above and file suits in such cases, and file criminal cases in regard to willful defaults. Board of Directors are required to review NPA accounts of Rs.1 crore and above with special reference to fixing of staff accountability. On their part RBI and the Government are contemplating several supporting measures including legal reforms, some of them I would like to highlight.
6. Corporate Debt Restructuring (CDR)
Corporate Debt Restructuring mechanism has been institutionalised in 2001 to provide a timely and transparent system for restructuring of the corporate debts of Rs.20 crore and above with the banks and financial institutions. The CDR process would also enable viable corporate entities to restructure their dues outside the existing legal framework and reduce the incidence of fresh NPAs. The CDR structure has been headquartered in IDBI, Mumbai and a Standing Forum and Core Group for administering the mechanism had already been put in place. The experiment however has not taken off at the desired pace though more than six months have lapsed since introduction. As announced by the Hon'ble Finance Minister in the Union Budget 2002-03, RBI has set up a high
34
Need for the Securitisation Act
level Group under the Chairmanship of Shri. Vepa Kamesam, Deputy Governor, RBI to review the implementation procedures of CDR mechanism and to make it more effective. The Group will review the operation of the CDR Scheme, identify the operational difficulties, if any, in the smooth implementation of the scheme and suggest measures to make the operation of the scheme more efficient.
7. Credit Information Bureau
Institutionalisation of information sharing arrangements through the newly formed Credit Information Bureau of India Ltd. (CIBIL) is under way. RBI is considering the recommendations of the S.R.Iyer Group (Chairman of CIBIL) to
operationalise the scheme of information dissemination on defaults to the financial system. The main recommendations of the Group include dissemination of information relating to suit-filed accounts regardless of the amount claimed in the suit or amount of credit granted by a credit institution as also such irregular accounts where the borrower has given consent for disclosure. This, I hope, would prevent those who take advantage of lack of system of information sharing amongst lending institutions to borrow large amounts against same assets and property, which had in no small measure contributed to the incremental NPAs of banks.
8. Proposed guidelines on willful defaults/diversion of funds
RBI is examining the recommendation of Kohli Group on willful defaulters. It is working out a proper definition covering such classes of defaulters so that credit denials to this group of borrowers can be made effective and criminal prosecution can be made demonstrative against willful defaulters.
9. Corporate Governance
A Consultative Group under the chairmanship of Dr.A.Ganguly was set up by the Reserve Bank to review the supervisory role of Boards of banks and financial
35
Need for the Securitisation Act
institutions and to obtain feedback on the functioning of the Boards vis-à-vis compliance, transparency, disclosures, audit committees etc. and make recommendations for making the role of Board of Directors more effective with a view to minimising risks and over-exposure. The Group is finalising its recommendations shortly and may come out with guidelines for effective control and supervision by bank boards over credit management and NPA prevention measures.
Problems with previous methods of loan recovery
1. Inadequate security & Erosion in value of security
Generally, banks tend to find that there is a major gap in the valuation of the security, as carried out at the time of providing the loan and at the time of loan recovery. The value of the security has generally deteriorated over the period, and according to experts, it may further deteriorate by almost 10-50% in quick action is not taken for its immediate sale.
2. Political interference
Political interference in the day – to – day functioning of public sector banks created a number of problems for them. The populist policies of the national level politicians, such as waiver in repayment only added to these problems.
3. Slow legal procedures
Before the establishment of DRTs in 1993, the banks had to approach the normal courts to recover their dues. There were provisions under various acts which hampered the smooth takeover and sale of secured assets. The legal process could take years to be completed, with the borrower having ample scope for delaying the takeover of assets. A number of loopholes provided the borrower with opportunities to delay or ignore repayment of loans. During
36
Need for the Securitisation Act
this period, it was said by some unscrupulous businessmen that – “there is no difference between equity and debt – you never have to repay either of them.”
4. Swamping of DRTs with cases
Once DRTs were established to quicken the pace of recovery procedures, the pace of recovery improved quite a bit. However, the DRTs were soon drowned in the ever increasing number of cases. The pending number of cases with the DRTs increased manifold during the period 1993-2002.
5. Misuse of BIFR / SICA
This was one of the favourite methods of willful defaulters to delay repayment. If the defaulter?s company is declared sick and taken for financial reconstruction under BIFR, it is not possible to undertake any recovery proceeding against the company. The procedure of financial reconstruction can take a number of years together, thereby delaying recovery to a great extent.
6. Transfer of property Act, English mortgage
Under provisions of Section 69 of Transfer of Property Act, mortgagee can take possession of mortgaged property and sell the same without the intervention of the Court only in the case of English Mortgage. In addition, mortgagee can take possession of mortgaged property where there is specific provision in mortgage deed and it is situated in the towns of Mumbai, Kolkata and Chennai only. In other cases, intervention of the court is required. However, this is very slow and time consuming process and by the time bank / FI is able to get possession; the asset either does not exist or has become valueless.
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Need for the Securitisation Act
Causes of NPAs
It is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of 'ever-greening' of advances, through subtle techniques. As per report appearing in a national daily the banking industry has under-estimated its non-performing assets (NPAs) by whopping Rs. 3,862.10 Crore as on March 1997. The industry is also estimated to have underprovided to the extent of Rs 1,412.29 Crore. The worst "offender" is the public sector banking industry. Nineteen nationalised banks along with the State Bank of India and its seven associate banks have underestimated their NPAs by Rs 3,029.29 Crore. Such deception of NPA statistics is executed through the following ways.
?
Failure to identify an NPA as per stipulated guidelines: There were instances of `sub-standard' assets being classified as `standard';
?
Wrong classification of an NPA: classifying a `loss' asset as a `doubtful' or `sub-standard' asset; classifying a `doubtful' asset as a `sub-standard' asset.
?
Classifying an account of a credit customer as `substandard' and other accounts of the same credit customer as `standard', throwing prudential norms to the winds.
Essentially arising from the wrong classification of NPAs, there was a variation in the level of loan loss provisioning actually held by the bank and the level required to be made. This practice can be logically explained as a desperate attempt on the part of the bankers, whenever adequate current earnings were not available to meet provisioning obligations. Driven to desperation and impelled by the desire not to accept defeat, they have chosen to mislead and claim compliance with the provisioning norms, without actually providing. This only shows that the problem has swelled to graver dimensions.
38
Need for the Securitisation Act
Conclusion
Hence, it can be concluded from the above factual and empirical data as shown in Tables 1 to __ that earlier mechanisms to tackle the problems of NPAs had various loopholes and could not deliver the desired results. Hence, there was a need felt by the government, banking sector and corporates for a new legislation to tackle the menace of increasing NPAs and remove the loopholes of the previous methods.
39
Chapter Three
Securitisation Act – A new landmark in the Indian financial sector
Securitisation Act – A New Landmark in the Indian Financial Sector
Scope & Objectives of the Act
The object clause of the Act describes the legal measure as "An Act to regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto". The Act allows setting up of ARC/SC companies to be registered with and regulated by RBI. Under the Act identical powers and functions are prescribed for both types of companies, Securitisation Companies and Asset Reconstruction Companies. Scope of the Act As per an official release of Government of India from New Delhi, "The act deals with three distinct actions in respect of financial assets held by banks and FIs in the form of securitisation of financial assets, setting up of asset reconstruction companies and enforcement of security interest." These three actions are in fact not seen as distinct, but inter-connected. Securitisation as a co-function helps ARC/SC companies to operate with minimum capital under a sort of selfgenerated source of funding, while enforcement of security interest helps ARC/SC companies to take possession, to securitise and later to realise the financial assets, more quickly and easily without approaching DRTs or Law Courts. During January 2002, the Reserve Bank of India, while forwarding its recommendation to the Government for setting up of Asset Reconstruction Companies, had suggested such companies for one time operation with a maximum life-span of seven years and a minimum initial paid-up capital of Rs 100-crore. The suggestion places the authorised capital of ARCs at Rs 500 crore. RBI had then contemplated ARC companies as distinct entities, without the function of securitisation of assets. They would only take over past NPAs of the bank at the time of their incorporation and not NPAs accruing subsequently. However the Government of India by combining and empowering the functions of
41
Securitisation Act – A New Landmark in the Indian Financial Sector
Asset Reconstruction and securitisation to be exercised by a single entity, has enabled ARC/SC companies to be incorporated with an initial capital of Rs.2 Crores (minimum) or 15% of the financial assets to be acquired (maximum). RBI is vested with powers, under the Act, to stipulate the quantum of capital to be owned by ARC/SC companies within this range, and for regulating the functioning of these companies after registration. a) registration and regulation of securitisation companies or reconstruction companies by the Reserve Bank of India; b) facilitating securitisation of financial assets of banks and financial institutions with or without the benefit of underlying securities; c) facilitating easy transferability of financial assets by the securitisation company or reconstruction company to acquire financial assets of banks and financial institutions by issue of debentures or bonds or any other security in the nature of a debenture; d) empowering securitisation companies' or reconstruction companies to raise funds by issue of security receipts to qualified institutional buyers; e) facilitating reconstruction of financial assets acquired by exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks and financial institutions; f) declaration of any securitisation company or reconstruction company registered with the Reserve Bank of India as a public financial institution for the purpose of section 4A of the Companies Act, 1956; g) defining 'security interest' as any type of security including mortgage and change on immovable properties given for due repayment of any financial assistance given by any bank or financial institution;
42
Securitisation Act – A New Landmark in the Indian Financial Sector
h) empowering banks and financial institutions to take possession of securities given for financial assistance and sell or lease the same or take over management in the event of default, i.e. classification of the borrower's account as non-performing asset in accordance with the directions given or under guidelines issued by the Reserve Bank of India from time to time; i) the rights of a secured creditor to be exercised by one or more of its officers authorised in this behalf in accordance with the rules made by the Central Government; j) an appeal against the action of any bank or financial institution to the concerned Debts Recovery Tribunal and a second appeal to the Appellate Debts Recovery Tribunal; k) setting up or causing to be set up a Central Registry by the Central Government for the purpose of registration of transactions relating to securitisation, asset reconstruction and creation of security interest; l) application of the proposed legislation initially to banks and financial institutions and empowerment of the Central Government to extend the application of the proposed legislation to non-banking financial companies and other entities; m) Non-application of the proposed legislation to security interests in agricultural lands, loans not exceeding rupees one lakh and cases where eighty per cent, of the loans are repaid by the borrower.
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Securitisation Act – A New Landmark in the Indian Financial Sector
Some important definitions
Understanding the legal definitions of the words and terms is important for the proper interpretation of the provisions of the act. It is also provided that "Words and expressions used and not defined in this Act but defined in the Indian Contract Act, 1872 or the Transfer of Property Act, 1882 or the Companies Act, 1956 or the Securities and Exchange Board of India Act, 1992 shall have the same meanings respectively assigned to them in those Acts."[Section 2(2)]
The Act defines securitisation as per Clause 2(1)(z) as under: "securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise;[Section 2(1)(z)]
The term "financial assets" has been defined in Clause 2(1)(l) as under: "Financial asset" means debt or receivables and includes-i. a claim to any debt or receivables or part thereof, whether secured or unsecured; or ii. any debt or receivables secured by, mortgage of, or charge on, immovable property; or iii. a mortgage, charge, hypothecation or pledge of movable property; or iv. any right or interest in the security, whether full or part underlying such debt or receivables; or
44
Securitisation Act – A New Landmark in the Indian Financial Sector
v. any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, accruing, conditional or contingent; or vi. any financial assistance; "Originator" means the owner of a financial asset which is acquired by a securitisation company or reconstruction company for the purpose of securitisation or asset reconstruction;[Section 2(1)(r)]
The act defines "Securitisation Company" as any company formed and registered under the Companies Act, 1956 for the purpose of securitisation. [(Section 2(1)(za)]. It thus precludes such companies registered under the Indian Trusts Act and engaging exclusively in the function of securitisation of assets. There is no bar on securitisation through non-corporate Special Purpose Vehicles (SPVs) outside the law, but such entities cannot exercise powers under this Act. The act therefore may be considered as not to be legislating on "securitisation" as such but on this function to be exercised specifically by ARC companies for asset reconstruction of NPAs of banks/FIs exclusively.
"Qualified institutional buyer" is defined as "a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or any asset management company making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund or a foreign institutional investor registered under the Securities and Exchange Board of India Act, 1992 or regulations made thereunder, or any other body corporate as may be specified by the Board."[Section 2(1)(u)] As per this definition 'securitisation' implies acquisition of the financial asset by
45
Securitisation Act – A New Landmark in the Indian Financial Sector
the ARC/SC from the bank or financial institution (referred as originator). Acquisition can be normally by raising funds by securitisation of financial assets taken over by issue of security receipts. The security receipts are backed by a charge on the financial assets and the eventual cash flow to be generated from that asset by sale, lease or by managing such assets. The security receipt are to be offered to the QIB i.e. qualified institutional buyers only and not to the general public.
"Security receipt" is defined vide Section 2(1)(zg) as :a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation". A distinct scheme is to be formulated by the ARC/SC for each group of security receipts issued by them to QIBs.
Asset Reconstruction & Asset Reconstruction Company "Asset reconstruction" means acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realisation of such financial assistance; [Section 2(1)(b)] The act, as explicitly stated in the above definition applies only to securitisation of financial assets of banks and financial institution. In particular only NPAs can be handled by the ARC/SC companies formed under the Act. NPAs relating to certain categories of borrowers are exempted under the provisions of the Act.
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Securitisation Act – A New Landmark in the Indian Financial Sector
However under Section 2(1)(m) a wide definition is given to the term "financial institution" to include not only banks and Term Lending Institutions, but also "any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934, which the Central Government may, by notification, specify as financial institution for the purposes of this Act".
The term financial institution is defined as: "Financial institution" means: i. a public financial institution within the meaning of section 4A of the Companies Act, 1956; ii. any institution specified by the Central Government under sub-clause (ii) of clause (h) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993; iii. the International Finance Corporation established under the International Finance Corporation (Status, Immunities and Privileges ) Act, 1958; iv. Any other institution or non-banking financial company as defined in clause (f) of section 45-1 of the Reserve Bank of India Act, 1934, which the Central Government may, by notification, specify as financial institution for the purposes of this Act.
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Securitisation Act – A New Landmark in the Indian Financial Sector
"Reconstruction company" means a company formed and registered under the Companies Act, 1956 for the purpose of asset reconstruction; [(Section 2(1) (v)] "Borrower", "Obligor" & "Default" "Borrower" means any person who has been granted financial assistance by any bank or financial institution or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance. The definition of the term borrower under the act is wider and covers not only borrowers, but also guarantors and all types of co-obligants. "Obligor" means a person liable to the originator, whether under a contract or otherwise, to pay a financial asset or to discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent and includes the borrower;[Section 2(1)(q)]. The term "obligor" includes in addition to the "borrower" as defined above, 3rd parties, who have taken on credit part or all of the secured assets, but have not paid for the same. In other words, obligor means, debtors of the borrower on the date of take over of the secured assets under the Act. It may be clarified that the borrower is referred as "obligor" and "Bank/FI" as "originator" respectively in relation to the ARC/SC. For the ARC/SC the borrower is not a borrower, but an "obligor" and the bank/FI, the "originator".
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Securitisation Act – A New Landmark in the Indian Financial Sector
"Default" means non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor in accordance with the directions or guidelines issued by the Reserve Bank;[Section 2(1)(j)] There should be "default" by the "borrower"(as defined in the Act) for the process under the Act to be initiated. Default implies failure to repay plus as a consequent classification of the borrower's account as a non-performing asset. Thus if the account of the borrower is not transferred as NPA, action under the act is not possible even if there is default.
Security Interest & allied terms "security interest" means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31;[ section 2(1)(zf)] It is important to understand correct meaning of this term, as the Act deals extensively with "enforcement of security interest"
"secured debt" means a debt which is secured by any security interest;[Section 2(1)(ze)]
"Secured
asset"
means
the
property
on
which
security
interest
is
created;[Section 2(1)(zc)
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Securitisation Act – A New Landmark in the Indian Financial Sector
"security agreement" means an agreement, instrument or any other document or arrangement under which security interest is created in favour of the secured creditor including the creation of mortgage by deposit of title deeds with the secured creditor; [Section 2(1)zb)]
"Secured creditor" means any bank or financial institution or any consortium or group of banks or financial institutions and includes-i. ii. iii. debenture trustee appointed by any bank or financial institution; or securitisation company or reconstruction company; or any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by any borrower of any financial assistance;[Section 2(1)(zd)]
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Securitisation Act – A New Landmark in the Indian Financial Sector
Registration of securitisation or reconstruction company
A securitisation or reconstruction company cannot commence or carry on business of securitisation or asset reconstruction without obtaining registration certificate from RBI.
1. Requirements for registration of securitisation company
? Minimum owned funds: The company must have minimum owned funds of Rs. 2 Crore or such amount as may be prescribed by RBI. The amount prescribed by RBI shall not exceed 15% of total financial assets acquired or to be acquired by the securitisation or reconstruction company [section 3(1)]. RBI can prescribe different „owned funds? for different classes of securitisation or reconstruction companies. ? Should be profit making company: The company should not have incurred a loss in any of the three preceding financial years. ? Adequate financial agreements: The company should have made adequate arrangements for realisation of assets and should be able to pay periodic returns and redeem investments made by QIBs in the securitisation or reconstruction company. ? Professional directors: The directors should have adequate experience in matters relating to finance, securitisation and reconstruction. ? At least 50% independent directors: The board directors of the securitisation or reconstruction company can have maximum 50% directors who are nominees of sponsors or who are associated in any manner with the sponsor or any of its subsidiaries. In other words, at least 50% of the directors should be professional and independent.
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Securitisation Act – A New Landmark in the Indian Financial Sector
?
Directors convicted in offence involving moral turpitude not eligible: Any of the directors should not have been convicted of an offence involving moral turpitude.
?
No single person to hold controlling interest: A sponsor should not be holding company of securitisation or reconstruction company, or should not hold any controlling interesting the company.
?
Prudential norms of RBI to be complied with: The company should have complied with or in a position to comply with the prudential norms specified by the RBI.
?
No other business: The company shall not carry on any business other than securitisation or asset reconstruction or business as permitted u /s 10(1), without prior approval of RBI [Section 10(2)]. This restriction does not apply to a subsidiary of the securitisation or reconstruction company.
2. Operational Rules for Already Existing ARCs/SCs
The securitisation and reconstruction companies existing on the commencement of the Act should also apply for registration with RBI within a period of six months from the date of the Act and they are permitted to continue transacting business of securitisation or asset reconstruction until a certificate of registration is granted to it or, as the case may be, rejection of application for registration is communicated to it.
3. Procedure for Registration
Every securitisation company or reconstruction company is required to make an application for registration to the Reserve Bank in such form and manner as it may specify [Section 3(2)].
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Securitisation Act – A New Landmark in the Indian Financial Sector
The RBI after being satisfied that the conditions specified are fulfilled, grant a certificate of registration to the securitisation company or the reconstruction company to carry on or commence business of securitisation or asset reconstruction, subject to such conditions, which it may consider, fit to impose [Section 3(4)]. The Reserve Bank may reject the application made if it is satisfied that the conditions specified in the Act are not fulfilled, but subject to the condition that before rejecting the application, the applicant shall be given a reasonable opportunity of being heard [Section 3(5)].
4. Approval of RBI for Change in Management
Every securitisation company or reconstruction company, shall obtain prior approval of the Reserve Bank for any substantial change in its management or change of location of its registered office or change in its name. The decision of the Reserve Bank, whether the change in management of a securitisation company or a reconstruction company is a substantial change in its management or not, shall be final. For the purposes of this section, the expression "substantial change in management" means the change in the management by way of transfer of shares or amalgamation or transfer of the business of the company [Section 3(6)].
5. Business that can be carried out
In addition to securitisation and asset reconstruction, the company can undertake following activities: a) Act as agent for any bank or FI for the purpose of recovering dues from the borrower, on payment of such fees or charges as may be mutually agreed. b) Act as manager u / s 13(4)(c) to manage secured assets, the possession of
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Securitisation Act – A New Landmark in the Indian Financial Sector
which has been taken over by secured creditor. It cannot act as Manager if acting such gives rise to any pecuniary liability. c) To act as receiver if appointed by any Court or Tribunal [Section 10(1)].
6. Powers of RBI
RBI is empowered to give directions to any securitisation or reconstruction company in matters relating to income recognition, accounting standards, making provisions for bad and doubtful debts and capital adequacy based on risk weights for assets. It can also give directions relating to deployment funds. The securitisation or reconstruction company is bound to follow the policy determined by RBI and the directions issued [Section 12(1)]. RBI can also give directions regarding type of financial assets and aggregate value of financial assets that can be acquired by securitisation or reconstruction company [Section 12(2)]. Punishment for Non-Compliance: If any securitisation or reconstruction company fails to comply with any directions issued by RBI u/s 12, such officer and every officer of company who is in default shall be punishable with fine upto Rs five lakh plus additional fine upto Rs 10,000 for every day during which the default continues [Section 28]. The offence can be tried by any Court not inferior to that of a Metropolitan Magistrate or Judicial Magistrate of First Class [Section 30].
7. Cancellation of registration
RBI can cancel registration of a securitisation or reconstruction company, if a) It ceases to carry on business of securitisation or asset reconstruction b) Ceases to hold or receive any investment from QIB c) Fails to comply with conditions stipulated by RBI while granting registration
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Securitisation Act – A New Landmark in the Indian Financial Sector
d) Fails to comply with conditions for registration as stipulated u/s 3(3) e) Fails to comply with instructions of RBI or fails to maintain accounts as per requirements or fails to offer them for inspection or makes substantial changes in management without approval of RBI [Section 4(1)]. RBI can give opportunity to company for taking steps to comply with the requirements, unless RBI is of the opinion that the delay in cancellation of registration is prejudicial in public interest or the interest of investors of the securitisation or reconstruction company [proviso to section 4(1)]. If registration is cancelled, appeal can be filed within 30 days to Central Government. Personal hearing will have to be given [section 4(2)]. Even if registration is cancelled, the company will have to repay the investments made by QIBs and will be deemed to be a securitisation or reconstruction company till it repays the investments with interest [section 4(3)].
8. Other companies/entities can carry out securitisation
There is no provision that securitisation can be undertaken only by securitisation company or asset reconstruction company only. In the opinion of author, it can be done by other entities also, even if not registered with RBI. However, the special provisions and protections u/s 5 to 8 will not be applicable to such securitisation.
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Securitisation Act – A New Landmark in the Indian Financial Sector
Acquiring financial assets from Bank / FI
The securitisation or reconstruction company can acquire financial assets from banks/financial institutions etc. Since the provisions of securitisation and enforcement of security interest are clubbed in one Act, there may be impression that the financial assets can be acquired only in cases where the borrower makes default in payment to secured creditor and the debt is classified as Non Performing Asset (NPA) as per RBI guidelines. In fact, this is not so. Any asset can be acquired by securitisation company. - -The asset may be present or even future earnings. In fact, only assets having good credit rating are normally securitised. However, financial asset can be acquired for asset reconstruction only for purpose of realising the financial assistance.
1. Modes of acquiring financial asset
The Act envisages two modes of acquiring financial asset by the securitisation or reconstruction company Agreeing for Specific Consideration The securitisation or reconstruction company will agree for consideration to be paid to the bank or Fl. It will issue debenture, bond or other similar security to the bank or Fl on agreed terms and conditions. [Section 5(l)(a)] Without Agreeing for Specific Consideration - The securitisation or reconstruction company may enter into an agreement with Bank/Fl for acquisition of financial assets on such terms and conditions as may be agreed upon [Section 5(l)(b)]. In such case, probably, it may be contracted (in case of NPA i.e. stressed assets) that an agreed percentage of amount realised may be paid to Bank. There is full flexibility and any other terms/conditions can also be agreed upon.
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Securitisation Act – A New Landmark in the Indian Financial Sector
2. Is it transfer of actionable claim? As per section 3 of Transfer of Property Act, „actionable claim? means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, actual or constructive of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent. - - In view of this definition, it is clear that in respect of immovable property, securitisation is not transfer of actionable claim. In case of movable property, the second part of definition i.e. „claim to any beneficial interest in movable property not in possession?. If so, sections 130 to 137 of Transfer of Property Act may apply. - - Further, it can be argued that the transaction is not „transfer of actionable claim? (under Transfer of Property Act), but acquisition of „financial asset? under Securities - - Act. Moreover, provisions in respect of securitisation are special provisions and it is a later Act, and in case of conflict, specific provisions in Securities - - Act will prevail over general provisions. Thus, it appears that securitisation process can be independent of provisions of sections 130 to 137 of Transfer of Property Act.
3. Registration of agreement
The agreement for securitisation or asset reconstruction will have to be registered with „Central Registry? which will be formed u/s 20(1) of the Act. It is clarified that provisions of „Central Registry? are in addition to and not in derogation of provisions of Companies Act, Merchant Shipping Act, Patents Act, Motor Vehicles Act, Designs Act or any other law requiring registration of charges. Hence, registration of charge as required under those Acts will be required in addition to registration with „Central Registry?. In fact, priority and validity of charge will be as per provisions of those Acts and not as per re with
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Securitisation Act – A New Landmark in the Indian Financial Sector
„Central Registry? [Section 20(4)].
4. Stamp Duty Payable
Stamp duty is payable at two stages – (a) When agreement to acquire the „financial asset? is executed with original lender. (b) When security receipt is issued to the investors. In addition, if the securitisation company has to enforce security and sell the asset, stamp duty will have to be paid. Stamp Duty on Securitisation Agreement As per section 5(1) of Securitisation Act, the securitisation or asset reconstruction company will acquire only „financial asset? i.e. debts and receivables or claim to debts or receivables. It will not acquire the asset as such from the lender. The securities (mortgage, hypothecation etc.) continue to be in name of original lender and are not transferred to securitisation company. The securitisation company can issue either a debenture/bond or any other security in the nature of debenture for a consideration, incorporating therein such terms and conditions as may be agreed upon. Thus, the debenture or bond itself contains all terms and conditions as agreed upon and separate agreement is not executed. Thus, if debenture or bond is issued, stamp duty will be payable as is payable on debenture or bond. [Of course, merely calling an instrument debenture or bond does not mean that it is a debenture or bond. If the instrument is held as debenture or bond, issue of the debenture/bond from Karnataka or Maharashtra State seems advisable as stamp duty on these instruments in these States is „reasonable?.
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Securitisation Act – A New Landmark in the Indian Financial Sector
5. Company enters into shoes of Bank/Fl after acquiring asset
After the financial asset is acquired by securitisation or reconstruction company as per provisions of section 5(1) from Bank/Fl, the securitisation or reconstruction company will be deemed to be lender. All rights of the Bank/FI will vest in the securitisation or reconstruction company in relation to the financial assets acquired [Section 5(2)]. CONTRACTS, DEEDS TRANSFERRED - All contracts, deeds, bonds, agreements, power-of-attorney, grants of legal representation, approvals, consents, or no-objections and other instruments of whatever nature which relate to the financial asset acquired and to which Bank/Fl is a party or which are in favour of Bank/FT will be in full force and effect against or in favour of the securitisation or reconstruction company which has acquired the assets. The securitisation or reconstruction company may enforce or act upon any of the instrument as if in place of Bank/Fl, the securitisation or reconstruction company is a party thereto and as if the instrument has been issued in its favour [Section 5(3)]. COMPANY BECOMES PARTY TO SUIT/APPEALS - If any suit, appeal or other proceeding of whatever nature relating to the financial asset are pending on date of acquisition of financial asset by or against the Bank/Fl, these will continued, prosecuted and enforced by or against the securitisation or reconstruction company [Section 5(4)]. - - However, if reference is pending before BIFR u/s 15(1) of SICA, it will automatically abate.
6. Notice to borrower/Registrar
After the asset is acquired by securitisation or reconstruction company, the Bank/Fl, may give notice to the obligor and or any other concerned. It may also give notice to registering authority in whose jurisdiction the mortgage, charge,
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Securitisation Act – A New Landmark in the Indian Financial Sector
hypothecation, assignment or other interest created on the financial assets has been registered [Section 6(1)]. - - Since the word used is „may?, such notice is not mandatory and the transfer or acquisition will be valid even if such notice is not given. Thus, notice may be given to borrowers as well as guarantors.
7. Effect of the notice
Once such a notice is given, the obligor shall make all subsequent payments to the securitisation or reconstruction company and not to Bank/Fl, to discharge obligation in relation to financial asset specified in the notice. Such payment shall be full discharge to the obligor making the payment from all liability in respect of such payment [Section 6(2)]. This transaction will be similar to „Pay through Certificate?. If such notice is not given by Bank/Fl, the obligor (borrower) may make payment to the Bank/FT. Any payment made by the obligor to Bank/Fl after acquisition of financial asset by securitisation or reconstruction company, will be held by such Bank/Fl in trust for the benefit of and on behalf of the securitisation or reconstruction company. Such payment will be delivered by Bank/Fl to securitisation or reconstruction company or its duly authorised agent [Section 6(3)].
8. Arbitration Mandatory
If there is any dispute between securitisation or reconstruction company and Bank/Financial Institution or Qualified Institutional Buyers (QIBs), in respect of securitisation or reconstruction or non-payment of any amount including interest, it shall be settled by conciliation or arbitration as provided in the Arbitration and Conciliation Act, 1996 only, as if the parties have agreed in writing to Arbitration
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Securitisation Act – A New Landmark in the Indian Financial Sector
[Section 11]. Thus, dispute between securitisation or reconstruction company, Bank/FI and QIB cannot be taken to civil court.
9. Protection to secured creditor for acts in good faith
No suit, prosecution or other legal proceedings shall lie against secured creditor or any of his officers or manager exercising any of the rights of secured creditor or borrower for any thing done or omitted to be done in good faith [Section 32]. - In other words, action can be taken only if malafide is alleged and established. - Since the securitisation or reconstruction company is „secured creditor? as per definition of section 2(1)(zd), the protection is available to the securitisation or reconstruction company.
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Securitisation Act – A New Landmark in the Indian Financial Sector
Central Registry
The Act proposes to establish a „Central Registry? with its own seal for purpose of registration of transactions of securitisation or reconstruction of financial assets and creation of security interest [Section 20(1)]. The Head Office will be at place determined by Central Government and its branches may also be set up [Section 20(2)]. Central Registry means the registry set up or caused to be set up u/s 20(1) of the Act [Section 2(1)(g)]. Registration with Central Registry will be in addition to and not in derogation of provisions of Companies Act, Merchant Shipping Act, Patents Act, Motor Vehicles Act, Designs Act or any other law requiring registration of charges. Hence, registration of charge as required under those Acts will be required in addition to registration with „Central Registry?. In fact, priority and validity of charge will be as per provisions of those Acts and not as per registration with „Central Registry? [Section 20(4)]. „Central Registrar? will be appointed for purpose of registration of transactions relating to securitisation, reconstruction of financial assets and security interest created over properties. [Section 2 1(1)] Other suitable officers can also be appointed [Section 21(2)].
1. Maintenance of Central Register
A Central Register will be kept at HO of Central Registry for entering particulars of transactions relating to securitisation of financial assets, reconstruction of financial assets and security interest created over properties [Section 22(1)]. Register can be kept in computer floppies, diskettes or in any other electronic form subject to safeguards as may be prescribed [Section
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Securitisation Act – A New Landmark in the Indian Financial Sector
22(2)]. Central Government can make rules providing safeguards subject to which the records maybe maintained in electronic form. [Section 38(2)(c)]. The Register will be under control and management of Central Registrar [Section 22(4)]. Particulars of every transaction relating to securitisation, reconstruction of financial assets and security interest created over properties shall be filed with Central Registrar within 30 days after date of transaction on payment of prescribed fees. Late filing upto further 30 days may be made on payment of additional fees [Section 23]. The manner in which the particulars of transaction shall be filed u/s 23 and fees for filing shall be prescribed by rules by Central Government [Section 38(2)(d)]. Modification of terms and conditions will be filed [Section 24].
2. Satisfaction or payment of security interest
Satisfaction or payment in full of security interest will be intimated within 30 days. [Section 25(1)] On receipt of such intimation, notice may be given to securitisation or reconstruction company or secured creditor as to why the payment or satisfaction should not be recorded. [Section 25(2)] If no cause is shown within 14 days, the intimation will be recorded. [Section 25(3)] If cause is shown (i.e. objection is raised), it will be noted. [Section 25(4)]
3. Inspection of Central Register
The Central Register will be open for inspection during business hours on payment of fees as may be prescribed [Section 26(1)] Register maintained in electronic form will be available for inspection through electronic media on payment of pre scribed fees. [Section 26(2)] Fees will be prescribed by Central Government by rules. [Section 38(2)(e) in respect of register in book form and section 38(2)(f) in respect of register in electronic form].
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Securitisation Act – A New Landmark in the Indian Financial Sector
4. Penalty for default
If default is made in filing particulars u/s 23, sending particulars of modification u/s 24 or sending intimation for satisfaction u/s 25, every company and every officer who is in default shall be punishable with fine upto Rs 5,000 for every day during which the default continues. [Section 27] The offence can be tried by any Court not inferior to that of a Metropolitan Magistrate or Judicial Magistrate of First Class. [Section 30] If offence is committed by a company (the term includes partnership firm or association of individuals), every person who was in-charge of or was responsible to affairs of the Company/firm is deemed to be guilty. Normally, a Managing Director (partner in case of firm) or other person specially authorised is deemed to be in-charge. However, such person can prove that offence was committed without his knowledge or he had taken due care to prevent the offence [Section 33(1)]. In addition, if it is proved that the offence in relation to Company is committed with consent or connivance of, or due to neglect on part of any director, manager or Secretary or other officer of Company, such person shall be deemed to be guilty [Section 33(2)]. Difference between provisions of section 33(1) and 33(2) is that in former case, the person in charge is deemed to be guilty and burden of proof is on him to prove that he had no knowledge; while in later case, burden of proof is on prosecution to prove that offence was committed with knowledge or connivance of the director, manager, secretary or other officer. A director/partner as well as the Company/firm can be prosecuted. Of course, Company/firm can only be fined, while the guilty officers/ partners can be imprisoned and personal fine also can be imposed. In some cases, it has been held that a director can be prosecuted even if company itself is not prosecuted.
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Securitisation Act – A New Landmark in the Indian Financial Sector
5. Provisions to apply only after Central Registry is setup
Provisions of sections 20 to 27 will apply only after Central Registry is setup u/s 20(1). [Section 39]. It may be noted that the registration with „Central Registry? is in addition to registration that may be required under any other Act.
6. All security interest created to be registered?
Section 2 that „creation of security interest? should be registered with Central Registrar. As per section 2(zf), „security interest? includes mortgage, charge, hypothecation, assignment excluding those specified u/s 31 etc. Thus, by strict legal interpretation, all mortgages, charges, hypothecation deeds executed by all secured creditors all over India will have to be registered. This seems to be practically impossible and very costly task. It appears that the intention is to register only transactions relating to securitisation and asset reconstruction. This aspect must be looked into and clarified/amended.
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Securitisation Act – A New Landmark in the Indian Financial Sector
Enforcement of security interest
We saw above the pre-conditions for taking action to enforce security interest. If these requirements are satisfied, the secured creditor can send a written notice to the borrower to discharge in full his liabilities within 60 days from date of notice failing which the secured creditor shall be entitled to exercise all his rights u/s 13(4) [Section 13(2)].
1. Requirements of notice
As clarified in section 13(2), the notice must be in writing, giving the borrower time of 60 days to discharge his liabilities. Notice must specify that the secured creditor (Bank/Fl) will be entitled to exercise any of his right as specified in section 13(4). The notice shall give details of amount payable by the borrower and the secured asset intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower [Section 13(3)]. If loan is foreclosed, entire amount becomes due immediately. Hence, notice should cover entire loan, including installments not due, and interest payable upto date of notice. It should be specified that future interest will also be payable till date of repayment.
2. Mode of Serving Notice
Secured creditor has to issue „demand notice? u/s 13(2). „Demand notice? means a notice in writing u/s 13(2). [Rule 2(b) of Security Interest (Enforcement) Rules, 2002]. As per rule 3 of Security Interest (Enforcement) Rules, 2002, demand notice u/s 13(4) is required to be issued either by secured creditor or by his authorised officer. Notice can be served by delivering or transmitting at the place where borrower or his agent, empowered to accept notice or documents on behalf of borrower resides or carries on business or personally works for gain. Notice can be sent
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Securitisation Act – A New Landmark in the Indian Financial Sector
by registered post with AD or speed post or by courier or even by fax or e-mail [Rule 3(1)]. As per rule 3(2), if the borrower or his agent is trying to avoid the service of notice, or if notice cannot be served for any other reason, notice can be served by affixing its copy on door or some conspicuous place in house or building where borrower or his agent ordinarily resides or carries on business or personally works for gain. If the borrower is body corporate, demand notice can be served on registered office or at any of the branches as specified in rule 3(1). [Rule 3(3) of Security Interest (Enforcement) Rules, 2002] - - Thus, a notice can be served at registered office or even at factory / administrative office where the body corporate is carrying on business. If there are more than one borrowers, demand notice shall be served on all borrowers. [Rule 3(4) of Security Interest (Enforcement) Rules, 2002]
3. Provision when joint financing is involved
In cases where financing of asset is by more than one secured creditor or there is joint financing of a financial asset, an individual secured creditor cannot take any action as contemplated u/s 13(4), unless exercise of such right is agreed upon by secured creditors representing at least 75% of the amount outstanding on record date. If 75% of creditors agree to the action, that decision will be binding on all remaining secured creditors. [Section 13(9)] As per explanation to section 13(9), „record date? means the date agreed upon by secured creditors representing not less than seventy five percent of the amount outstanding. „Amount outstanding? shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor. Though there is no clear provision, it is apparent that once 75% secured
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creditors agree, notice u/s 13(2) can be sent by any one of secured creditor. It is futile to send notice u/s 13(2) unless creditors holding 75% of outstanding amount consent. It may be advisable to send joint notice or to specifically authorise one of the banks/FI to avoid possible challenge to the notice. Of course, notice should specify the total amount payable to all secured creditors and not only to the secured creditor issuing the notice. Consent Of 75% Secured Creditor Of Only Particular Asset Are Required - The joint financing envisaged in section 13(9) relates to financing of „financial asset? by more than one secured creditors. Thus, consent of only those creditors who have financed against the specific asset is required. For example, if A, B and C secured creditors hold security in respect of fixed assets while D, E and F secured creditors hold security in respect of current assets, consent of only A, B and C (or those having 75% outstanding) is sufficient to issue notice in respect of fixed assets. Similarly, consent of D, E and F (or those having 75% outstanding) is sufficient to issue notice in respect of current assets. In other words, the 75% outstanding amount is qua assets and not qua the borrower.
4. Measures that can be taken
If the borrower pays entire amount within 60 days, no question arises and no further action can be taken. However, if he fails to pay full amount within specified period (which will happen in most of the cases), the secured creditor can take one or more of the following measures to recover his secured debt [Section 13(4)] (a) Take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset (b) Takeover the management of secured asset of the borrower including the right to transfer by way of lease, assignment or sale and realise the secured
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asset (c) Appoint any person (hereafter referred to as the manager) to manage the secured assets the possession of which has been taken over by the secured creditor (d) Require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt. Can Management of Business of Borrower be Taken Over? - Interestingly section 13(4) makes no provision for taking over management of business of a borrower, though section 15 provides for manner and effect of takeover of management. However, in absence of any specific power to takeover management of business of borrower, it is doubtful if such power can be exercised.
5. Cost and expenses can be recovered from borrower
If the secured creditor takes any action as specified u/s 13(4) (taking over assets or management of assets, selling it etc.), he can recover from the buyer all costs, charges and expenses properly incurred by him or any expenses thereto. If the secured creditor receives some amount (by sale of asset etc.), he will first apply them for payment of such costs, charges and expenses and secondly in discharge of dues of the secured creditor. If any amount is left (of course chances are negligible), it shall be paid to the person entitled thereto, in accordance with his rights and interests. [Section 13(7)]. Thus, the secured creditor can recover expenses of safe keeping of assets, expenses of manager who might be appointed to look after assets, incidental expenses and expenses incurred for selling/transferring the asset.
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6. Excess amount to be refunded to borrower
If any excess amount is left after adjusting all dues and expenses, normally it will be payable to borrower. Payment of interest on excess amount not necessary - If asset is sold, the amount recovered may exceed the dues receivable. In such case, there is no statutory obligation on part of SFC to pay interest to the defaulter on the excess amount received. Interest can be awarded by Court on equitable grounds only.
7. Secured creditor can proceed against borrower for balance amount
If dues of secured creditor are not fully satisfied with the sale proceeds of the secured asset, the secured creditor can proceed against the borrower for balance amount by filing application to Debt Recovery Tribunal having jurisdiction, or the competent court, for recovery of balance amount from borrower. [Section 13(10)] Section 38(2)(a) of Act authorises Central Government to make rules to prescribe the form and manner in which an application may be filed u/s 13(10). As per rule 11 of Security Interest (Enforcement) Rules, 2002, application for recovery of balance amount shall be made to DRT in the form given in Appendix VI of the Rules. Application shall be accompanied by fees as provided in rule 7 of DRT (Procedure) Rules, 1993. Interim order can be prayed for in same application. Index in duplicate of documents relied upon shall be submitted. Secured creditor can proceed against guarantor or sell pledged assets - The secured creditor can proceed against guarantor without first taking any of the measures specified in section 13(4)(a) to 13(4)(d). Similarly, secured creditor
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can sell the pledged assets without first taking any of the measures specified in section 13(4)(a) to 13(4)(d). [He can do so as the assets are already in his possession, as these are pledged to him]. [Section 13(11)]
8. How the secured creditor can exercise his right
The rights of e secured creditor can be exercised by one or more of his officers authorised in the manner as may be prescribed. [Section 13(12)] Section 38(2)(b) authorises Central Government to make rules for this purpose. Security Interest (Enforcement) Rules, 2002 issued under these powers make provisions for procedure to be followed. The secured creditor is required to appoint an „authorised officer?.
9. Restrictions on borrower after receipt of notice
Once borrower receives notice from secured creditor u/s 13(2), he cannot transfer any of his secured assets referred to in the notice by way of sale, lease or otherwise (other than in ordinary course of business). [Section 13(13)] Thus, the borrower can continue to sale, lease or otherwise deal with the current assets which may have been hypothecated to Bank/Fl.
10. Effect of transfer of asset to third person
As per section 13(4)(a), the secured creditor can lease, assign or sell the asset to any person. Section 13(6) provides that such transfer shall vest in the transferee all rights in, or in relation to, the secured asset transferred, as if the transfer had been made by the owner of such secured asset.
11. Significance OF ‘AS IF TRANSFER IS MADE BY OWNER OF ASSET’
One major problem is that as per section 13(6), if the assets taken over by Bank/FI are transferred, all rights are vested in the transferee as if the transfer
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has been made by owner of such asset. Thus, the buyer cannot get a title better than what original owner had. In other words, the transferee gets the asset saddled with all liabilities which the original owner had. The liabilities may be pertaining to (a) Labour (b) Past electricity dues (without which electricity supply may not be restored) (c) Earlier taxation dues relating to excise, sales tax etc. - - Strictly legally, the transferee is getting only assets of the company and not the company as such. However, quite possibly, these liabilities will haunt him. If so, the price the secured creditor may get will be much lower. Clear legal provision that the transferee will get asset without past liabilities will ensure that the transferee can start using the asset acquired by him without any apprehensions about past liabilities. Presently, there is no such assurance to the transferee who is acquiring the property from secured creditor.
12. Payment of amount by Borrower any taking back possession
The borrower can pay the amount due along with costs, charges and expenses incurred by secured creditor any time before the date fixed for transfer of the asset. If he makes such payment, the secured asset shall not be sold or transferred [Section 13(8)]. Entire amount of debt, including installments which were not due, will have to be paid It is not specifically mentioned, but it is implied that the asset will be handed over back to the borrower, if he makes full payment. It is also implied that once asset is sold/transferred by secured creditor, the borrower has no remedy other than filing appeal and claiming compensation u/s 19, if he can prove that the possession of secured asset by secured creditor was wrongful. Even after assets are taken over by secured creditor, if borrower makes full payment of debt, the management of business shall be restored to him. [Section 15(4)]
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13. Time limit for taking action after serving of notice
The secured creditor can take action u/s 13(4) any time after expiry of 60 days? notice. There is no time limit. However, it has been consistently held that when no time limit has been prescribed, action must be taken within reasonable time. Thus, the secured creditor must take action within reasonable time. The notice given u/s 13(2) cannot be said to be perpetually valid. In particular, if the secured creditor does an act which is contrary to intention of notice (e.g. reschedules loans or gives further time for repayment), it can be argued that the notice has abated and no action can be taken against such stale notice. Even otherwise, Limitation Act is applicable, and no action can be taken u/s 13(4) unless the claim is made within period of limitation prescribed under Limitation Act [Section 36].
14. Jurisdiction of civil court barred
Civil Court is barred from entertaining any suit or proceeding where Debt Recovery Tribunal is empowered to determine. No injunction shall be granted by any Court or other authority in respect of any action taken in pursuance of any power conferred under the Act [Section 34]. Of course, writ jurisdiction of High Court remains unaffected, as that power is conferred under Constitution of India and cannot be taken away by any Parliamentary Act. It may be noted that appeal to DRT can be filed only after possession or management of asset is taken over by the secured creditor.
15. Protection to secured creditor for acts in good faith
No suit, prosecution or other legal proceedings shall lie against secured creditor or any of his officers or manager exercising any of the rights of secured creditor or borrower for any thing done or omitted to be done in good faith. [Section 32]. - - In other words, action can be taken only if malafide is alleged and established.
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16. Can Secured Creditor take action if matter is with DRT / Civil Court?
The Act makes no provision whether action can be taken if the matter is already pending with DRT/Civil Court. There is neither specific permission nor prohibition. Section 13(10) provides that secured creditor can proceed against the guarantor for balance amount due. Hence, it can be argued that secured creditor can take action u/s 13 even if matter is pending with DRT. However, since the matter is sub judice, it will be highly advisable to seek permission of DRT before taking action u/s 13. It will be advisable to make specific provision in the Act to avoid disputes.
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Taking Over of Assets
1. Assistance of Magistrate to take over possession
The secured creditor can take over possession of assets 60 days after giving notice. Where the possession of assets is required to be taken or if any asset is required to be sold or transferred and if secured creditor expects resistance, he can request in writing, the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction the assets or the documents are located, to take possession of the assets or documents. On such request, Chief Metropolitan Magistrate or the District Magistrate shall take possession of such assets and documents relating thereto and forward such assets and documents to secured creditor [Section 14(1)]. Since the word used is „shall?, it is mandatory for Chief Metropolitan Magistrate or the District Magistrate to take possession once written request is received. The Chief Metropolitan Magistrate or the District Magistrate can use necessary force to take over possession [Section 14(2)]. Action of the Chief Metropolitan Magistrate or the District Magistrate pursuant to this section is fully protected and cannot be questioned in court or before any authority [Section 14(3)].
2. Change of directors/appointment of administrator
When the management of business of the borrower is taken over, the secured creditor can change the directors of borrower company if borrower is a company and appoint administrator if borrower is not a company. He may publish notice in newspaper published in English as well as regional language circulating iii the place where principal office of borrower is situated. [Section 15(1)]. (The word used is „may?, really advertisement must be published, if management is to be changed). Note that these provisions are applicable only when management of business
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is taken over and not when merely assets are taken over. Can management of business of borrower be taken over? - Interestingly section 13(4) of Act makes no provision for taking over management of business of a borrower, though section 15 of Act provides for manner and effect of takeover of management. However, in absence of any specific power to take over management of business of borrower, it is doubtful if such power can be exercised. However, these powers can be exercised by Asset Reconstruction Company or Securitisation Company u/s 9(a).
3. Effect of the notice
Publishing of such notice has following effect: [Section 15(2)] ? Earlier directors/authorised persons cease to hold office - On publishing of such notice, the earlier directors (in case of company) and persons holding any office of power of superintendence (if borrower is not a company e.g. partnership firm, proprietary firm etc.) shall be deemed to have vacated their office. [Section 15(2)(a)] ? Contract of management is terminated - Any contract of management which borrower had with any director or manager of borrower holding office as such shall be deemed to be terminated. [Section 15(2)(b)] ? New director/administrator can take over - The new directors / administrator appointed by secured creditor will take over in custody or control all the property, effects or actionable claims to which the business of borrower is, or appears to be entitled. Effects of business of borrower shall be deemed to be in custody of new directors/administrator. [Section 1 5(2)(c)] ? New directors/administrator to exercise all powers - The new directors / administrator shall alone be entitled to exercise all the powers of
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superintendence, direction and control of business of business of borrower, whether such powers are derived from Memorandum or Articles of the company or any other source whatsoever. [Section 1 5(2)(d)]
4. Effect of takeover of management
The takeover of management has following effect ? Shareholders cannot appoint directors - After the takeover of assets, shareholders of company cannot appoint or nominate any director of the company. [Section l5(3)(a)] ? No resolution without consent of secured creditors - Any resolution passed by shareholders will be effective only if approved by secured creditor [Section 1 5(3)(b)]. ? No proceeding for winding up - No proceeding for winding up of such company or appointment of receiver shall lie in any court, without the consent of secured creditor [Section 1 5(3)(c)] ? No compensation for loss of office - Any Managing Director or Director of the borrower shall not be entitled to compensation for loss of office or for premature termination of any contract of agreement with the borrower [Section 16(1)]. However, the MD or director or manager shall be entitled to any other money receivable, other than compensation [Section 16(2)].
5. Guidelines for exercise of power
Guidelines on how to use the powers are contained in Security Interest (Enforcement) Rules, 2002. These are briefly discussed below: ? Appointment of authorised officer - The secured creditor is required to appoint an authorised officer to exercise rights of secured creditor under the
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Act. He should not be below „Chief Manager? of a public sector bank or equivalent. “Authorised Officer” can be appointed by Board of Directors or Board of Trustees of secured creditor or any other person or authority exercising powers of superintendence, direction or control over business of secured creditor [rule 2(a) of Security Interest (Enforcement) Rules, 2002]. ? Serving of demand notice - The demand notice should be served on borrower as prescribed in rule 3 of Security Interest (Enforcement) Rules, 2002, as explained earlier.
a) Procedure in respect of movable secured asset
If movable property is taken over, the authorised officer shall prepare a „Panchanama? in presence of two witnesses. The „Panchanama? shall be signed by two witnesses and be in form as near as possible to Appendix I of Security Interest (Enforcement) Rules, 2002 [rule 4(1) of Security Interest (Enforcement) Rules, 2002]. The authorised officer will make or cause to be made an inventory of property of the borrower in form given in Appendix II of Security Interest (Enforcement) Rules, 2002. Copy of the inventory shall be given to the borrower or person entitled to receive it on behalf of borrower [rule 4(2) of Security Interest (Enforcement) Rules, 2002]. The property will be taken in custody of authorised person or any authorised person. Care shall be taken as an owner of ordinary prudence would take. The asset should be properly preserved, protected and insured [rule 4(3) and rule 4(4) of Security Interest (Enforcement) Rules, 2002]. Property Subject to Decay - If the property is subject to speedy and natural decay, or the expense of keeping the property in custody is likely to exceed its value, authorised person may sale it at once [proviso to rule 4(3) of
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Security Interest (Enforcement) Rules, 2002] Debt Not Secured By Negotiable Instrument - The debts of borrower may have been hypothecated to the secured creditor. - - If such debt is not secured by any negotiable instrument, the authorised officer can direct the debtor to pay the dues directly to him instead of paying to the borrower. Rule 4(5)(a) of Security Interest (Enforcement) Rules, 2002]. [If such debt was secured by a negotiable instrument, the authorised officer can enforce the same]. Shares in a Body Corporate - The borrower may have provided shares of a body corporate as security. In such case, the authorised officer can send notice to the borrower as well as to body corporate not to transfer the shares in favour of any person other than secured creditor [rule 4(5)(b) of Security Interest (Enforcement) Rules, 2002]. Other Movable Property Not In Possession Of Borrower - Some property belonging to the borrower may not be in his possession. For example, it may be in possession of job worker, consignment agent, transporter or godownkeeper. In such case, the authorised officer can take possession of such property in the same manner in which possession of other property is taken. [Such possession would not be possible if such other person (like transporter, job worker, consignment agent, godown keeper etc.) has lien over the goods or movables are pledged or he is unpaid seller, as in such cases, provisions of Act do not apply in view of clear provisions of section 31]. Moreover, authorised officer cannot take possession if the assets are in custody of Court or any like authority [rule 4(5)(c) of Security Interest (Enforcement) Rules, 2002] Possession of Assets ny Possession of Documents of Title – The authorised officer can take possession of movable secured assets by taking
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possession of document evidencing title in such secured assets [rule 4(5)(iv) of Security Interest (Enforcement) Rules, 2002]. Valuation of Movable Secured Asset - After the assets are taken over, the authorised officer shall obtain estimated value of assets and then, if considered necessary, fix a reserve price of assets to be sold, in consultation with secured creditor, to ensure maximum realization of dues [rule 5 of Security Interest (Enforcement) Rules, 2002]. It is not indicated how he will obtain „estimated value?. It is not provided that estimated value should be obtained from approved valuer only, as is provided in case of immovable assets. - - There is no provision to consult borrower or involve him in the process of valuation. In fact, fixing reserve price itself is at the option of authorised officer. However, in case of immovable property, valuation by approved valuer and fixing of reserve price is mandatory. Sale of Movable Secured Assets - The movable assets can be sold by any of the following methods - (a) Obtaining quotations from parties dealing in secured assets or those who may be interested in buying such asset (b) Inviting tenders (c) Holding public auction or (d) By private treaty [rule 6(1) of Security Interest (Enforcement) Rules, 2002]. A 30 day notice is required to be given to the borrower for sale of movable secured assets. If sale is by public auction or tenders, secured creditor shall put up a public notice in two leading newspapers, one in vernacular language, by setting out term of sale, which may include (a) Details about borrower and secured creditor (b) Description of assets with identification marks or numbers if any (c) Reserve price if any and time and manner of payment (Thus, fixing reserve price is not mandatory in case of movable assets) (d) Time and place of public auction or time after which sale by any other mode will be completed
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(e) Earnest money deposit (f) any other material details as considered essential by authorised officer. [Proviso to Rule 6(2) of Security Interest (Enforcement) Rules, 2002] Sale by methods other than public auction or public tender shall be on such terms as may be agreed upon [rule 6(3)]. If the buyer does not pay for the asset within time as per agreed terms, the movable asset can be offered for sale again. Transfer of Mortgage, Hypothecation or Pledge of Movable Property or Right or Interest in Security - „Financial asset? means normally „debts or receivables?. However, the definition of financial asset is inclusive and it includes a mortgage, charge, hypothecation or pledge of movable property [section 2(l)(l)(iii)] and any right or interest in the security, whether full or part, underlying the debt or receivables. [Section 2(1)(l)(iv)]. Rule 7(3) of Security Interest (Enforcement) Rules, 2002 states that sale of asset covered u/s 2(1)(iii) or 2(l)(l)(iv) shall be as if it is a sale of movable secured asset and provisions of rules as applicable to sale of movable assets applies. Wide Flexibility in Sale of Assets - It can be seen that wide flexibility has been provided to the secured creditor. Certificate of Sale - On receipt of sale price, the authorised officer shall issue a certificate of sale in form prescribed in Appendix Ill. Thereafter, the sale shall be absolute. The certificate of sale shall be prima facie evidence of title of purchaser [rule 7(2) of Security Interest (Enforcement) Rules, 2002]. - - The certificate is not „conclusive evidence?. The reason is that the purchaser cannot get a title better than what the borrower has. This is also clarified in section 13(6) of the Act which states that transfer of asset by secured creditor shall vest in the transferee all rights as if the transfer had been made by the
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borrower. Thus, a title better that what borrower had cannot be transferred to purchaser.
b) Procedure in respect of immovable secured asset
If immovable property is taken over, the authorised officer shall take possession by delivering possession notice to the borrower. The possession notice shall be in form as near as possible to Appendix IV of Security Interest (Enforcement) Rules, 2002. Copy of such possession notice shall also be affixed on outer door or at a conspicuous place of the property. [Section 8(1) of Security Interest (Enforcement) Rules, 2002] Possession receipt is also required to be published in two leading newspapers in locality, one of which should be in vernacular language of the locality Provisions in respect of panchanama or inventory, as applicable to taking over of movable assets, are not applicable for taking over of immovable assets. The property will be taken in custody of authorised person or any authorised person. Care shall be taken as an owner of ordinary prudence would take. The immovable asset should be properly preserved and protected and insured. [Rule 8(3) and rule 8(4) of Security Interest (Enforcement) Rules, 2002] Valuation Of Immovable Secured Asset - After the assets are taken over, the authorised officer is required to obtain estimated value of assets and fix a reserve price of assets to be sold from an approved valuer, in consultation with secured creditor, to ensure maximum realization of dues. [Rule 8(5) of Security Interest (Enforcement) Rules, 2002] There is no provision to consult borrower or involve him in the process of valuation. In case of immovable assets, valuation by approved valuer and fixing of reserve price is mandatory.
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Approved valuer means a valuer as approved by Board of Trustees or Board of Directors of the secured creditor. [Rule 2(d) of Security Interest (Enforcement) Rules, 2002]. Thus, appointment of approved valuer is the prerogative of secured creditor. Sale of Immovable Secured Assets - The immovable assets can be sold by any of the following methods - (a) Obtaining quotations from parties dealing in secured assets or those who may be interested in buying such asset (b) Inviting tenders (c) Holding public auction or (d) By private treaty. [Rule 8(5) of Security Interest (Enforcement) Rules, 2002]. 30 day notice is required to be given to the borrower for sale of immovable secured assets [Rule 8(6) of Security Interest (Enforcement) Rules, 2002]. Notice of sale shall also be fixed on a conspicuous part of immovable property and may be put on website of the secured creditor on internet. [Rule 8(7)] If sale is by public auction or tenders, secured creditor shall put up a public notice in two leading newspapers, one in vernacular language, by setting out term of sale, which shall include (a) Description of immovable property to be sold, including encumbrances known to secured creditor (b) Secured debt for recovery of which property is to be sold (c) Reserve price below which the property may not be sold (d) Time and place of public auction or time after which sale by any other mode will be completed (e) Earnest money deposit (f) any other material details as considered essential by authorised officer. [Proviso to Rule 8(6) of Security Interest (Enforcement) Rules, 2002] Sale by methods other than public auction or public tender shall be on such terms as may be agreed upon. [Rule 8(8) of Security Interest (Enforcement) Rules, 2002]
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Sale of immovable property shall not take place before expiry of 30 days from date on which public notice of sale is published in newspapers or notice of sale has been served on the borrower. [Rule 9(1) of Security Interest (Enforcement) Rules, 2002] The sale shall be confirmed in favour of highest bid or tender, but shall be subject to confirmation by the secured creditor. Sale cannot be confirmed if the offer is below the reserve price. However, if authorised officer is unable to obtain price higher than reserve price, he may sale at price lower than reserve price with consent of the borrower and secured creditor. [Rule 9(2) of Security Interest (Enforcement) Rules, 2002] [Interestingly, consent of borrower is required for sale below the reserve price]. The buyer is required to deposit 25% of sale price immediately. If he does not pay the deposit, the immovable asset shall be offered for sale again. [Rule 9(3) of Security Interest (Enforcement) Rules, 2002] - - Meaning of „immediately? is not clear. Certainly, it is not expected that an intending buyer will keep so much idle cash in bank accounts. Balance amount of purchase price should be paid within 15 days of confirmation of sale of immovable property on such extended period that may be agreed upon in writing. If the buyer fails to pay the balance consideration, the 25% deposit shall stand forfeited and the property shall be sold again. The defaulting purchaser will forfeit all claim to the property or to any part of sum for which the immovable property may be subsequently sold. [Rule 9(5) of Security Interest (Enforcement) Rules, 2002] Wide Flexibility in Sale of Immovable Assets - It can be seen that wide flexibility has been provided to the secured creditor. This may not be held as over delegation, as in State Financial Corporation v. Jagdamba Oil Mills 2002 AIR SCW 500 = 4 CLA-BL Supp 32 (SC 3 member bench), it was held that any mode of sale of assets can be adopted. The only requirement is that it
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should be fair and transparent. Provision in respect of immovable property subject to encumbrances The provision in respect of encumbrances is really a very good V e and welcome provision in the rules. - - Section 13(6) of the Act states that transfer of asset by secured creditor shall vest in the transferee all rights as if the transfer had been made by the borrower. Thus, a title better than what borrower had cannot be transferred to purchaser. - - Proviso to rule 8(6) provides that all encumbrances known to the secured creditor must be disclosed in the advertisement published. Authorised Officer may allow the purchaser to deposit with him the money required to discharge the encumbrances together with such amount as may be sufficient to meet the contingencies of further cost, expenses and interest as may be determined by authorised officer. On deposit of such amount, the authorised officer will issue notices to the persons entitled to receive the money deposited and take steps to make payments accordingly. [Rule 9(8)] The authorised officer shall deliver the property to the purchaser free from any encumbrances known to the secured creditor on deposit of money. The certificate shall specify that the asset is free from encumbrances known to secured creditor. It should be noted that paying encumbrances through authorised officer is optional and in fact at the option of authorised officer. Moreover, the certificate is only in respect of encumbrances known to the secured creditor. Meaning of Encumbrance - This word has not been defined in the Act. Encumbrance means a claim, lien, liability attached to property, as mortgage etc. Encumbrance means a burden, impediment, a mortgage or other charge on property. [Oxford Dictionary]
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Tenancy right is an encumbrance which will not go even if immovable property is transferred. One doubt is whether past electricity dues or past tax dues can be termed as „encumbrance?. Legally, a view is possible that these are not „encumbrances?. However, practically, they may be so, as explained below. Past Electricity and Tax Dues - Normally, a purchaser faces problems in beheld respect of past electricity dues, past tax demands etc. Strictly legally, the transferee is getting only assets of the company and not the company as such. However, quite possibly, the past liabilities in respect of electricity dues, tax dues etc. will haunt him. Appointment of Manager for secured assets - As per rule 10(1) of Security Interest (Enforcement) Rules, 2002, the Board of Directors or Board of Trustees of secured creditor may appoint a „Manager? in consultation with borrower to manage the secured assets. The Manager so appointed shall be deemed to be an agent of borrower. The borrower shall be solely responsible for commission or omission of acts of Manager, unless such commission or omission are due to improper intervention of secured creditor or the authorised officer. The Manager shall have power to recover any money from any person who has acquired secured assets from the borrower, which is due or may become due to the borrower. The Manager shall give a valid discharge to person making payment as if he has made payment to the borrower. [Rule 10(5) of Security Interest (Enforcement) Rules, 2002] The Manager shall apply the money received by him in payments in accordance with section 13(7) of the Act. [Rule 10(6) of Security Interest (Enforcement) Rules, 2002] As per this section, if the secured creditor
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receives some amount (by sale of asset etc.), he will first apply them for payment of such costs, charges and expenses and secondly in discharge of dues of the secured creditor. If any amount is left (of course chances are negligible), it shall be paid to the person entitled thereto, in accordance with his rights and interests. Manager is a Novel Idea - Appointment of „Manager? in consultation with borrower is an innovative idea. If the borrower and secured creditor agree, a „Manager? can be appointed to look after secured assets taken over by the secured creditor. Naturally, he will be someone associated with the borrower (maybe even an employee of borrower). Advantage of the idea is that for an outsider, managing assets taken over is not an easy task, particularly if he has to face hostile employees of the borrower all over the place. The „Manager? who is having confidence of borrower will be in a much better position to do so. Of course, the idea will work only if borrower agrees. It is doubtful if the Manager can be thrust upon him. The borrower may or at least should normally agree, as a person who has knowledge of affairs of the undertaking can certainly manage assets better than an outsider who has no knowledge of the working of the undertaking. In other words, the assets will continue to be under indirect supervision and control of the borrower himself, but he acts as trustee of the secured creditor. This is a practical idea, as for an outsider, it is indeed difficult to manage assets taken over Note that this provision applies only when secured assets of the borrower are taken over and not when management of business is taken over. Consultation or Concurrence? - It is interesting to note that only consultation with borrower is required for appointment of Manager, which is different from „concurrence?. Thus, even if the borrower does not agree to
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appointment of a person as Manager, he will be liable for his acts. This seems rather hard and strange. How can you appoint a person as agent against will of the Principal and still hold Principal liable for acts of the Agent, who is thrust upon him without his ascent? It is doubtful if such provision can stand in any Court of Law. The word „consultation? has different shades of meaning. The word „consult? as understood in ordinary parlance means to ask or seek advice on the view of a person on any given subject, i.e. to take counsel from another, but it does not convey that the consultant is bound by the advice. When Courts may interfere - Though section 34 of the Act bars jurisdiction of civil court, writ jurisdiction of High Court remains unaffected. Supervisory powers of High Court under Article 227 of Constitution are also unaffected.- No doubt, matters will go to High Court.
c) Effect of Winding up proceedings
In many cases, winding up proceedings might have already commenced, when Bank/Financial Institution decides to take measures u/s 13(4) of the Act. The Act does make some provisions, but some disputes seem possible. It will be advisable to make clear and explicit provisions. Enforcement of security if company is under winding up - Provisos to section 13(9) of the Act state as follows - [Really, these provisos are placed at wrong place in the Act, and some litigation on this count is possible.] Disbursement of Proceeds as Per Company Law Provisions - In case of company under liquidation, the amount realised from sale of secured assets shall be disbursed in accordance with section 529A of Companies Act. [First proviso to section 13(9)]
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Secured Creditor to Retain Sale Proceedings - In case of company being wound up, the secured creditor who opts to realise his security instead of relinquishing his security and proving his debt u/s 529(1), may retain the sale proceeds of his secured assets, after depositing the workmen?s dues with liquidator as per provisions of section 529A of Companies Act. [second proviso to section 13(9)] - - What this implies is that secured creditor can realise his security by remaining outside the winding up proceedings and realise his debt, subject to the condition that he deposits part of the proceedings as per section 529A with liquidator. Liquidator to Inform Quantum of Workmen’s Dues - The liquidator shall inform the secured creditors about workmen?s dues. [Third proviso to section 13(9)] If Workmen’s Dues Cannot be Ascertained - If the workmen?s dues cannot be ascertained, the liquidator shall intimate the estimated amount and the secured creditor shall deposit such estimated amount with liquidator. [Of course, as per provisions of section 529A, though not specifically stated] [Third proviso to section 13(9)] If such amount is deposited and if actual quantum is more, the secured creditor will have to pay the difference. Similarly, if actual amount is less, he can receive the excess amount deposited with official liquidator. [Fourth proviso to section 13(9)] The secured creditor is required to furnish undertaking to the liquidator to pay the balance of workmen?s dues, if any. [Fifth and last provisos to section 13(9)] Provision in respect of workmen’s dues - As per proviso to section 529(1) of Companies Act, security of secured creditor is deemed to be pari passu with workmen?s dues. Thus, Workmen?s dues are given same priority as secured creditors. This debt ranks pari passu with secured creditors.
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If the secured creditor stands outside liquidation and enforces his security, following provisions apply – (a) Liquidator is entitled to represent workmen and enforce the pari passu charge in favour of workmen (b) If liquidator realises any amount by enforcement of the charge, it will be distributed ratably (pro rata) for discharge of workmen?s dues (c) In view of pari passu charge in favour of workmen, it is possible that the secured creditor may not be able to realise his full debts. In such cases, the debt short recovered is given top priority in distribution, to the extent of workmen?s portion of his security. [Proviso to section 529(1) of Companies Act] However, the top priority is given only to the extent of workmen?s portion of security e.g. assume that (a) Value of security of a secured creditor is Rs one lakh (b) Total amount of workmen?s dues as per definition are Rs one lakh (c) Debt due from company to secured creditor is Rs 3 lakhs. In such case, „workmen?s portion of security? is 25% (one lakh out of four lakhs total secured debt). Hence, workmen will get 25% of security i.e. Rs 25,000. [Illustration to section 529(3)(c) of Companies Act] If workmen get security of Rs 25,000, the secured creditor will get priority in respect of only Rs 25,000 from other assets of the company. However, if value of security is Rs 3.6 lakhs, secured creditor will get Rs 2.70 lakhs, workmen will get Rs 90,000. In that case, the secured creditor will get priority only for balance Rs 30,000 from other assets as total dues to him are only Rs. 3 lakhs. [Section 529A of Companies Act]
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What are workmen’s dues - Only dues of „workmen? as defined under Industrial Disputes Act are covered. Thus, employees in supervision and managerial category are not entitled to any priority. Following amounts payable get position of „secured charge? [Section 529(3) of Companies Act] i. Wages and salaries in respect of services rendered to company and any compensation payable under Industrial Disputes Act to any workman ii. All accrued holiday remuneration becoming payable to any workman on termination of his employment before or by effect of winding up. In case of death, the amount payable to any other person as his right also gets secured status. iii. All amounts due in respect of compensation or liability for compensation to workmen under Workmen?s Compensation Act in respect of death or disablement of the workmen. This amount does not get status of secured debt, if the amount is insured or if the company being wound up voluntarily merely for purpose of reconstruction or amalgamation with another company. iv. All sums due to workman from provident fund, pension fun gratuity fund or any other fund for welfare of workmen maintained by the company. Permission of Company Court required after winding up order made - It is true that a secured creditor can remain outside winding up. However, in case of company where winding up order has been made or provisional liquidator has been appointed, the assets are in custody of official liquidator, as per section 456(1) of Companies Act. All property and effects of the company shall be deemed to be in custody of Company Court from date of winding up order, as per Section 456(2) of Companies Act. The provisos to section 13(9) of Securities Act, 2002 do not make any specific
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provision on the issue. In fact, section 37 of the Act states that the provisions of Act are in addition to provisions of Companies Act, SCRA, SEBI Act, RDDBFIA Act and other laws. Thus, no overriding provision has been given to the Act and hence, permission of Company Court will have to be obtained by secured creditor to take possession, sale or transfer the asset, if provisional liquidator has been appointed or winding up order has been issued by Company Court. No winding up proceedings if management of business of borrower is taken over - Once management of business of borrower is taken over by secured creditor, no proceeding for winding up of such company or appointment of receiver shall lie in any court, without the consent of secured creditor. [Section 16(3)(c)] However, in case of company where winding up order has been made or provisional liquidator has been appointed, the assets are in custody of official liquidator, as per section 456(1) of Companies Act. All property and effects of the comp shall be deemed to be in custody of Company Court from date of winding up order, as per 456(2) of Companies Act. In such cases, the secured creditor cannot take over business of borrower without permission of Company Court.
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Appeals and Penalties
1. Appeal against action of secured creditor
Provisions have been made to file appeal with Debt recovery Tribunal (DRT) against action of Banks / FI taken u/s 13(4) of Act.
2. Appeal to DRT
Any person (including borrower) aggrieved by any measure taken by secured creditor or his authorised officer u/s 13(4) may prefer appeal to DRT having jurisdiction in the matter, within 45 days from date on which such measure has been taken. [Section 17(1)] What this implies is that no appeal can be filed at the stage when notice has been given by secured creditor u/s 13(2). Appeal can be filed only after action u/s 13(4) [of taking possession of asset, takeover of management business of borrower, appointment of person to manage secured asset, etc.] is already taken by secured creditor. DRT will dispose off appeals as per the provisions of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and rules made thereunder. [Section 17(3)] Deposit of partial dues: When an appeal is filed by a borrower, the appeal shall not be entertained, unless the borrower deposits 75% of the amount claimed in the notice by secured creditor. The DRT can waive or reduce the amount required to be deposited [Section 17(2)]. [The amount will include even installments which were not due as per loan agreement.] The amount is not required to be deposited at the time of filing appeal, but appeal will not be heard till the amount is deposited.
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3. Appeal to Appellate Tribunal
Any person aggrieved by any order made by the Debts Recovery Tribunal under section 17 may prefer an appeal to an Appellate Tribunal within thirty days from the date of receipt of the order of Debts Recovery Tribunal.[Section 18(1)] Save as otherwise provided in this Act, the Appellate Tribunal shall, as far as may be, dispose of the appeal in accordance with the provisions of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and rules made thereunder.[Section 18(2)]
4. Right of Borrower to Receive Compensation and Costs for Wrongful Action
If the Debts Recovery Tribunal or the Appellate Tribunal, as the case may be, on an appeal filed under section 17 or section 18, holds the possession of secured assets by the secured creditor as wrongful and directs the secured creditor to return such secured assets to the concerned borrower, such borrower shall be entitled to payment of such compensation and costs as may be determined by such Tribunal or Appellate Tribunal. It is however, not clear whether the Tribunal can direct return of asset, if the secured creditor has already sold or transferred the asset.
5. Reliefs that can be granted
If the DRT or the Appellate Tribunal holds that possession of assets by the secured creditor was wrongful and directs the secured creditor to return the asset to the concerned borrower, the borrower shall be entitled to compensation and costs as shall be determined by the DRT or Tribunal.
6. Only compensation, no damages
It may be noted that Tribunal can award compensation and costs, but not
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damages. If the borrower intends to claim damages, he may have to try his luck in civil court.
7. Punishment
The act provides a general punishment of imprisonment upto one year and/or fine, if a person contravenes or attempts to contravene any provision of the Act [Section 29]. The penalty can be imposed by Court not lower than Metropolitan Magistrate of First Class [Section 30]. If offence is committed by a company (the term includes partnership firm or associate of individuals), every person who is in-charge of or was responsible to the affairs of the company/firm, is deemed to be guilty. Normally, a managing director, or another person specially authorised is deemed to be in-charge. However, such person can prove that offence was committed without his knowledge, or he had taken due care to prevent the offence [Section 33(1)].
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Chapter Four
Punjab National Bank – A Case Study
Punjab National Bank – A Case Study
Research Methodology
For the purpose of understanding the loan recovery process under the provisions of the act, I decided to study a case example of successful implementation of the process of enforcement of security interest. Also, I prepared a questionnaire (Annexure 1) and posed it to experts from the banking sector to get their views on the new act.
Collection of data
Primary Sources
Primary data has been collected through a meeting with the following managers of Punjab National Bank who provided me with the required information: ? ? ? Mr. Anil Bhan, Chief Manager, Credit Risk Management Department Mr. Avinash Vaidya, Senior Manager, Credit Risk Management Department Mr. T. V. K. Subramanian, Senior Manager, Credit Risk Management Department ? Mrs. Padmaprabha, Senior Manager, Credit Risk Management Department
Secondary Sources
Secondary data has been collected from news papers, magazines, books and the internet. These sources have been outlined in the Bibliography.
About Punjab National Bank
Established in 1895 at Lahore, undivided India, Punjab National Bank (PNB) has the distinction of being the first bank to have been started solely with Indian capital. From its modest beginning, the bank has grown in size and stature to
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Punjab National Bank – A Case Study
become a front-line banking institution in India at present. During its existence of over one-hundred years, Punjab National Bank has faced many a trials of strength including the trauma of partition of India in 1947 at the time of independence. However, due to its inherent strengths and resilience, the bank not only withstood such adversities but established itself still firmly on the Indian subcontinent. The bank was nationalised in July 1969 along with 13 other banks. The bank's strength lies in its corporate belief of growth with stability. With its presence in virtually in all the important centres of the country, Punjab National Bank offers a wide variety of banking services which include corporate and personal banking, industrial finance, agricultural finance, financing of trade and international banking. Among the clients of the bank are multinational companies, Indian conglomerates, medium and small industrial units, exporters and non-resident Indians. The large presence and vast resource base have helped the bank to build strong links with trade and industry. At the same time, the bank has been conscious of its social responsibilities by financing agriculture and allied activities and small scale industries (SSI). Considering the importance of small scale industries bank has established 16 specialised branches to finance exclusively such industries. With its long tradition of sound banking and in-depth knowledge of Indian economy, the bank has been able to help its clients in their projects. Punjab National Bank is ranked 416 among the biggest banks in the world by Bankers' Almanac (July 2002) London. Strong correspondent banking relationship which Punjab National Bank maintains with 200 leading international banks all over the world enhances its capabilities to handle transactions world-wide. Besides, bank has Rupee Drawing Arrangements with exchange companies in the Gulf. Bank is a member of the
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Punjab National Bank – A Case Study
SWIFT and 85 branches of the bank are connected through its computer-based terminal at Bombay. With its state-of-art dealing rooms and well-trained dealers, the bank offers efficient forex dealing operations in India. The bank has been focussing on expanding its operations outside India and has identified some of the emerging economies which offer large business potential. Bank has set up a representative office at Almaty, Kazakhktan w.e.f. 23rd October 1998. Keeping with its tradition of excellence in customer service PNB has adopted a quality movement "Alliance with Quality". Under this as many as 364 offices of the bank have been awarded the coveted ISO 9002 certification. The bank is committed to maintaining the highest standards of service and will be covering more offices under this quality movement. Bank has its corporate office at New Delhi and 18 zonal offices which in turn supervise 65 regional offices under which the branches function. The delegation of powers is decentralised upto the branch level to facilitate quick decision making. It has 4038 branches spread across the length and breadth of India. ? ? ? ? ? A professionally managed bank with a successful track record of over 108 years. Largest branch network in India - 4038 branches and 426 Extension Counters spread throughout the country. Strategic business area covers the large Indo-Gangetic belt and the metropolitan centres. Ranked as 416th biggest bank in the world by Bankers Almanac (July 2002), London. Strong correspondent banking relationships with more than 217 international banks of the world.
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Punjab National Bank – A Case Study
? ? ?
More than 50 renowned international banks maintain their Rupee Accounts with PNB. Well equipped dealing rooms; 20 different foreign currency accounts are maintained at major centres all over the globe. Rupee drawing arrangements with M/s UAE Exchange Centre, UAE, M/s Al Fardan Exchange Co. Doha, Qatar, M/s Bahrain Exchange Co, Kuwait, M/s Bahrain Finance Co, Bahrain, M/s Thomas Cook Al Rostamani Exchange Co. Dubai,UAE, and M/s Musandam Exchange, Ruwi, Sultanate of Oman.
?
In 2002-03, the bank made a profit of Rs. 240.54 crore (up from Rs. 152.11 crore in 2001-02) on a turnover of Rs. 2,318.18 crore (up from Rs. 1,928.53 crore in 2001-02).
?
Government of India holding in Punjab National Bank reduced from 100% in 2001-02 to 80% in 2002-03.
Services provided by the bank Punjab National Bank operates in all major segments of the Indian Financial sector. It has a wide array of customers, right from the smallest retail clients to some of the largest corporates in India. The services of the bank can be classified into three main categories: ? Personal (Retail) Banking: This includes a vast array of services like operation of Savings and Current Accounts, maintaining Fixed Deposits and Recurring Deposits for varying time periods, Locker facilities, Issue of Drafts and Cash orders, Electronic Funds Transfer, Debit and Credit Cards, Tax Collections and Depository Services. These facilities can be availed through its vast network of branches and ATMs or electronically through the internet. The bank also provides its retail
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Punjab National Bank – A Case Study
customers the option of tele-banking and SMS-banking. ? Corporate Banking: This category includes the services provided by the bank to its corporate clients, which includes short term finance, term loans (long term finance), advisory services and financial management services. The bank also provides EXIM finance, trader loans, Loan against Future Lease Rentals and Cash Management Services. ? Personal Loans: The bank provides various loans such as Housing Loans Car Finance, Consumer Finance, Personal Loans, Professional Loans, Vidya Laksyapurti (Education Loan scheme), Krishi Cards for farmers, Loans against mortgage of property, Scheme for House wives and other women and Mahila Udyam Nidhi Scheme for women entrepreneurs.
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Interpretation of data
The answers provided to the questionnaire yielded the following information:
Process of recovery under enforcement of security interest
Mr. Avinash Vaidya, who is in charge of handling the NPA cases through Securitisation Act at Punjab National Bank, provided the following basic guidelines which need to be followed: NPA Classification: The bank follows the RBI guidelines for classification of NPAs. These guidelines have been outlined in the Annexure. Account monitoring initiated: Once an account is classified as doubtful, regular, continuous and stringent monitoring of the account is initiated by the bank. At this stage, any steps, if possible to reduce the further account deterioration, if possible, are taken. Analysis of security charge: Before initiating any recovery procedures, an analysis of the expected yield of the account through the initiation of proceedings, is done. Only if the security is found to be of significant value, are the proceedings initiated. Notice to the defaulter for a period of 60 days: The bank gives the defaulting borrower a notice of 60 days to repay the dues, in accordance with the provisions of the Act. Possession notice (10 days): If the borrower is unable or unwilling to repay the dues, the bank will give him another notice of 10 days before taking action to takeover the secured assets. At this stage, if the borrower decides to co-operate with the bank, the bank may be willing to negotiate a settlement on a case-tocase basis. Also, in this case, the bank may not initiate any legal proceedings against the defaulter.
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Punjab National Bank – A Case Study
If the borrower does not co-operate with the bank representative, and creates obstructions in the smooth takeover of the assets, the bank may approach the Chief metropolitan magistrate or the District magistrate who shall then take over possession of the assets and documents relating to the assets and hand them over to the bank. The bank may also request police security for its representative for providing the formal possession notice to the defaulter. Publication of possession notice: The bank is mandated by law to publish the notice in newspapers, one of which must be a local language. Sale of assets: The following procedure is followed by Punjab National Bank to sell of the taken over assets: i. Valuation: Firstly, a valuation of the asset is carried out to find out the optimum sale price. ii. Advertisements for sale: The bank publishes advertisements in various leading newspapers in order to attract a number of interested buyers so that the best possible amount is received for the sale. iii. Sale negotiations, Tenders, Quotations: The bank may follow any suitable method for sale of assets. Legal action if recovery not complete: The bank may decide to pursue the case further if the above proceedings do not result in complete/satisfactory recovery. Besides possession and sale of secured assets, the bank has the following options under the provisions of the act: ? ? Takeover of management Sale to Asset Reconstruction Company
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Punjab National Bank – A Case Study
Example of recovery through enforcement of security interest
Highlights of the case
Defaulter: Amount Defaulted: Amount Recovered: Initiation of Recovery Process: Completion of Recovery Process:
Silverline Technologies Not Disclosed More than 80% 3rd December, 2002 6th June, 2003
About Silverline Technologies At the time of financing by the bank, Silverline Technologies was doing quite well. Silverline Technologies was a global IT services company providing end-to-end IT solutions in the following areas: ? ? ? ? ? ? Custom Development Application Management Enterprise Application Integration Data Warehousing eBusiness Customer Relationship Management
However, its condition deteriorated. Silverline Technologies Ltd posted a net loss of Rs 6.47 crore for the quarter ended September 30, 2002, compared to a net profit Rs 13.88 crore in the quarter ended September 30, 2001. Total income of
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Punjab National Bank – A Case Study
the company decreased from Rs 50.12 crore in the year-ago period to Rs 6.23 crore in the quarter ended September 30, 2002. Silverline Technologies, facing severe financial crisis, sold some assets owned by its subsidiary Silverline Technologies Inc, to Cognizant Technology Solutions US Corporation. It was facing cash crunch and had not been able to pay salaries to its US employees for the last few months. Further, the increase in receivable cycles amid global economic slowdown had affected its working capital position. About the financing Punjab National Bank had opened a Letter of Credit (LC on Documents against Acceptance) at the request of Silverline Technologies for import. However, Silverline could not arrange for the payment of the imported products at the end of the period of credit provided by the exporter. The LC was devolved and Punjab National Bank was forced to pay the amount. This amount was recoverable against thee mentioned security from Silverline. Primary security: The company had provided primary security which consisted of software and hardware. On the face of it, the value of this security was adequate; however there were some flaws, which need to be understood. ? The software was a highly customized package which had been developed for a specific client. Hence it had no application, except for the client of the company. ? Computer hardware becomes obsolete very fast. For example, a computer bought today will become outdated within a year. Hence the value of hardware goes down very fast and hence does not form a very good security
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Punjab National Bank – A Case Study
for a loan Secondary security: Looking at the above problems of the security provided by Silverline Technologies, the loan appraisal department of Punjab National Bank asked for a secondary security before approving the FLC. Hence, the company provided the bank with a secondary security which consisted of 16 flats and a property in Thane. Enforcement process Once the account was classified as an NPA, the bank initiated recovery proceedings against the company. The steps undertaken by the bank for the loan recovery are underlined below. (The general steps to be followed, as mandated by the Act are detailed in Section 3 of the project) ? Issue of notice: The bank issued a notice to the company, under the provisions of the Securitisation act, on 3rd December, 2002. The notice mainly outlined the balance yet to be received from the company by the bank and gave the company a period of 60 days to repay the amount. If the company did not repay the amount within the above noted period, the bank could attach the security provided by the company. The notice issued has been attached as part of the annexure. ? Notice for taking possession of security: The bank gave a further 10 day notice to the company. It stated that if the amount was not repaid within 10 days, the bank would initiate attachment proceedings. ? No response by the company: The company failed to respond within the allotted period of 60 days as well as the additional period of 10 days. ? Attachment process started: The bank sent an authorized person to take
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Punjab National Bank – A Case Study
possession of the primary security. However, the bank
realized that the
primary security could not repay the entire amount under default. ? Negotiation: At this time, the company also came to the bank to negotiate some more time to pay off the loan and also offered to transfer the secondary security to the bank. The bank gave the company one month?s time, but did not write off any part of the loan. ? Transfer of property: As the company did not repay the default amount, the bank insisted that the company transfer the property in its name. The company agreed to this in principal. ? Winding up proceedings initiated: With the company delaying in transferring the property, the bank decided to apply pressure by initiating winding up proceedings against the company. ? Defaulter’s attempt to leave the country: At this moment the directors of the company attempted to leave the country. But the bank displayed its alertness and applied for the cancellation of their passports and requested a stay against them from leaving the country. ? Transfer and Registration of flats completed on 6th June, 2003: Due to the mounting pressure, the company transferred the flats in the bank?s name and the registration papers were signed on 6th June, 2003.
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Chapter Five
Benefits, Problems and Recommendations
Conclusion – Benefits, Problems and Recommendations
Benefits of the Act
The bankers feel that the current Act will greatly improve the recovery climate in the country. They feel that this act can prove as a major deterrent to the willful defaulters, who will now have to think twice before taking the banks and the financial institutions for a ride. Till now, the bankers did not have any weapon to take action against such defaulters and were found incapable of even threatening them with action. However this case has greatly improved after the passing of the act. As has already been seen from the preceding example, the banks can use the Act to pressurize the defaulters, in order to recover their money. Also, the defaulters have been given very little opportunity to put hindrances in the recovery process, as can be seen in the Mardia Chemicals vs. ICICI Bank case. In this case, the defaulter, Mardia Chemicals, approached the Supreme Court to get a stay against the banks, which had sent them a notice for taking possession of the secured asset. Here, the appeal was turned down and the banks were allowed to take over the management of the company. The bankers also feel that the time of recovery proceedings will come down greatly, from the present 1-10 years to just a few months. This will greatly improve the NPA position of banks. Development of ARCs will bring in professionalism into the recovery process. These ARCs will help the banks, as the banks can transfer their NPAs to them, thereby recovering their locked up funds quickly and efficiently. Finally, banks are highly optimistic about the future of the act. Punjab National bank is targeting an improved recovery rate of 40% in the next 5 years as compared to 22 – 23% today. A number of other banks have also come out with
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Conclusion – Benefits, Problems and Recommendations
press releases about optimistic future guidelines. A number of banks have already recovered substantial amounts by carrying out proceedings under the provisions of the Act.
Problems Envisaged
The bankers I talked to, feel that a number of minor and major hindrances are still present which need to be tackled. The Act is an effort to tackle NPA from the terminal end. Its provisions are operative only when an account has turned bad and transferred as NPA. There are no remedial steps contemplated to arrest NPA at source. This is possible only by change in "habits" or practices followed by both the Banks and the borrowers. A relevant point with regards to taking over the management of defaulting units is brought out by the bankers as another handicap. The bigger amounts, where defaulters may show no sign of loosening up, can be realised by encashing the secured assets in the form of huge real estate, plant and machinery. As a senior law official with IFCI Ltd points out, there are, however, two provisions - section 13(4) and section 9 - that need clarification before banks and FIs move in a big way towards management control. Section 9, for instance, allows a securitisation or asset reconstruction company to take over the management of a company of "the business of the borrower" or bring in change of management. Section 13(4), though, permits a "secured creditor" to take over the management of the secured assets of the borrower. It is apparent the act is intended to allow asset reconstruction companies to take over the "management of the business" of a company, whereas a secured creditor can only take over the "management of the secured assets" and not
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Conclusion – Benefits, Problems and Recommendations
bring in any change in management. With the task of setting up and getting the asset reconstruction companies functional still incomplete, prospects of takeover of defaulters' assets right away seem remote. ? Internal Problems of banks Without solving the internal problems of the banks related to credit appraisal and recovery, any other measures taken to reduce NPAs will be useless and will not provide the desired results. ? No difference between willful and normal business default The Act, in no way differentiates between willful defaulters, against whom stern action is required, and genuine defaults which may occur in the normal course of business and may require restructuring. ? Sections 35 and 37 contradict each other Section 37 of the Act states that the provisions of Act are in addition to the provisions of Companies Act, SCRA, SEBI Act, RDDBFIA Act and other laws. Thus, no overriding provision has been given to the Act. However, Section 35 makes exactly contrary provision that the provisions of the Act override provisions of all other laws in force. Thus, sections 35 and 37 are contradictory provisions. It appears that section 35 is meant for provisions in respect of enforcement of security interest and Asset Reconstruction Company, while section 37 is meant for provisions in respect of securitisation. However, there is no such clarification and interpretation of these contradictory provisions will be very difficult.
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Conclusion – Benefits, Problems and Recommendations
?
Joint financing In cases where financing of asset is by more than one secured creditor or there is joint financing of a financial asset, an individual secured creditor cannot take any action as contemplated u/s 13(4), unless exercise of such right is agreed upon by secured creditors representing at least 75% of the amount outstanding on record date. If 75% of creditors agree to the action, that decision will be binding on all remaining secured creditors. [Section 13(9)] This can create a number of problems in the recovery process. Firstly, according to Mr. Anil Bhan (Chief Manager, NPA Department, Punjab National Bank), there are a number of conflicts of interests due to the fact that different lenders have different security charges with different priority of charges. As a result, each lender does not want to provide approval for taking action, as it may result in lower recoveries for his organization and would aid the recovery of other lenders. Also, different lenders have different recovery records of the borrower, resulting in them wanting to take different approaches to the recovery process.
?
Management cannot be taken over Section 13(4) makes no provision for taking over management of business of a borrower, though section 15 provides for manner and effect of takeover of management. However, in absence of any specific power to takeover management of business of borrower, it is doubtful if such power can be exercised. Also, takeover of management is not a viable option for banks, as the
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Conclusion – Benefits, Problems and Recommendations
defaulters may be operating in extremely diverse sectors and the banks may not have the people who can professionally handle the day-to-day operations of such a large number of firms. ? Secured Creditor may require permission to take action if matter is with DRT/Civil Court The Act makes no provision whether action can be taken if the matter is already pending with DRT/Civil Court. There is neither specific permission nor prohibition. Section 13(10) provides that secured creditor can proceed against the guarantor for balance amount due. Hence, it can be argued that secured creditor can take action u/s 13 even if matter is pending with DRT. However, since the matter is sub judice, it will be highly advisable to seek permission of DRT before taking action u/s 13. It will be advisable to make specific provision in the Act to avoid disputes. This will only result in delays for the implementation of the recovery procedure. ? Major chunk of financial market left out The definition of „financial institution? [Section 2(l)(m)(iv)] makes it clear that it does not include NBFC (though these can be included by issuing a notification by Central Government). If so, one major chunk of financial market is outside the provisions of Act, as many NBFCs are involved in housing finance, hire purchase finance, car loans etc. ? Approach to BIFR by defaulter If the defaulter approaches the BIFR and the company is entered into restructuring under this act, the lender may find it difficult to take any action under the Securitisation Act.
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Conclusion – Benefits, Problems and Recommendations
?
Security sell off in the notice period This is a problem being faced by a number of banks who have initiated proceedings under the provisions of the act. The defaulters, on receiving the notice under the act, get a period of 60 days before any further action can be taken by the lender. During this period, the defaulter may sell off a part or the entire security, thus providing the lenders with no opportunities to recover the amount. This is especially true when liquid assets such as stocks have been provided as security.
?
Valuation problems Generally, banks tend to find that there is a major gap in the valuation of the security, as carried out at the time of providing the loan and at the time of loan recovery. The value of the security has generally deteriorated over the period, and according to experts, it may further deteriorate by almost 10-50% in quick action is not taken for its immediate sale.
?
Liabilities attached to the property transferred on takeover This can prove as a major deterrent in getting an optimal price for the secured asset. The lender has to take care of all attached liabilities before a sale can be affected. These liabilities can form a major chunk of the value of the asset, thereby reducing the recovery from sale of asset manifold.
?
Problems in taking possession The lender may face various problems in taking possession of secured assets, especially if they are unmovable property. The bank may have to apply forceful tactics to take possession and may have to take the help of the Metropolitan Magistrate and police.
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Conclusion – Benefits, Problems and Recommendations
Recommendations
The bankers are of the opinion that a number of Amendments are required to make the Act foolproof. They also feel that a number of fundamental changes in the functioning of the financial sector as a whole are needed to tackle the problem of NPAs effectively. ? No super-priority rights to the government The government and its various agencies enjoy super priority rights. For example, if Sales Tax or other duties are outstanding, these agencies have a first right to recover the amount. In the case of a borrower, this right can hamper recovery. On taking over an asset, the lender has to first pay these dues before a sale of the asset can be made. I am of the opinion that this right should not be provided to the government. The government and its agencies should be at par with the unsecured creditors and should follow the normal recovery process to recover its dues. They should also be willing to take a hit, as is the case with the other secured and unsecured creditors. ? No priority / weighted average method in calculation of charge As we have already seen the problems created due to priority of security charge, I recommend that a weighted average method should be used when more than one creditor have a charge on the same security. Under this method, the creditor with the first charge should be given a higher weight, based on the amount of credit, and a mutual understanding between the different creditors, while the creditors with second or third charge may be given a lower weight.
115
Conclusion – Benefits, Problems and Recommendations
?
Market of ARC to be developed Currently, there are no ARCs in India. This area needs to be looked at. A large number of ARCs should be allowed to operate to facilitate competition, which would improve pricing and the quality of services. Also, it is preferable that the ARCs set up should not be subsidiaries of banks, but different companies, this would ensure that the process is followed in legality as well as spirit. This would reduce the possibilities, that bad loans are not just transferred from one balance sheet to the other, and actual recovery takes place.
?
ARCs should be developed on industry basis only ARCs are specialized agencies which will be managing the taken over companies of the borrowers. These securitisation companies, therefore, should be experts in the area of operations of the borrowers to successfully manage them. This can be made possible if an industry – wise bifurcation is done for the creation of securitisation companies and they function in only one specialized area.
?
Securitisation should be without-recourse only Securitisation under the act can be with or without recourse. Under with recourse securitisation, the securitisation or reconstruction company can approach the banks and ask them to pay the balance amount, if they are not able to recover the full amount from the borrower. Under without recourse securitisation, the securitisation or reconstruction company does not have any such right. According to Mr. Anil Bhan, with recourse securitisation nullifies the entire benefit of transfer of NPAs to these companies. Also, since these companies are not willing to share any profits made with the banks, they should be willing to take the risks involved in the transaction.
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Conclusion – Benefits, Problems and Recommendations
It is the policy of Punjab National Bank to recover the highest amount in the shortest possible time. For example, a securitisation company offers the following two different options for the securitisation transaction; one, where the securitisation company is willing to pay only 50% of the loan amount immediately, and two, wherein the securitisation company will pay 20% upfront and will share any profits on the recovery with the banks in a 60-40 ratio. Punjab National Bank would accept the first option even if there is a high possibility of recovering a higher amount in the second instance. ? Political interference should be reduced Political interference in the day – to – day functioning of public sector banks creates a number of problems for them. The populist policies of the national level politicians, such as waiver in repayment of loans should be curbed and the banks should be allowed to function as normal commercial organizations. ? Transactions relating to the secured asset after the issue of notice to be considered void To solve the problem of the sale of secured assets during the notice period, an amendment should be made, whereby, all transactions related to the secured asset by the borrower like sale, lease, etc. will be considered as void, and the secured creditor will have first right to take over the asset and sell it to recover his dues.
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Conclusion – Benefits, Problems and Recommendations
Annexure
Questionnaire
Part A
1. 2. 3. 4. What are the main reasons for huge NPAs in the banking industry? What are the statutory guidelines of RBI in relation to NPAs? What percentage of total loan disbursements turn into NPAs? Do you have a separate department for dealing with NPAs? If so, what is the procedure followed for dealing with NPAs? 5. 6. What are the major problems faced in loan recovery? Over the years, what steps has the government taken to assist the finance sector for reducing NPAs? 7. What were the problems with the above steps i.e. why has the industry not been able to reduce NPAs?
Part B
8. How, in your opinion, will the recently introduced concept of securitization help in reducing NPAs? 9. 10. What are your views on the new Securitisation Act? What benefits of securitisation do you envisage over other methods of loan recovery? 11. Have you initiated proceedings against defaulters under the provisions of the act?
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Conclusion – Benefits, Problems and Recommendations
12. 13. 14.
If so, what has been your experience? Have you faced any problems? Do you feel that the act has any shortcomings or loopholes? What amendments do you think would be a step in the direction to remove these shortcomings?
15.
What other features not covered by present legislations would you like to be included?
16.
Which points should be included in a framework, which would be effective in curbing NPAs?
17.
Besides legislations, what can the government and the banks themselves do to reduce NPAs?
18.
Do you think, the act sends a strong enough message to habitual defaulters which will check them in repeating this in future?
19.
Today, banks can opt for Debt Recovery Tribunals or Securitisation for recovery of NPAs. In your opinion, which is a better tool for recovery? What are the pros and cons of each tool?
20.
Do you think that proceedings under the securitisation act have impacted the PR of the bank? If so, has the impact been positive or negative?
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Conclusion – Benefits, Problems and Recommendations
Possession Notice [Rule 8(1)]
(For immovable property) Whereas The undersigned being the authorised officer of the …… (name of the Institution) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and in exercise of powers conferred under section 13(12) read with rule 9 of the Security Interest (Enforcement) Rules, 2002 issued a demand notice dated …… calling upon the borrower Shri …… / M/s …… to repay the amount mentioned in the notice being Rs ….. (in words ……… ) within 60 days from the date of receipt of the said notice. The borrower having failed to repay the amount, notice is hereby given to the borrower and the public in general that the undersigned has taken possession of the property described hereinbelow in exercise of powers conferred on him/her under section 13(4) of the said Act read with rule 9 of the said rule on this ……day of…… of the year …… The borrower in particular and the public in general is hereby cautioned not to deal with the property and any dealings with the property will be subject to the charge of the …… (name of the Institution) for an amount Rs …… and interest thereon.
Description of the Immovable Property
All that part and parcel of the property consisting of Flat No …… / Plot No …… In Survey No …… / City or Town Survey No …… / Khasra No …… within the registration Sub-district …… and District …… Bounded: On the North by On the South by On the East by On the West by Sd/Authorised Officer (Name of the Institution) Date: Place:
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Conclusion – Benefits, Problems and Recommendations
SALE CERTIFICATE [Rule 9(6)]
(For immovable property) Whereas The undersigned being the authorised officer of the …… (name of the Institution) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and in exercise of the powers conferred under section 13 read with rule 12 of the Security Interest (Enforcement) Rules, 2002 sold on behalf of the …… (name of the secured creditor/institution) in favour of …… (purchaser), the immovable property shown in the schedule below secured in favour of the …… (name of the secured creditor) by ……… (the names of the borrowers) towards the financial facility …… (description) offered by …… (secured creditor). The undersigned acknowledge the receipt of the sale price in full and handed over the delivery and possession of the scheduled property. The sale of the scheduled property was made free from all encumbrances known to the secured creditor listed below on deposit of the money demanded by the undersigned.
Description of the Movable Property
All that part and parcel of the property consisting of Flat No …… /Plot No …… In Survey No …… /City or Town Survey No …… /Khasra No …… Within the registration sub-district …… and District …… Bounded: On the North by On the South by On the East by On the West by List of encumbrances
1. 2.
Sd/ Authorised Officer (Name of the Institution) Date: Place:
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Conclusion – Benefits, Problems and Recommendations
RBI Norms for Classification of NPAs
Definition of NPAs An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A „non performing asset? was defined as a credit facility in respect of which the interest and / or installment of principal had remained „past due? for a specified period of time. The specified period was reduced in a phased manner as under: Year ending March 31 1993 1994 1995 Onwards Specified period Four Quarters Three Quarters Two quaters
An amount due under any credit facility is treated as „past due? when it has not been paid within 30 days from the due date. Due to the improvements in the payment and settlement systems, recovery climate, upgradation of technology in the banking sector, etc, it was decided to dispense with the „past due? concept, with effect from 31st March, 2001. Accordingly, as from that date, a NPA shall be an advance where, i. Interest and/or installment of principal remain overdue for a period of more than 180 days in respect of a term loan ii. The account remains „our of order? for a period of more than 180 days, in respect of an overdraft/cash credit iii. Interest and/or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agriculture purposes iv. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.
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Conclusion – Benefits, Problems and Recommendations
With a view to move towards international best practices, it has been decided to adopt the ?90 days? overdue norm for identification of NPAs, from 31 st March, 2004. ‘Out of Order’ Status An account should be treated as „out of order? if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for six months as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as „out of order?. ‘Overdue’ Any amount due to the bank under any credit facility is „overdue? if it is not paid on the due date fixed by the bank. Classification of NPAs Banks are required to classify NPAs further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues: i. Sub-standard Assets: A sub-standard asset is one which has remained NPA for a period less than or equal to 18 months. In such cases, the current net worth of the borrower, or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. Such assets will have well defined credit weakness that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the bank will sustain a loss. ii. Doubtful Assets: A Doubtful Asset which has remained NPA for a period
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Conclusion – Benefits, Problems and Recommendations
exceeding 18 months. It has all the weaknesses inherent to a substandard asset with the added characteristic that the collection or liquidation in full – on the basis of currently known facts – is highly questionable and improbable. iii. Loss Assets: A loss asset is one where a loss has been identified by the bank or, internal or external auditors but the amount has not been written off wholly. Guidelines for Classification of NPAs Broadly speaking, classification should be done taking into account the degree of well defined credit weaknesses and the extent of dependence on collateral security for realization of dues. Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts. ? Accounts with temporary deficiencies: These should be classified based on the past recovery records. ? Accounts regularize near about the balance sheet date: These accounts should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness based on available data, it should be deemed as an NPA. ? Asset classification should be borrower-wise and not facility-wise: If a single facility to a borrower is classified as NPA, others should also be classified the same way, as it is difficult to envisage only a solitary facility becoming a problem credit and not others.
124
Conclusion – Benefits, Problems and Recommendations
?
Advances under consortium arrangements: Classification here should be based on the recovery record of the individual member banks.
?
Accounts where there is erosion in the value of the security: If there is a significant (i.e. the realizable value of the security is less than 50% of that assessed by the bank during acceptance) the account may be classified as NPA.
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Conclusion – Benefits, Problems and Recommendations
Bibliography
Books
“Taxmann?s Law Relating to Securitisation, Reconstruction of Financial Assets & Enforcement of Security Interest” by V. S. Datey “Securitisation, Asset Reconstruction & Enforcement of Security Interest” by Vinod Kothari
Reports
“Trend and Progress of Banking in India 2001-02” by RBI “Prudential Norms for Classification of NPAs” by RBI
Newspapers and Magazines
The Economic Times The Times of India The Financial Express Business Today RBI Bulletin
126
doc_117497813.docx
This is a document about the impact of securitization on IPA of banks.
The Impact of Securitization on NPA of Banks in India
i
Table of Contents
TABLE OF CONTENTS
I
EXECUTIVE SUMMARY
VII
OBJECTIVES OF THE STUDY
VIII
ACKNOWLEDGEMENTS
IX
CHAPTER ONE - THE CONCEPT OF SECURITISATION
FEATURES OF SECURITISATION 1. Marketability 2. 3. 4. 5. 6. Merchantable quality Wide Distribution Homogeneity Special purpose vehicle Assets that can be securitised
1
5 5 6 7 7 8 8 10 10 13 14 14
PROCESS OF SECURITISATION TERMS USED IN A SECURITISATION TRANSACTION BENEFITS FROM SECURITISATION OF ASSETS RISKS FACED, THREATS INVOLVED IF SECURITISATION IS NOT CARRIED OUT
PRUDENTIALLY
SECURITISATION IN INDIA
ii
CHAPTER TWO - NEED FOR SECURITISATION ACT
NPAS IN THE BANKING SECTOR DEFINITION OF NON-PERFORMING ASSET NPA STATISTICS 1. Impact on Profitability 2. Impact on Liquidity of the Nationalised Banks 3. Impact on Outlook of Bankers towards Credit Delivery INITIATIVES OF GOVERNMENT AND RBI FOR REDUCTION OF NPAS 1. 2. 3. 4. 5. 6. 7. 8. 9. Compromise settlement schemes Lok Adalats Debt Recovery Tribunals Circulation of information on defaulters Recovery action against large NPAs Corporate Debt Restructuring (CDR) Credit Information Bureau Proposed guidelines on willful defaults/diversion of funds Corporate Governance
17
18 20 20 24 29 29 31 31 32 32 33 34 34 35 35 35 36 36 36 36 37 37 37 38 39
PROBLEMS WITH PREVIOUS METHODS 1. Inadequate security & Erosion in value of security 2. Political interference 3. Slow legal procedures 4. Swamping of DRTs with cases 5. Misuse of BIFR / SICA 6. Transfer of property Act, English mortgage CAUSES OF NPAS CONCLUSION
iii
CHAPTER THREE - SECURITISATION ACT – A NEW LANDMARK IN THE INDIAN FINANCIAL SECTOR
SCOPE & OBJECTIVES OF THE ACT SOME IMPORTANT DEFINITIONS REGISTRATION OF SECURITISATION OR RECONSTRUCTION COMPANY 1. Requirements for registration of securitisation company 2. Operational Rules for Already Existing ARCs/SCs 3. Procedure for Registration Approval of RBI for Change in Management Business that can be carried out Powers of RBI Cancellation of registration Other companies/entities can carry out securitisation ACQUIRING FINANCIAL ASSETS FROM BANK / FI 1. Modes of acquiring financial asset 2. Is it transfer of actionable claim? 3. Registration of agreement 4. Stamp Duty Payable Company enters into shoes of Bank/Fl after acquiring asset Notice to borrower/Registrar Effect of the notice Arbitration Mandatory Protection to secured creditor for acts in good faith CENTRAL REGISTRY 1. Maintenance of Central Register 2. Satisfaction or payment of security interest 3. Inspection of Central Register 4. 5. 6. Penalty for default Provisions to apply only after Central Registry is setup All security interest created to be registered? 5. 6. 7. 8. 9. 4. 5. 6. 7. 8.
40
41 44 51 51 52 52 53 53 54 54 55 56 56 57 57 58 59 59 60 60 61 62 62 63 63 64 65 65 66 66
ENFORCEMENT OF SECURITY INTEREST 1. Requirements of notice
iv
2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Mode of Serving Notice Provision when joint financing is involved Measures that can be taken Cost and expenses can be recovered from borrower Excess amount to be refunded to borrower Secured creditor can proceed against borrower for balance amount How the secured creditor can exercise his right Restrictions on borrower after receipt of notice Effect of transfer of asset to third person Significance OF ‘AS IF TRANSFER IS MADE BY OWNER OF ASSET’
66 67 68 69 70 70 71 71 71 71 72 73 73 73 74 75 75 75 76 77 77 93 93 93 94 94 94 94 95
Payment of amount by Borrower any taking back possession Time limit for taking action after serving of notice Jurisdiction of civil court barred Protection to secured creditor for acts in good faith Can Secured Creditor take action if matter is with DRT / Civil Court? TAKING OVER OF ASSETS 1. Assistance of Magistrate to take over possession 2. Change of directors/appointment of administrator 3. Effect of the notice Effect of takeover of management Guidelines for exercise of power APPEALS AND PENALTIES 1. Appeal against action of secured creditor 2. Appeal to DRT 3. Appeal to Appellate Tribunal 4. Right of Borrower to Receive Compensation and Costs for Wrongful Action 5. Reliefs that can be granted 6. Only compensation, no damages 7. Punishment 4. 5.
v
CHAPTER FOUR - PUNJAB NATIONAL BANK – A CASE STUDY
RESEARCH METHODOLOGY COLLECTION OF DATA Primary Sources Secondary Sources ABOUT PUNJAB NATIONAL BANK INTERPRETATION OF DATA Process of recovery under enforcement of security interest Example of recovery through enforcement of security interest
96
97 97 97 97 97 102 102 104
CHAPTER FIVE - BENEFITS, PROBLEMS AND RECOMMENDATIONS
BENEFITS OF THE ACT PROBLEMS ENVISAGED RECOMMENDATIONS
108
109 110 115
ANNEXURE
QUESTIONNAIRE Part A Part B POSSESSION NOTICE [RULE 8(1)] RBI NORMS FOR CLASSIFICATION OF NPAS BIBLIOGRAPHY Books Reports Newspapers and Magazines
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118 118 118 120 122 126 126 126 126
vi
Executive Summary
The project report is divided into five main chapters. In the first chapter, the concept of Securitisation has been dealt with. This chapter explains the salient features, the process and the parties involved in a Securitisation transaction. It explains the major benefits of securitisation and the risks involved. It shows the various stages through which the development of Securitisation in India has gone through. In the second chapter, the reasons behind the need for the present act are analysed. The huge mountain of NPAs in the banking sector, and the inability to find an appropriate method to curb their rise, contributed to this need. The problems with the previous methods of loan recovery are explained, and a case for the new act prepared. In the third chapter, the provisions of the ‘The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002’ are detailed. It includes the scope and objectives of the act, a number of important definitions and procedures for regulation of securitisation companies, enforcement of security interest by banks and for taking over assets without the intervention of courts. In the fourth chapter, an attempt has been made to understand the impact of the current legislation on the NPAs of banks with regards to its effectiveness in enabling recovery of NPAs. This is done by taking the example of Punjab National Bank as a case study. The procedure followed by the bank for the successful recovery from Silverline Technologies is used to form the ideal procedure to be followed by banks. In the final chapter, the benefits of the current act, as discussed by the bankers, as well ass problems which need to be solved are outlined. Based on the
vii
discussion of these problems, a number of recommendations have been formulated, which can make this Act a strong instrument for the improvement of the banking sector?s financial condition.
Objectives of the Study
My main objectives in undertaking this project report are as follows: ? To understand the working of banks with regards to loan appraisal and recovery ? ? To understand the problems faced by banks in the loan recovery process To analyze the impact of „The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002? on the NPAs of banks
viii
Acknowledgements
Any project report cannot be completed without the help and co-operation of a number of people, who equally contribute to its successful completion. I would like to offer my sincere gratitude to these people. Firstly, my wholehearted gratitude goes to Professor Sanjay Kaila, my mentor, and project guide, without whose help and frank opinion, this project would not have been possible. He motivated me to undertake this detailed study and helped me with all my queries. Thanks a lot, Sir! I would also like to thank Professor Sapna Mallaya, who has taught me the financial concepts. Last, but not the least, I would like to thank the following people at Punjab National Bank for providing their precious time to discuss my project, and providing the information for my case study: ? ? ? Mr. Anil Bhan, Chief Manager, Credit Risk Management Department Mr. Avinash Vaidya, Senior Manager, Credit Risk Management Department Mr. T. V. K. Subramanian, Senior Manager, Credit Risk Management Department ? Mrs. Padmaprabha, Senior Manager, Credit Risk Management Department
ix
Chapter One
The Concept of Securitisation
Concept of Securitisation
Concept of Securitisation
Normally, a lender (financier) finances loans to borrowers and gets repayment with interest over a period. The lender would collect the periodic installments and use them to finance new loans. This limits his capacity to give fresh loans, as he has to wait until he recovers the installments along with interest. Instead of waiting for a long time, he can pool the loans together and sell his right to receive future payments from the borrowers of these loans. This is termed as securitisation of loans. The original lender will receive consideration for the same upfront, i.e. immediately, by securitizing his loans portfolio. Of course he will receive the amount at a discounted value. He can then use the proceeds to further develop his business, which is of giving loans. These „securitised loans? will be purchased by mutual funds, provident funds and insurance companies, which have funds but do not have a mechanism to assess, grant and recover loans. Thus corporate bodies like finance companies having expertise in assessing, granting and recovering loans get the funds from corporate bodies like mutual funds, provident funds and insurance companies which have funds but do not have expertise in loan assessment and disbursal. However, securitisation is a wider term, which can include all future cash flows. Assets which can be securitised and the types of securitisation are discussed later.
Legal definition
“Securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise.
2
Concept of Securitisation
?
Meaning of security: In connection with securitisation, the word "security" does not mean what it traditionally might have meant under corporate laws or commerce: a secured instrument. The word "security" here means a financial claim which is generally manifested in form of a document, its essential feature being marketability. To ensure marketability, the instrument must have general acceptability as a store of value. Hence, either it is generally rated by credit rating agencies, or it is secured by charge over substantial assets. Further, to ensure liquidity, the instrument is generally made in homogenous lots.
?
Securitisation is the process of commoditisation: The basic idea is to take the outcome of this process into the market, the capital market. Thus, the result of every securitisation process, whatever might be the area to which it is applied, is to create certain instruments which can be placed in the market.
?
Securitisation is the process of integration and differentiation: The entity that securitises its assets first pools them together into a common hotchpot (assuming it is not one asset but several assets, as is normally the case). Thus the process of integration. Then, the pool itself is broken into instruments of fixed denomination. This is the process of differentiation.
?
Securitisation is the process of de-construction of an entity: If one envisages an entity's assets as being composed of claims to various cash flows, the process of securitisation would split apart these cash flows into different buckets, classify them, and sell these classified parts to different investors as per their needs. Thus, securitisation breaks the entity into various sub-sets.
3
Concept of Securitisation
Example to understand the concept
The simplest way to understand the concept of securitisation is to take an example. Let us say, I want to own a car to run it for hire. I could take a loan with which I could buy the car. The loan is my obligation and the car is my asset, and both are affected by my other assets and other obligations. This is the case of simple financing. On the other hand, if I were to analytically envisage the car, my asset in the instant case, as claim to value over a period of time, that is, ability to generate a series of hire rentals over a period of time, I might sell a part of the cash flow by way of hire rentals for a stipulated time and thereby raise enough money to buy the car. The investor is happier now, because he has a claim for a cash flow which is not affected by my other obligations; I am happier because I have the cake and eat it also, and also, because the obligation to repay the financier is taken care of by the cash flows from the car itself. This is a win-win situation for both the financier and for me.
4
Concept of Securitisation
Features of securitisation
A securitised instrument, as compared to a direct claim on the issuer, will generally have the following features:
1. Marketability
The very purpose of securitisation is to ensure marketability to financial claims. Hence, the instrument is structured so as to be marketable. This is one of the most important features of a securitised instrument, and the others that follow are mostly imported only to ensure this one. The concept of marketability involves two postulates: (a) the legal and systemic possibility of marketing the instrument; (b) the existence of a market for the instrument. As far as the legal possibility of marketing the instrument is concerned, traditional mercantile law took a contemporaneous view of marketable documents. In most jurisdictions of the world, laws dealing with marketable instruments (also referred to as negotiable instruments) were mostly limited in application to what were then in circulation as such. Besides, the corporate laws mostly defined and sought to regulate issuance of very usual corporate financial claims, such as shares, bonds and debentures. For any codified law, this is not unexpected, since laws do not lead commerce: most often, they follow, as the concern of the law-maker is mostly regulatory and not promotional. Hence, in most jurisdictions of the world, well-coded laws exist to enable and regulate the issuance of traditional forms of securitised claims, such as shares, bonds, debentures and trade paper (negotiable instruments). Most countries lack in legal systems pertaining to other securitised products, of recent or exotic origin, such as securitisation of receivables. On a policy plane, it is incumbent on the part of the regulator to view any securitised instrument with the same concern as in case of traditional instruments, for reasons of investor protection.
5
Concept of Securitisation
However, it needs to be noted that where a law does not exist to regulate issuance of a securitised instrument, it is naive to believe that the law does not permit such issuance. As regulation is a design by humanity itself, it would be ridiculous to presume that everything that is not regulated is not even allowed. Regulation is an exception and freedom is the rule. The second issue is one of having or creating a market for the instrument. Securitisation is a fallacy unless the securitised product is marketable. The very purpose of securitisation will be defeated if the instrument is loaded on to a few professional investors without any possibility of having a liquid market therein. Liquidity to a securitised instrument is afforded either by introducing it into an organised market (such as securities exchanges) or by one or more agencies acting as market makers in it, that is, agreeing to buy and sell the instrument at either pre-determined or market-determined prices.
2. Merchantable quality
To be market-acceptable, a securitised product has to have a merchantable quality. The concept of merchantable quality in case of physical goods is something which is acceptable to merchants in normal trade. When applied to financial products, it would mean the financial commitments embodied in the instruments are secured to the investors' satisfaction. "To the investors' satisfaction" is a relative term, and therefore, the originator of the securitised instrument secures the instrument based on the needs of the investors. The general rule is: the broader the base of the investors, the less is the investors' ability to absorb the risk, and hence, the more the need to securitise. For widely distributed securitised instruments, evaluation of the quality, and its certification by an independent expert, viz., rating is common. The rating serves for the benefit of the lay investor, who is otherwise not expected to be in a position to appraise the degree of risk involved.
6
Concept of Securitisation
In case of securitisation of receivables, the concept of quality undergoes drastic change making rating is a universal requirement for securitisations. As already discussed, securitisation is a case where a claim on the debtors of the originator is being bought by the investors. Hence, the quality of the claim of the debtors assumes significance, which at times enables to investors to rely purely on the credit-rating of debtors (or a portfolio of debtors) and so, make the instrument totally independent of the originators' own rating.
3. Wide Distribution
The basic purpose of securitisation is to distribute the product. The extent of distribution which the originator would like to achieve is based on a comparative analysis of the costs and the benefits achieved thereby. Wider distribution leads to a cost-benefit in the sense that the issuer is able to market the product with lower return, and hence, lower financial cost to himself. But wide investor base involves costs of distribution and servicing. In practice, securitisation issues are still difficult for retail investors to understand. Hence, most securitisations have been privately placed with professional investors. However, it is likely that in to come, retail investors could be attracted into securitised products.
4. Homogeneity
To serve as a marketable instrument, the instrument should be packaged as into homogenous lots. Homogeneity, like the above features, is a function of retail marketing. Most securitised instruments are broken into lots affordable to the marginal investor, and hence, the minimum denomination becomes relative to the needs of the smallest investor. Shares in companies may be broken into slices as small as Re. 1 each, but debentures and bonds are sliced into Rs. 100 each to Rs. 1000 each. Designed for larger investors, commercial paper may be in denominations as high as Rs. 5 Lac. Other securitisation applications may also follow this logic. The need to break the whole lot to be securitised into several
7
Concept of Securitisation
homogenous lots makes securitisation an exercise of integration and differentiation: integration of those several assets into one lump, and then the latter's differentiation into uniform marketable lots. This often invites the next feature: an intermediary to achieve this process.
5. Special purpose vehicle
In case the securitisation involves any asset or claim which needs to be integrated and differentiated, that is, unless it is a direct and unsecured claim on the issuer, the issuer will need an intermediary agency to act as a repository of the asset or claim which is being securitised. Let us take the easiest example of a secured debenture, in essence, a secured loan from several investors. Here, security charge over the issuer's several assets needs to be integrated, and thereafter broken into marketable lots. For this purpose, the issuer will bring in an intermediary agency whose basic function is to hold the security charge on behalf of the investors, and then issue certificates to the investors of beneficial interest in the charge held by the intermediary. So, whereas the charge continues to be held by the intermediary, beneficial interest therein becomes a marketable security. The same process is involved in securitisation of receivables, where the special purpose intermediary holds the receivables with itself, and issues beneficial interest certificates to the investors.
6. Assets that can be securitised
Basically, all assets which generate a cash flow can be securitised e.g. mortgage loans, housing loans, automobile loans, credit card receivables, trade receivables, consumer loans, lease finance, etc. a perfectly and normal financial asset is usually securitised. A difference is usually made between asset securitisation and mortgage securitisation.
8
Concept of Securitisation
Process of Securitisation
Owner (Originator)
Original Loan
Obligor(s)
Consideration
Financial assets such as loans etc., which are securitised Repayment of Loan
Servicer Special purpose Vehicle / Entity
Credit Enhancement
Collections
Consideration Redemption of securities Investors
Securities such as PTCs and/or debt-securities
1. Obligor is an entity which has received a loan giving rise to the financial asset that is securitised by the Originator. 2. Servicer can be Originator also 3. Credit enhancement may be provided by the Originator or any other third party.
9
Concept of Securitisation
Process of securitisation
1. The lender (originator) provides various types of loans to borrowers (obligor). 2. Out of these loans, the originator pools certain loans together and sells these to a securitisation company (SPV). 3. The securitisation company makes payment (consideration) to the originator for the loans purchased. 4. These loans are converted into a pool of securities by the securitisation company for the purpose of issuing Pass Through or Pay Through Certificates (PTCs) 5. These PTCs are then rated by Credit Rating Agencies (e.g. CRISIL). 6. The PTCs are sold to individual investors (QIBs) 7. The recovery from original borrower are obtained by original lender (in case of Pass Through Certificates) and by securitisation company (in case of Pay Through Certificates). If collection is made by original lender, he is under obligation to pass on the money to the securitisation company. 8. The securitisation company then, makes payment to the investors.
Terms used in a securitisation transaction
1. The entity that securitises its assets is called the originator: the name signifies the fact that the entity was responsible for originating the claims that are to be ultimately securitised. 2. There is no distinctive name for the investors who invest their money in the instrument: therefore, they might simply be called investors. However, the
10
Concept of Securitisation
Act provides for the offer of securities to ‘Qualified Institutional Buyers (QIBs)’ only. No public participation is allowed. QIBs include financial institutions, insurance companies, banks, state financial corporations, state industrial development corporations, trustees or any asset management companies making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund or foreign institutional investors registered under the Securities and Exchange Board of India Act, 1992. 3. The claims that the originator securitise could either be existing claims, or existing assets (in form of claims), or expected claims over time. In other words, the securitised assets could be either existing receivables, or receivables to arise in future. The latter, for the sake of distinction, is sometimes called future flows securitisation, in which case the former is a case of asset-backed securitisation. 4. In US markets, another distinction is mostly common: between mortgagebacked securities and asset-backed securities. This only is to indicate the distinct application: the former relates to the market for securities based on mortgage receivables, which in the USA forms a substantial part of total securitisation markets, and securitisation of other receivables. 5. Since it is important for the entire exercise to be a case of transfer of receivables by the originator, not a borrowing on the security of the receivables, there is a legal transfer of the receivables to a separate entity. In legal parlance, transfer of receivables is called assignment of receivables. It is also necessary to ensure that the transfer of receivables is respected by the legal system as a genuine transfer, and not as a mere eyewash where the reality is only a mode of borrowing. In other words, the transfer of receivables has to be a true sale of the receivables, and not merely a financing against the security of the receivables.
11
Concept of Securitisation
6. Since securitisation involves a transfer of receivables from the originator, it would be inconvenient, to the extent of being impossible, to transfer such receivables to the investors directly, since the receivables are as diverse as the investors themselves are. Besides, the base of investors could keep changing as the resulting security is essentially a marketable security. Therefore, it is necessary to bring in an intermediary that would hold the receivables on behalf of the end investors. This entity is created solely for the purpose of the transaction: therefore, it is called a special purpose vehicle (SPV) or a special purpose entity (SPE) or, if such entity is a company, special purpose company (SPC). The function of the SPV in a securitisation transaction could stretch from being a pure conduit or intermediary vehicle, to a more active role in reinvesting or reshaping the cash flows arising from the assets transferred to it. Therefore, the originator transfers the assets to the SPV, which holds the assets on behalf of the investors, and issues to the investors its own securities. Therefore, the SPV is also called the issuer. In the Act an independent ‘Securitisation Company’ or ‘Asset Reconstruction Company’ is envisaged. 7. There is no uniform name for the securities issued by the SPV as such securities take different forms. These securities could either represent a direct claim of the investors on all that the SPV collects from the receivables transferred to it: in this case, the securities are called pass through certificates or beneficial interest certificates as they imply certificates of proportional beneficial interest in the assets held by the SPV. Alternatively, the SPV might be re-configuring the cashflows by reinvesting it, so as to pay to the investors on fixed dates, not matching with the dates on which the transferred receivables are collected by the SPV. In this case, the securities held by the investors are called pay through certificates. The securities
12
Concept of Securitisation
issued by the SPV could also be named based on their risk or other features, such as senior notes or junior notes, floating rate notes, etc. 8. Another word commonly used in securitisation exercises is bankruptcy remote transfer. What it means is that the transfer of the assets by the originator to the SPV is such that even if the originator were to go bankrupt, or get into other financial difficulties, the rights of the investors on the assets held by the SPV is not affected. In other words, the investors would continue to have a paramount interest in the assets irrespective of the difficulties, distress or bankruptcy of the originator.
Benefits from Securitisation of Assets
Securitisation is designed to offer a number of advantages to the seller, investor and debt markets. 1. For seller or originator: Securitisation mainly results in receivables being replaced by cash thereby improving the liquidity position. It removes the assets from the balance sheet of the originator, thus liberating capital for other uses, and enabling restructuring of the balance sheet by reducing large exposures or sectoral concentration. It facilitates better asset liability management by reducing market risks resulting from interest rate mismatches. The process also enables the issuer to recycle assets more frequently and thereby improve earning. Finally, transparency may be improved since securitisation results in identifiable assets in the balance sheet. 2. For investor: Securitisation essentially provides an avenue for relatively riskfree investment. The credit enhancement provides an opportunity to investors to acquire good quality assets and to diversify their portfolios.
13
Concept of Securitisation
3. From the point of view of the financial system as a whole: Securitisation increases the number of debt instruments in the market, and provides additional liquidity in the market. It also facilitates unbundling, better allocation and management of project risks. It could widen the market by attracting new players on account of superior quality assets being available. 4. It also provides opportunity for matching cash flows and managing ALM since a securitised instrument carries regular monthly cash flows and has varying maturities. The prevalence of secondary markets would offer liquidity.
Risks faced, Threats Involved if Securitisation is not carried out prudentially
If not carried out prudentially, Securitisation can leave risks with the originating bank without allocating capital to back them. While all banking activity entails operational and legal risks, these may be greater, the more complex the activity. It is felt that the main risk a bank may face in a securitisation scheme arises if a true sale has not been achieved and the selling bank is forced to recognise some or all of the losses if the assets subsequently cease to perform. Also, funding risks and constraints on liquidity may arise if assets designed to be securitised have been originated, but because of disturbances in the market, the securities cannot be placed. There is also a view that there is at least a potential conflict of interest if a bank originates, sells, services and underwrites the same issue of securities.
Securitisation in India
Available data indicates that ICICI had securitised assets to the tune of Rs.2,750 crore in its books as at end March 1999. Assets to the tune of Rs.1,200 crore was in the process of being bought over up to end of FY-1998'99.. CRISIL is
14
Concept of Securitisation
reported to have rated about Rs. 1,200 crore of securitised transactions up to 1998. In addition, there have been several unrated transactions. The first widely reported securitisation deal in India dates back to 1990 when Citibank securitised auto loans and placed a paper with GIC mutual fund. Since then, a variety of deals have been undertaken. Asset classes chosen have concentrated mostly on auto and hire purchase receivables of NBFCs. According to some estimates, 35 per cent of all securitisation deals between 1992 and 1998 related to hire purchase receivables of trucks and the rest towards other auto/transport segment receivables. Apart from these, some innovative deals have also been struck. Earlier, in 199495, SBI Cap structured an innovative deal where a pool of future cash flows of high value customers of Rajasthan State Industrial and Development Corporation was securitised. An oil monetisation deal has been structured where the future flows of oil receivables accruing to a company was securitised. Real estate developers have securitised receivables arising out of installment sales. The recent securitisation deal of Larsen & Toubro has opened a new vista for financing power projects. The deal was a securitisation of lease receivables even before the plant was completed. Thus, this securitisation deal financed even the asset creation. National Housing Bank (NHB) has made efforts to structure the pilot issue of mortgage backed securities (MBS) within the existing legal, fiscal and regulatory framework. Under the proposed transaction, mortgage debt shall be
transferred/assigned/sold to NHB by Housing Finance Companies (HFC) (originator) pursuant to an agreement/contract in the 'debt simplicitor form'. NHB will act as an issuer of pass through certificates (PTCs) and as a trustee on behalf of the investors. There is a view that there will be a conflict of interest if NHB, a regulator also acts as a trustee. However, as stated in the RBI discussion paper on universal banking, the ownership, regulatory and supervisory
15
Concept of Securitisation
framework of the development financial institutions are under review. Based on the Indian experience before the Act has been passed, the following features of securitisation appear noteworthy. 1. Most deals have involved the transfer of beneficial interest on the asset and not the legal title. 2. Most transactions have followed the pass-through mechanism. 3. In fact, many transactions have followed the escrow mechanism where receivables are transferred to an escrow account for payment to the buyer. 4. According to Duff & Phelps India, a rating agency, past deals have mostly been direct purchases of receivables by institutions and bigger NBFCs. 5. Routing the transaction through a Special Purpose Vehicle is yet to gain popularity. 6. There appears to be no secondary market for securitised debt. 7. The market is unregulated and lacks transparency in terms of volume, price, parties to the transaction, etc. 8. The settlement procedures are not clear. 9. There are no standard accounting and valuation norms.
16
Chapter Two
Need for Securitisation Act
Need for the Securitisation Act
NPAs in the banking sector
Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures taken under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports have been neutralised by the ill effects of this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by Nationalised Banks, followed by the SBI group, and the all India Financial Institutions. NPA is a brought forward legacy accumulated over the past three decades, when prudent norms of banking were forsaken basking by the halo of security provided by government ownership. It is not wrong to have pursued social goals, but this does not justify relegating banking goals and fiscal discipline to the background. But despite this extravagance the malaise remained invisible to the public eyes due to the practice of not following transparent accounting standards, but keeping the balance sheets opaque. This artificially conveyed picture of 'all is well' with PSBs suddenly came to an end when the lid was open with the introduction of the prudential norms of banking in the year 1992-93, bringing total transparency in disclosure norms and 'cleansing' the balance sheets of commercial banks for the first time in the country.
18
Need for the Securitisation Act
How RBI Describes this New Development in its Web Site In the peak crisis period in early Nineties, when the first Series of Banking Reforms were introduced, the working position of the State-owned banks exhibited the severest strain. Commenting on this situation the Reserve Bank of India in its web-site has pointed out as under: "Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twentyseven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed." Consequently PSBs in the post reform period came to be classified under three categories as ?
healthy banks (those that are currently showing profits and hold no accumulated losses in their balance sheet)
?
banks showing currently profits, but still continuing to have accumulated losses of prior years carried forward in their balance sheets
?
Banks which are still in the red, i.e. showing losses in the past and in the present.
19
Need for the Securitisation Act
Definition of Non-performing Asset
"Non-performing asset" means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or under guidelines relating to assets classifications issued by the Reserve Bank. RBI Guidelines for classification of NPAs have been provided in Annexure 3.
NPA statistics
As at 31.03.2002 the aggregate gross NPA of all scheduled commercial banks amounted to Rs.70,904 Crore. Table No. I gives the figures of gross and net NPA for the last five years. It shows an increase of Rs. 7,163 Crore or more than 11% in the last financial year, indicating that fresh accretion to NPA is more than the recoveries that were effected, thus signifying a losing battle in containing this menace. Table No. I - NPA Statistics -All Scheduled Commercial Banks
Year
Total Gross Net Net NPA Advances NPA Advances 50,815 58,722 60,408 3,25,522 3,67,012 4,44,292 25,734 27,892 30,211
%-age Gross NPA to total advances 14.4 14.7 12.7
%-age Net NPA to net advances 7.3 7.6 6.8
1997-98 3,52,697 1998-99 3,99,496 19992000 20002001 20012002 4,75,113
5,58,766 6,80,958
63,741 70,904
5,26,329 6,45,859
32,632 35,546
11.4 10.4
6.2 5.5
(Amount in Crores, Source: RBI Report)
20
Need for the Securitisation Act
The apparent reduction of gross NPA from 14.4% to 10.4% between 1998 and 2002 provides little comfort, since this accomplishment is on account of credit growth, which was higher than the growth of Gross NPA and not through appreciable recovery of NPA. There is neither reduction nor even containment of the threat. The gross NPA for Public Sector Banks (PSBs) as at 31.03.2002 are 11.1% are higher than the figures for All Scheduled Commercial Banks at 10.4%. Comparative figures for PSBs, SBI Group and Nationalised Banks are as under. Table - 2: NPA of PSBs (Amount in Crores)
Year
Total Gross NPA Net NPA Advances
%-age of Gross NPA to total advances 17.8 % 16.0 % 15.9 % 14.00 % 12.39 % 11.1%
%-age of Net NPA to net advances 9.2 % 8.2 % 8.1 % 7.9% 6.74% 5.8%
1996-97 1997-98 1998-99 1999-2000 2000-2001 2001-2002
2,44,214 2,84,971 3,25,328 3,80,077 4,42,134 5,09,368
43,577 45,563 51,710 53,033 54,773 56,507
20,285 21,232 24,211 26,188 27,967 27,958
21
Need for the Securitisation Act
Table -3: NPA of State Bank Group (Amount in Crores)
Year 1997-98 1998-99 19992000 20002001
Total Advances 113360 118959 129253 150390
Gross NPA 15522 18641 19773 20586
Net NPA 6829 7764 7411 8125
%-age of Gross NPA to total advances 14.57% 15.67 % 14.08 % 12.73 %
%-age of Net NPA to net advances 6.98 % 7.74 % 6.77 % 6.26 %
Table -4: NPA of Nationalised Banks (Amount in Crores)
Year
Total Advances
Gross NPA
Net NPA
%-age of Gross NPA to total advances 16.88 16.02 13.99 12.19
%-age of Net NPA to net advances 8.91 8.35 7.80 7.01
1997-98 1998-99 1999-2000 2000-2001
166222 188926 224818 264237
30130 33069 33521 34609
14441 15759 17399 16096
Further it is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of 'ever-greening' of advances, through subtle techniques. As per report appearing in a national daily the banking industry has under-estimated its non-performing assets (NPAs) by whopping Rs. 3,862.10 Crore as on March 1997. The industry is also estimated
22
Need for the Securitisation Act
to have under-provided to the extent of Rs 1,412.29 Crore. The worst "offender" is the public sector banking industry. Nineteen nationalised banks along with the State Bank of India and its seven associate banks have underestimated their NPAs by Rs 3,029.29 Crore. Financial institutions have not far lagged behind. NPAs of ten leading institutions have reported a rise of 11.89 per cent, or Rs 1,929 Crore, to Rs 18,146 Crore during the year ended March 2000 from Rs 16,217 Crore last year. The NPA statistics of the three leading Financial Institutions for the last two years are given in Table-5 IDBI tops the list by notching up bad loans worth Rs 7665 Crore by March 2000. In fact, its NPAs have gone up by Rs 1,185 Crore from Rs 6,490 Crore in the previous year. IFCI followed with NPAs of Rs 4,103 Crore, but it reported fall of Rs 134 Crore from the previous year's level of Rs 4,237 Crore. ICICI's NPAs went up to Rs 3,959 Crore from Rs 3,623 Crore in the previous year. Table 5- NPA Statistics of the three Major Term Lending Institutions as at 31.03.2001.
Name Total Loans Total Loans NPA NPA -% age NPA NPA -% age of FI 31.3.2000 31.3.2001 31.3.2000 31.3.2000 31.3.2001 31.3.2001 IDBI ICICI IFCI 57099 52341 19841 56477 57507 18715 7665 3959 4103 13.4 7.6 20.7 8363 2782 3897 13.9 5.2 20.8
(Amount in Crores)
23
Need for the Securitisation Act
Adverse effects of NPAs on banks
NPA has affected the profitability, liquidity and competitive functioning of PSBs and finally the psychology of the bankers in respect of their disposition towards credit delivery and credit expansion.
1. Impact on Profitability
"The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks, but at the same time banks are required to make provisions for such NPAs from their current profits. NPAs have a deleterious effect on the return on assets in several ways ? ? ?
They erode current profits through provisioning requirements They result in reduced interest income They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future, and
?
They limit recycling of funds, set in asset-liability mismatches, etc
There is at times a tendency among some of the banks to understate the level of NPAs in order to reduce the provisioning and boost up bottom lines. It would only postpone the process. In the context of crippling effect on a bank's operations in all spheres, asset quality has been placed as one of the most important parameters in the measurement of a bank's performance under the CAMELS supervisory rating system of RBI.
24
Need for the Securitisation Act
Between 01.04.93 to 31.03.2001, Commercial banks incurred a total amount of Rs.31251 Crores towards provisioning NPA. This has brought Net NPA to Rs.32632 Crores or 6.2% of net advances. To this extent, the problem is contained, but at what cost? This costly remedy is made at the sacrifice of building healthy reserves for future capital adequacy. The enormous provisioning of NPA together with the holding cost of such nonproductive assets over the years has acted as a severe drain on the profitability of the PSBs. In turn PSBs are seen as poor performers and unable to approach the market for raising additional capital. Equity issues of nationalised banks that have already tapped the market are now quoted at a discount in the secondary market. Other banks hesitate to approach the market to raise new issues. This has alternatively forced PSBs to borrow heavily from the debt market to build Tier II Capital to meet capital adequacy norms putting severe pressure on their profit margins, else they are to seek the bounty of the Central Government for repeated Recapitalisation. Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of funds at 6% plus 1% service charge) the net NPA of Rs.32632 Crores absorbs a recurring holding cost of Rs.2300 Crores annually. Considering the average provisions made for the last 8 years, which works out to average of Rs.3300 crores from annum, a sizeable portion of the interest income is absorbed in servicing NPA. NPA is not merely non-remunerative. It is also cost absorbing and profit eroding. In the context of severe competition in the banking industry, the weak banks are at disadvantage for leveraging the rate of interest in the deregulated market and securing remunerative business growth. The options for these banks are lost. "The spread is the bread for the banks". This is the margin between the cost of resources employed and the return therefrom. In other words it is gap between the return on funds deployed (Interest earned on credit and investments) and
25
Need for the Securitisation Act
cost of funds employed (Interest paid on deposits). When the interest rates were directed by RBI, as heretofore, there was no option for banks. But today in the deregulated market the banks decide their lending rates and borrowing rates. In the competitive money and capital Markets, inability to offer competitive market rates adds to the disadvantage of marketing and building new business. In the face of the deregulated banking industry, an ideal competitive working is reached, when the banks are able to earn adequate amount of non-interest income to cover their entire operating expenses i.e. a positive burden. In that event the spread factor i.e. the difference between the gross interest income and interest cost will constitute its operating profits. Theoretically even if the bank keeps 0% spread, it will still break even in terms of operating profit and not return an operating loss. The net profit is the amount of the operating profit minus the amount of provisions to be made including for taxation. On account of the burden of heavy NPA, many nationalised banks have little option and they are unable to lower lending rates competitively, as a wider spread is necessitated to cover cost of NPA in the face of lower income from off balance sheet business yielding non-interest income. The following working results of Corporation bank an identified well managed nationalised banks for the last two years and for the first nine months of the current financial year, will be revealing to prove this statement-
26
Need for the Securitisation Act
Table - 6 (part-1) - Performance of Corporation Bank (Amount in Crores)
Performance indicator Earnings interest Non-
Year ended Year ended Mar. 9 months Mar. 2000 2001 Apr.Decr.2001 270.81 292.09 341.36 - 49.27 285.85 280.52 5.33
Operating expenses 303.99 Difference - 33.18
Non-interest income fully absorbs the operating expenses of this bank in the current financial year for the first 9 months. In the last two financial years, though such income has substantially covered the operating expenses (between 80 to 90%) there is still a deficit left. Now what are the interest earnings and expenses of Corporation Bank during this period? Table - 6 (part-2) Corporation Bank - Interest Earnings and Expense (Amount in Crores)
Performance indicator Earnings - Interest Income Exp.- Interest expenses Interest spread Operating Profit Provisions Net Profit
Year ended Mar. 2000 1604.39 1146.09 458.30 425.12 192.68 232.44
Year ended 9 months Mar. 2001 Apr.Decr.2001 1804.54 1223.21 581.33 482.21 270.22 261.84 1458.33 981.45 476.88 532.06 219.48 262.73
27
Need for the Securitisation Act
The strength of Corporation Bank is identified by the following positive features: 1. It's sizeable earnings under of non-interest income substantially/totally meets its non-interest expenses. 2. Its obligation for provisioning requirements is within bounds. (Net NPA/Net Advances is 1.92%) It is worthwhile to compare the aggregate figures of the 19 Nationalised banks for the year ended March 2001, as published by RBI in its Report on trends and progress of banking in India. Table 7- Nationalised banks operational statistics (Amount in Crores)
Performance indicator Earnings - Non-interest Operating expenses Difference Earnings - interest income Exp.-Interest expenses Interest spread Intt. On Recap bonds Operating Profit Provisions Net Profit
Year ended Mar. 2000 6662.42 14251.87 - 7589.45 50234.01 35477.41 14756.60 1797.88 5405.27 4766.15 639.12
Year ended Mar. 2001 7159.41 17283.55 - 10124.14 56967.11 38789.64 18177.47 1795.48 6257.85 5958.24 299.61
28
Need for the Securitisation Act
Interest on Recapitalisation Bonds is a income earned from the Government, who had issued the Recapitalisation Bonds to the weak banks to sustain their capital adequacy under a bail out package. The statistics above show the other weaknesses of the nationalised banks in addition to the heavy burden they have to bear for servicing NPA by way of provisioning and holding cost as under: ? Their operating expenses are higher due to surplus manpower employed. Wage costs to total assets is much higher to PSBs compared to new private banks or foreign banks. ? Their earnings from sources other than interest income are meagre. This is due to failure to develop off balance sheet business through innovative banking products.
2. Impact on Liquidity of the Nationalised Banks
Though nationalised banks (except Indian Bank) are able to meet norms of Capital Adequacy, as per RBI guidelines, the fact that their net NPA in the average is as much as 7% is a potential threat for them. RBI has indicated the ideal position as Zero percent Net NPA. Even granting 3% net NPA within limits of tolerance the nationalised banks are holding an uncomfortable burden at 7.1% as at March 2001. They have not been able to build additional capital needed for business expansion through internal generations or by tapping the equity market, but have resorted to II-Tier capital in the debt market or looking to recapitalistion by Government of India.
3. Impact on Outlook of Bankers towards Credit Delivery
The fear of NPA permeates the psychology of bank managers in the PSBs in entertaining new projects for credit expansion. In the world of banking the concepts of business and risks are inseparable. Business is an exercise of balancing between risk and reward. Accept justifiable risks and implement de-
29
Need for the Securitisation Act
risking steps. Without accepting risk, there can be no reward. The psychology of the banks today is to insulate themselves with zero percent risk and turn lukewarm to fresh credit. This has affected adversely credit growth compared to growth of deposits, resulting in a low C/D Ratio around 50 to 54% for the industry. The fear psychosis also leads to excessive security-consciousness in the approach towards lending to the small and medium sized credit customers. There is insistence on provision of collateral security, sometimes up to 200% value of the advance, and consequently due to a feeling of assumed protection on account of holding adequate security (albeit over-confidence), a tendency towards laxity in the standards of credit appraisal comes to the fore. It is well known that the existence of collateral security at best may convert the credit extended to productive sectors into an investment against real estate, but will not prevent the account turning into NPA. Further blocked assets and real estate represent the most illiquid security and NPA in such advances has the tendency to persist for a long duration. Nationalised banks have reached a dead-end of the tunnel and their future prosperity depends on an urgent solution threat. for handling this hovering
30
Need for the Securitisation Act
What does the RBI Governor feel about the banks’ problems? "As regards internal factors leading to NPAs, the onus rests with the banks themselves. This calls for organisational restructuring, improvement in managerial efficiency, skill upgradation for proper assessment of
creditworthiness and a change in the attitude of the banks towards legal action which is traditionally viewed as a measure of the last resort. These are the elements on the agenda of the second phase of reforms”. Dr.Bimal Jalan, Governor, RBI (In a speech titled "Banking and Finance in the New Millennium." at 22nd Bank Economists Conference, New Delhi,15th February, 2001)
Initiatives of Government and RBI for Reduction of NPAs
1. Compromise settlement schemes
The RBI / Government of India have been constantly goading the banks to take steps for arresting the incidence of fresh NPAs and have also been creating legal and regulatory environment to facilitate the recovery of existing NPAs of banks. More significant of them, I would like to recapitulate at this stage.
?
The broad framework for compromise or negotiated settlement of NPAs advised by RBI in July 1995 continues to be in place. Banks are free to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements with the approval of their Boards, particularly for old and unresolved cases falling under the NPA category. The policy framework suggested by RBI provides for setting up of an independent Settlement Advisory Committees headed by a retired Judge of the High Court to scrutinise and recommend compromise proposals
31
Need for the Securitisation Act ?
Specific guidelines were issued in May 1999 to public sector banks for one time non discretionary and non discriminatory settlement of NPAs of small sector. The scheme was operative up to September 30, 2000. [Public sector banks recovered Rs. 668 crore through compromise settlement under this scheme.]
?
Guidelines were modified in July 2000 for recovery of the stock of NPAs of Rs. 5 crore and less as on 31 March 1997. [The above guidelines which were valid up to June 30, 2001 helped the public sector banks to recover Rs. 2600 crore by September 2001]
?
An OTS Scheme covering advances of Rs.25000 and below continues to be in operation and guidelines in pursuance to the budget announcement of the Hon'ble Finance Minister providing for OTS for advances up to Rs.50,000 in respect of NPAs of small/marginal farmers are being drawn up.
2. Lok Adalats
Lok Adalats help banks to settle disputes involving accounts in "doubtful" and "loss" category, with outstanding balance of Rs.5 lakh for compromise settlement under Lok Adalats. Debt Recovery Tribunals have now been empowered to organize Lok Adalats to decide on cases of NPAs of Rs.10 lakhs and above. The public sector banks had recovered Rs.40.38 crore as on September 30, 2001, through the forum of Lok Adalat. The progress through this channel is expected to pick up in the coming years particularly looking at the recent initiatives taken by some of the public sector banks and DRTs in Mumbai.
3. Debt Recovery Tribunals
The Recovery of Debts due to Banks and Financial Institutions (amendment) Act, passed in March 2000 has helped in strengthening the functioning of DRTs. Provisions for placement of more than one Recovery Officer, power to attach
32
Need for the Securitisation Act
defendant's property/assets before judgement, penal provisions for disobedience of Tribunal's order or for breach of any terms of the order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in the times to come. Though there are 22 DRTs set up at major centres in the country with Appellate Tribunals located in five centres viz. Allahabad, Mumbai, Delhi, Calcutta and Chennai, they could decide only 9814 cases for Rs.6264.71 crore pertaining to public sector banks since inception of DRT mechanism and till September 30, 2001.The amount recovered in respect of these cases amounted to only Rs.1864.30 crore. Looking at the huge task on hand, with as many as 33049 cases involving Rs.42988.84 crore pending before them as on September 30, 2001, I would like the banks to institute appropriate documentation system and render all possible assistance to the DRTs for speeding up decisions and recovery of some of the well collateralised NPAs involving large amounts. I may add that familiarisation programmes have been offered in NIBM at periodical intervals to the presiding officers of DRTs in understanding the complexities of documentation and operational features and other legalities applicable of Indian banking system. RBI on its part has suggested to the Government to consider enactment of appropriate penal provisions against obstruction by borrowers in possession of attached properties by DRT receivers, and notify borrowers who default to honour the decrees passed against them.
4. Circulation of information on defaulters
The RBI has put in place a system for periodical circulation of details of willful defaults of borrowers of banks and financial institutions. This serves as a caution list while considering requests for new or additional credit limits from defaulting
33
Need for the Securitisation Act
borrowing units and also from the directors /proprietors / partners of these entities. RBI also publishes a list of borrowers (with outstanding aggregating Rs. 1 crore and above) against whom suits have been filed by banks and FIs for recovery of their funds, as on 31st March every year. It is our experience that these measures had not contributed to any perceptible recoveries from the defaulting entities. However, they serve as negative basket of steps shutting off fresh loans to these defaulters. I strongly believe that a real breakthrough can come only if there is a change in the repayment psyche of the Indian borrowers.
5. Recovery action against large NPAs
After a review of pendency in regard to NPAs by the Hon'ble Finance Minister, RBI had advised the public sector banks to examine all cases of willful default of Rs 1 crore and above and file suits in such cases, and file criminal cases in regard to willful defaults. Board of Directors are required to review NPA accounts of Rs.1 crore and above with special reference to fixing of staff accountability. On their part RBI and the Government are contemplating several supporting measures including legal reforms, some of them I would like to highlight.
6. Corporate Debt Restructuring (CDR)
Corporate Debt Restructuring mechanism has been institutionalised in 2001 to provide a timely and transparent system for restructuring of the corporate debts of Rs.20 crore and above with the banks and financial institutions. The CDR process would also enable viable corporate entities to restructure their dues outside the existing legal framework and reduce the incidence of fresh NPAs. The CDR structure has been headquartered in IDBI, Mumbai and a Standing Forum and Core Group for administering the mechanism had already been put in place. The experiment however has not taken off at the desired pace though more than six months have lapsed since introduction. As announced by the Hon'ble Finance Minister in the Union Budget 2002-03, RBI has set up a high
34
Need for the Securitisation Act
level Group under the Chairmanship of Shri. Vepa Kamesam, Deputy Governor, RBI to review the implementation procedures of CDR mechanism and to make it more effective. The Group will review the operation of the CDR Scheme, identify the operational difficulties, if any, in the smooth implementation of the scheme and suggest measures to make the operation of the scheme more efficient.
7. Credit Information Bureau
Institutionalisation of information sharing arrangements through the newly formed Credit Information Bureau of India Ltd. (CIBIL) is under way. RBI is considering the recommendations of the S.R.Iyer Group (Chairman of CIBIL) to
operationalise the scheme of information dissemination on defaults to the financial system. The main recommendations of the Group include dissemination of information relating to suit-filed accounts regardless of the amount claimed in the suit or amount of credit granted by a credit institution as also such irregular accounts where the borrower has given consent for disclosure. This, I hope, would prevent those who take advantage of lack of system of information sharing amongst lending institutions to borrow large amounts against same assets and property, which had in no small measure contributed to the incremental NPAs of banks.
8. Proposed guidelines on willful defaults/diversion of funds
RBI is examining the recommendation of Kohli Group on willful defaulters. It is working out a proper definition covering such classes of defaulters so that credit denials to this group of borrowers can be made effective and criminal prosecution can be made demonstrative against willful defaulters.
9. Corporate Governance
A Consultative Group under the chairmanship of Dr.A.Ganguly was set up by the Reserve Bank to review the supervisory role of Boards of banks and financial
35
Need for the Securitisation Act
institutions and to obtain feedback on the functioning of the Boards vis-à-vis compliance, transparency, disclosures, audit committees etc. and make recommendations for making the role of Board of Directors more effective with a view to minimising risks and over-exposure. The Group is finalising its recommendations shortly and may come out with guidelines for effective control and supervision by bank boards over credit management and NPA prevention measures.
Problems with previous methods of loan recovery
1. Inadequate security & Erosion in value of security
Generally, banks tend to find that there is a major gap in the valuation of the security, as carried out at the time of providing the loan and at the time of loan recovery. The value of the security has generally deteriorated over the period, and according to experts, it may further deteriorate by almost 10-50% in quick action is not taken for its immediate sale.
2. Political interference
Political interference in the day – to – day functioning of public sector banks created a number of problems for them. The populist policies of the national level politicians, such as waiver in repayment only added to these problems.
3. Slow legal procedures
Before the establishment of DRTs in 1993, the banks had to approach the normal courts to recover their dues. There were provisions under various acts which hampered the smooth takeover and sale of secured assets. The legal process could take years to be completed, with the borrower having ample scope for delaying the takeover of assets. A number of loopholes provided the borrower with opportunities to delay or ignore repayment of loans. During
36
Need for the Securitisation Act
this period, it was said by some unscrupulous businessmen that – “there is no difference between equity and debt – you never have to repay either of them.”
4. Swamping of DRTs with cases
Once DRTs were established to quicken the pace of recovery procedures, the pace of recovery improved quite a bit. However, the DRTs were soon drowned in the ever increasing number of cases. The pending number of cases with the DRTs increased manifold during the period 1993-2002.
5. Misuse of BIFR / SICA
This was one of the favourite methods of willful defaulters to delay repayment. If the defaulter?s company is declared sick and taken for financial reconstruction under BIFR, it is not possible to undertake any recovery proceeding against the company. The procedure of financial reconstruction can take a number of years together, thereby delaying recovery to a great extent.
6. Transfer of property Act, English mortgage
Under provisions of Section 69 of Transfer of Property Act, mortgagee can take possession of mortgaged property and sell the same without the intervention of the Court only in the case of English Mortgage. In addition, mortgagee can take possession of mortgaged property where there is specific provision in mortgage deed and it is situated in the towns of Mumbai, Kolkata and Chennai only. In other cases, intervention of the court is required. However, this is very slow and time consuming process and by the time bank / FI is able to get possession; the asset either does not exist or has become valueless.
37
Need for the Securitisation Act
Causes of NPAs
It is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of 'ever-greening' of advances, through subtle techniques. As per report appearing in a national daily the banking industry has under-estimated its non-performing assets (NPAs) by whopping Rs. 3,862.10 Crore as on March 1997. The industry is also estimated to have underprovided to the extent of Rs 1,412.29 Crore. The worst "offender" is the public sector banking industry. Nineteen nationalised banks along with the State Bank of India and its seven associate banks have underestimated their NPAs by Rs 3,029.29 Crore. Such deception of NPA statistics is executed through the following ways.
?
Failure to identify an NPA as per stipulated guidelines: There were instances of `sub-standard' assets being classified as `standard';
?
Wrong classification of an NPA: classifying a `loss' asset as a `doubtful' or `sub-standard' asset; classifying a `doubtful' asset as a `sub-standard' asset.
?
Classifying an account of a credit customer as `substandard' and other accounts of the same credit customer as `standard', throwing prudential norms to the winds.
Essentially arising from the wrong classification of NPAs, there was a variation in the level of loan loss provisioning actually held by the bank and the level required to be made. This practice can be logically explained as a desperate attempt on the part of the bankers, whenever adequate current earnings were not available to meet provisioning obligations. Driven to desperation and impelled by the desire not to accept defeat, they have chosen to mislead and claim compliance with the provisioning norms, without actually providing. This only shows that the problem has swelled to graver dimensions.
38
Need for the Securitisation Act
Conclusion
Hence, it can be concluded from the above factual and empirical data as shown in Tables 1 to __ that earlier mechanisms to tackle the problems of NPAs had various loopholes and could not deliver the desired results. Hence, there was a need felt by the government, banking sector and corporates for a new legislation to tackle the menace of increasing NPAs and remove the loopholes of the previous methods.
39
Chapter Three
Securitisation Act – A new landmark in the Indian financial sector
Securitisation Act – A New Landmark in the Indian Financial Sector
Scope & Objectives of the Act
The object clause of the Act describes the legal measure as "An Act to regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto". The Act allows setting up of ARC/SC companies to be registered with and regulated by RBI. Under the Act identical powers and functions are prescribed for both types of companies, Securitisation Companies and Asset Reconstruction Companies. Scope of the Act As per an official release of Government of India from New Delhi, "The act deals with three distinct actions in respect of financial assets held by banks and FIs in the form of securitisation of financial assets, setting up of asset reconstruction companies and enforcement of security interest." These three actions are in fact not seen as distinct, but inter-connected. Securitisation as a co-function helps ARC/SC companies to operate with minimum capital under a sort of selfgenerated source of funding, while enforcement of security interest helps ARC/SC companies to take possession, to securitise and later to realise the financial assets, more quickly and easily without approaching DRTs or Law Courts. During January 2002, the Reserve Bank of India, while forwarding its recommendation to the Government for setting up of Asset Reconstruction Companies, had suggested such companies for one time operation with a maximum life-span of seven years and a minimum initial paid-up capital of Rs 100-crore. The suggestion places the authorised capital of ARCs at Rs 500 crore. RBI had then contemplated ARC companies as distinct entities, without the function of securitisation of assets. They would only take over past NPAs of the bank at the time of their incorporation and not NPAs accruing subsequently. However the Government of India by combining and empowering the functions of
41
Securitisation Act – A New Landmark in the Indian Financial Sector
Asset Reconstruction and securitisation to be exercised by a single entity, has enabled ARC/SC companies to be incorporated with an initial capital of Rs.2 Crores (minimum) or 15% of the financial assets to be acquired (maximum). RBI is vested with powers, under the Act, to stipulate the quantum of capital to be owned by ARC/SC companies within this range, and for regulating the functioning of these companies after registration. a) registration and regulation of securitisation companies or reconstruction companies by the Reserve Bank of India; b) facilitating securitisation of financial assets of banks and financial institutions with or without the benefit of underlying securities; c) facilitating easy transferability of financial assets by the securitisation company or reconstruction company to acquire financial assets of banks and financial institutions by issue of debentures or bonds or any other security in the nature of a debenture; d) empowering securitisation companies' or reconstruction companies to raise funds by issue of security receipts to qualified institutional buyers; e) facilitating reconstruction of financial assets acquired by exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks and financial institutions; f) declaration of any securitisation company or reconstruction company registered with the Reserve Bank of India as a public financial institution for the purpose of section 4A of the Companies Act, 1956; g) defining 'security interest' as any type of security including mortgage and change on immovable properties given for due repayment of any financial assistance given by any bank or financial institution;
42
Securitisation Act – A New Landmark in the Indian Financial Sector
h) empowering banks and financial institutions to take possession of securities given for financial assistance and sell or lease the same or take over management in the event of default, i.e. classification of the borrower's account as non-performing asset in accordance with the directions given or under guidelines issued by the Reserve Bank of India from time to time; i) the rights of a secured creditor to be exercised by one or more of its officers authorised in this behalf in accordance with the rules made by the Central Government; j) an appeal against the action of any bank or financial institution to the concerned Debts Recovery Tribunal and a second appeal to the Appellate Debts Recovery Tribunal; k) setting up or causing to be set up a Central Registry by the Central Government for the purpose of registration of transactions relating to securitisation, asset reconstruction and creation of security interest; l) application of the proposed legislation initially to banks and financial institutions and empowerment of the Central Government to extend the application of the proposed legislation to non-banking financial companies and other entities; m) Non-application of the proposed legislation to security interests in agricultural lands, loans not exceeding rupees one lakh and cases where eighty per cent, of the loans are repaid by the borrower.
43
Securitisation Act – A New Landmark in the Indian Financial Sector
Some important definitions
Understanding the legal definitions of the words and terms is important for the proper interpretation of the provisions of the act. It is also provided that "Words and expressions used and not defined in this Act but defined in the Indian Contract Act, 1872 or the Transfer of Property Act, 1882 or the Companies Act, 1956 or the Securities and Exchange Board of India Act, 1992 shall have the same meanings respectively assigned to them in those Acts."[Section 2(2)]
The Act defines securitisation as per Clause 2(1)(z) as under: "securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise;[Section 2(1)(z)]
The term "financial assets" has been defined in Clause 2(1)(l) as under: "Financial asset" means debt or receivables and includes-i. a claim to any debt or receivables or part thereof, whether secured or unsecured; or ii. any debt or receivables secured by, mortgage of, or charge on, immovable property; or iii. a mortgage, charge, hypothecation or pledge of movable property; or iv. any right or interest in the security, whether full or part underlying such debt or receivables; or
44
Securitisation Act – A New Landmark in the Indian Financial Sector
v. any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, accruing, conditional or contingent; or vi. any financial assistance; "Originator" means the owner of a financial asset which is acquired by a securitisation company or reconstruction company for the purpose of securitisation or asset reconstruction;[Section 2(1)(r)]
The act defines "Securitisation Company" as any company formed and registered under the Companies Act, 1956 for the purpose of securitisation. [(Section 2(1)(za)]. It thus precludes such companies registered under the Indian Trusts Act and engaging exclusively in the function of securitisation of assets. There is no bar on securitisation through non-corporate Special Purpose Vehicles (SPVs) outside the law, but such entities cannot exercise powers under this Act. The act therefore may be considered as not to be legislating on "securitisation" as such but on this function to be exercised specifically by ARC companies for asset reconstruction of NPAs of banks/FIs exclusively.
"Qualified institutional buyer" is defined as "a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or any asset management company making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund or a foreign institutional investor registered under the Securities and Exchange Board of India Act, 1992 or regulations made thereunder, or any other body corporate as may be specified by the Board."[Section 2(1)(u)] As per this definition 'securitisation' implies acquisition of the financial asset by
45
Securitisation Act – A New Landmark in the Indian Financial Sector
the ARC/SC from the bank or financial institution (referred as originator). Acquisition can be normally by raising funds by securitisation of financial assets taken over by issue of security receipts. The security receipts are backed by a charge on the financial assets and the eventual cash flow to be generated from that asset by sale, lease or by managing such assets. The security receipt are to be offered to the QIB i.e. qualified institutional buyers only and not to the general public.
"Security receipt" is defined vide Section 2(1)(zg) as :a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation". A distinct scheme is to be formulated by the ARC/SC for each group of security receipts issued by them to QIBs.
Asset Reconstruction & Asset Reconstruction Company "Asset reconstruction" means acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realisation of such financial assistance; [Section 2(1)(b)] The act, as explicitly stated in the above definition applies only to securitisation of financial assets of banks and financial institution. In particular only NPAs can be handled by the ARC/SC companies formed under the Act. NPAs relating to certain categories of borrowers are exempted under the provisions of the Act.
46
Securitisation Act – A New Landmark in the Indian Financial Sector
However under Section 2(1)(m) a wide definition is given to the term "financial institution" to include not only banks and Term Lending Institutions, but also "any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934, which the Central Government may, by notification, specify as financial institution for the purposes of this Act".
The term financial institution is defined as: "Financial institution" means: i. a public financial institution within the meaning of section 4A of the Companies Act, 1956; ii. any institution specified by the Central Government under sub-clause (ii) of clause (h) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993; iii. the International Finance Corporation established under the International Finance Corporation (Status, Immunities and Privileges ) Act, 1958; iv. Any other institution or non-banking financial company as defined in clause (f) of section 45-1 of the Reserve Bank of India Act, 1934, which the Central Government may, by notification, specify as financial institution for the purposes of this Act.
47
Securitisation Act – A New Landmark in the Indian Financial Sector
"Reconstruction company" means a company formed and registered under the Companies Act, 1956 for the purpose of asset reconstruction; [(Section 2(1) (v)] "Borrower", "Obligor" & "Default" "Borrower" means any person who has been granted financial assistance by any bank or financial institution or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance. The definition of the term borrower under the act is wider and covers not only borrowers, but also guarantors and all types of co-obligants. "Obligor" means a person liable to the originator, whether under a contract or otherwise, to pay a financial asset or to discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent and includes the borrower;[Section 2(1)(q)]. The term "obligor" includes in addition to the "borrower" as defined above, 3rd parties, who have taken on credit part or all of the secured assets, but have not paid for the same. In other words, obligor means, debtors of the borrower on the date of take over of the secured assets under the Act. It may be clarified that the borrower is referred as "obligor" and "Bank/FI" as "originator" respectively in relation to the ARC/SC. For the ARC/SC the borrower is not a borrower, but an "obligor" and the bank/FI, the "originator".
48
Securitisation Act – A New Landmark in the Indian Financial Sector
"Default" means non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor in accordance with the directions or guidelines issued by the Reserve Bank;[Section 2(1)(j)] There should be "default" by the "borrower"(as defined in the Act) for the process under the Act to be initiated. Default implies failure to repay plus as a consequent classification of the borrower's account as a non-performing asset. Thus if the account of the borrower is not transferred as NPA, action under the act is not possible even if there is default.
Security Interest & allied terms "security interest" means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31;[ section 2(1)(zf)] It is important to understand correct meaning of this term, as the Act deals extensively with "enforcement of security interest"
"secured debt" means a debt which is secured by any security interest;[Section 2(1)(ze)]
"Secured
asset"
means
the
property
on
which
security
interest
is
created;[Section 2(1)(zc)
49
Securitisation Act – A New Landmark in the Indian Financial Sector
"security agreement" means an agreement, instrument or any other document or arrangement under which security interest is created in favour of the secured creditor including the creation of mortgage by deposit of title deeds with the secured creditor; [Section 2(1)zb)]
"Secured creditor" means any bank or financial institution or any consortium or group of banks or financial institutions and includes-i. ii. iii. debenture trustee appointed by any bank or financial institution; or securitisation company or reconstruction company; or any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by any borrower of any financial assistance;[Section 2(1)(zd)]
50
Securitisation Act – A New Landmark in the Indian Financial Sector
Registration of securitisation or reconstruction company
A securitisation or reconstruction company cannot commence or carry on business of securitisation or asset reconstruction without obtaining registration certificate from RBI.
1. Requirements for registration of securitisation company
? Minimum owned funds: The company must have minimum owned funds of Rs. 2 Crore or such amount as may be prescribed by RBI. The amount prescribed by RBI shall not exceed 15% of total financial assets acquired or to be acquired by the securitisation or reconstruction company [section 3(1)]. RBI can prescribe different „owned funds? for different classes of securitisation or reconstruction companies. ? Should be profit making company: The company should not have incurred a loss in any of the three preceding financial years. ? Adequate financial agreements: The company should have made adequate arrangements for realisation of assets and should be able to pay periodic returns and redeem investments made by QIBs in the securitisation or reconstruction company. ? Professional directors: The directors should have adequate experience in matters relating to finance, securitisation and reconstruction. ? At least 50% independent directors: The board directors of the securitisation or reconstruction company can have maximum 50% directors who are nominees of sponsors or who are associated in any manner with the sponsor or any of its subsidiaries. In other words, at least 50% of the directors should be professional and independent.
51
Securitisation Act – A New Landmark in the Indian Financial Sector
?
Directors convicted in offence involving moral turpitude not eligible: Any of the directors should not have been convicted of an offence involving moral turpitude.
?
No single person to hold controlling interest: A sponsor should not be holding company of securitisation or reconstruction company, or should not hold any controlling interesting the company.
?
Prudential norms of RBI to be complied with: The company should have complied with or in a position to comply with the prudential norms specified by the RBI.
?
No other business: The company shall not carry on any business other than securitisation or asset reconstruction or business as permitted u /s 10(1), without prior approval of RBI [Section 10(2)]. This restriction does not apply to a subsidiary of the securitisation or reconstruction company.
2. Operational Rules for Already Existing ARCs/SCs
The securitisation and reconstruction companies existing on the commencement of the Act should also apply for registration with RBI within a period of six months from the date of the Act and they are permitted to continue transacting business of securitisation or asset reconstruction until a certificate of registration is granted to it or, as the case may be, rejection of application for registration is communicated to it.
3. Procedure for Registration
Every securitisation company or reconstruction company is required to make an application for registration to the Reserve Bank in such form and manner as it may specify [Section 3(2)].
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Securitisation Act – A New Landmark in the Indian Financial Sector
The RBI after being satisfied that the conditions specified are fulfilled, grant a certificate of registration to the securitisation company or the reconstruction company to carry on or commence business of securitisation or asset reconstruction, subject to such conditions, which it may consider, fit to impose [Section 3(4)]. The Reserve Bank may reject the application made if it is satisfied that the conditions specified in the Act are not fulfilled, but subject to the condition that before rejecting the application, the applicant shall be given a reasonable opportunity of being heard [Section 3(5)].
4. Approval of RBI for Change in Management
Every securitisation company or reconstruction company, shall obtain prior approval of the Reserve Bank for any substantial change in its management or change of location of its registered office or change in its name. The decision of the Reserve Bank, whether the change in management of a securitisation company or a reconstruction company is a substantial change in its management or not, shall be final. For the purposes of this section, the expression "substantial change in management" means the change in the management by way of transfer of shares or amalgamation or transfer of the business of the company [Section 3(6)].
5. Business that can be carried out
In addition to securitisation and asset reconstruction, the company can undertake following activities: a) Act as agent for any bank or FI for the purpose of recovering dues from the borrower, on payment of such fees or charges as may be mutually agreed. b) Act as manager u / s 13(4)(c) to manage secured assets, the possession of
53
Securitisation Act – A New Landmark in the Indian Financial Sector
which has been taken over by secured creditor. It cannot act as Manager if acting such gives rise to any pecuniary liability. c) To act as receiver if appointed by any Court or Tribunal [Section 10(1)].
6. Powers of RBI
RBI is empowered to give directions to any securitisation or reconstruction company in matters relating to income recognition, accounting standards, making provisions for bad and doubtful debts and capital adequacy based on risk weights for assets. It can also give directions relating to deployment funds. The securitisation or reconstruction company is bound to follow the policy determined by RBI and the directions issued [Section 12(1)]. RBI can also give directions regarding type of financial assets and aggregate value of financial assets that can be acquired by securitisation or reconstruction company [Section 12(2)]. Punishment for Non-Compliance: If any securitisation or reconstruction company fails to comply with any directions issued by RBI u/s 12, such officer and every officer of company who is in default shall be punishable with fine upto Rs five lakh plus additional fine upto Rs 10,000 for every day during which the default continues [Section 28]. The offence can be tried by any Court not inferior to that of a Metropolitan Magistrate or Judicial Magistrate of First Class [Section 30].
7. Cancellation of registration
RBI can cancel registration of a securitisation or reconstruction company, if a) It ceases to carry on business of securitisation or asset reconstruction b) Ceases to hold or receive any investment from QIB c) Fails to comply with conditions stipulated by RBI while granting registration
54
Securitisation Act – A New Landmark in the Indian Financial Sector
d) Fails to comply with conditions for registration as stipulated u/s 3(3) e) Fails to comply with instructions of RBI or fails to maintain accounts as per requirements or fails to offer them for inspection or makes substantial changes in management without approval of RBI [Section 4(1)]. RBI can give opportunity to company for taking steps to comply with the requirements, unless RBI is of the opinion that the delay in cancellation of registration is prejudicial in public interest or the interest of investors of the securitisation or reconstruction company [proviso to section 4(1)]. If registration is cancelled, appeal can be filed within 30 days to Central Government. Personal hearing will have to be given [section 4(2)]. Even if registration is cancelled, the company will have to repay the investments made by QIBs and will be deemed to be a securitisation or reconstruction company till it repays the investments with interest [section 4(3)].
8. Other companies/entities can carry out securitisation
There is no provision that securitisation can be undertaken only by securitisation company or asset reconstruction company only. In the opinion of author, it can be done by other entities also, even if not registered with RBI. However, the special provisions and protections u/s 5 to 8 will not be applicable to such securitisation.
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Securitisation Act – A New Landmark in the Indian Financial Sector
Acquiring financial assets from Bank / FI
The securitisation or reconstruction company can acquire financial assets from banks/financial institutions etc. Since the provisions of securitisation and enforcement of security interest are clubbed in one Act, there may be impression that the financial assets can be acquired only in cases where the borrower makes default in payment to secured creditor and the debt is classified as Non Performing Asset (NPA) as per RBI guidelines. In fact, this is not so. Any asset can be acquired by securitisation company. - -The asset may be present or even future earnings. In fact, only assets having good credit rating are normally securitised. However, financial asset can be acquired for asset reconstruction only for purpose of realising the financial assistance.
1. Modes of acquiring financial asset
The Act envisages two modes of acquiring financial asset by the securitisation or reconstruction company Agreeing for Specific Consideration The securitisation or reconstruction company will agree for consideration to be paid to the bank or Fl. It will issue debenture, bond or other similar security to the bank or Fl on agreed terms and conditions. [Section 5(l)(a)] Without Agreeing for Specific Consideration - The securitisation or reconstruction company may enter into an agreement with Bank/Fl for acquisition of financial assets on such terms and conditions as may be agreed upon [Section 5(l)(b)]. In such case, probably, it may be contracted (in case of NPA i.e. stressed assets) that an agreed percentage of amount realised may be paid to Bank. There is full flexibility and any other terms/conditions can also be agreed upon.
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2. Is it transfer of actionable claim? As per section 3 of Transfer of Property Act, „actionable claim? means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, actual or constructive of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent. - - In view of this definition, it is clear that in respect of immovable property, securitisation is not transfer of actionable claim. In case of movable property, the second part of definition i.e. „claim to any beneficial interest in movable property not in possession?. If so, sections 130 to 137 of Transfer of Property Act may apply. - - Further, it can be argued that the transaction is not „transfer of actionable claim? (under Transfer of Property Act), but acquisition of „financial asset? under Securities - - Act. Moreover, provisions in respect of securitisation are special provisions and it is a later Act, and in case of conflict, specific provisions in Securities - - Act will prevail over general provisions. Thus, it appears that securitisation process can be independent of provisions of sections 130 to 137 of Transfer of Property Act.
3. Registration of agreement
The agreement for securitisation or asset reconstruction will have to be registered with „Central Registry? which will be formed u/s 20(1) of the Act. It is clarified that provisions of „Central Registry? are in addition to and not in derogation of provisions of Companies Act, Merchant Shipping Act, Patents Act, Motor Vehicles Act, Designs Act or any other law requiring registration of charges. Hence, registration of charge as required under those Acts will be required in addition to registration with „Central Registry?. In fact, priority and validity of charge will be as per provisions of those Acts and not as per re with
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„Central Registry? [Section 20(4)].
4. Stamp Duty Payable
Stamp duty is payable at two stages – (a) When agreement to acquire the „financial asset? is executed with original lender. (b) When security receipt is issued to the investors. In addition, if the securitisation company has to enforce security and sell the asset, stamp duty will have to be paid. Stamp Duty on Securitisation Agreement As per section 5(1) of Securitisation Act, the securitisation or asset reconstruction company will acquire only „financial asset? i.e. debts and receivables or claim to debts or receivables. It will not acquire the asset as such from the lender. The securities (mortgage, hypothecation etc.) continue to be in name of original lender and are not transferred to securitisation company. The securitisation company can issue either a debenture/bond or any other security in the nature of debenture for a consideration, incorporating therein such terms and conditions as may be agreed upon. Thus, the debenture or bond itself contains all terms and conditions as agreed upon and separate agreement is not executed. Thus, if debenture or bond is issued, stamp duty will be payable as is payable on debenture or bond. [Of course, merely calling an instrument debenture or bond does not mean that it is a debenture or bond. If the instrument is held as debenture or bond, issue of the debenture/bond from Karnataka or Maharashtra State seems advisable as stamp duty on these instruments in these States is „reasonable?.
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5. Company enters into shoes of Bank/Fl after acquiring asset
After the financial asset is acquired by securitisation or reconstruction company as per provisions of section 5(1) from Bank/Fl, the securitisation or reconstruction company will be deemed to be lender. All rights of the Bank/FI will vest in the securitisation or reconstruction company in relation to the financial assets acquired [Section 5(2)]. CONTRACTS, DEEDS TRANSFERRED - All contracts, deeds, bonds, agreements, power-of-attorney, grants of legal representation, approvals, consents, or no-objections and other instruments of whatever nature which relate to the financial asset acquired and to which Bank/Fl is a party or which are in favour of Bank/FT will be in full force and effect against or in favour of the securitisation or reconstruction company which has acquired the assets. The securitisation or reconstruction company may enforce or act upon any of the instrument as if in place of Bank/Fl, the securitisation or reconstruction company is a party thereto and as if the instrument has been issued in its favour [Section 5(3)]. COMPANY BECOMES PARTY TO SUIT/APPEALS - If any suit, appeal or other proceeding of whatever nature relating to the financial asset are pending on date of acquisition of financial asset by or against the Bank/Fl, these will continued, prosecuted and enforced by or against the securitisation or reconstruction company [Section 5(4)]. - - However, if reference is pending before BIFR u/s 15(1) of SICA, it will automatically abate.
6. Notice to borrower/Registrar
After the asset is acquired by securitisation or reconstruction company, the Bank/Fl, may give notice to the obligor and or any other concerned. It may also give notice to registering authority in whose jurisdiction the mortgage, charge,
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hypothecation, assignment or other interest created on the financial assets has been registered [Section 6(1)]. - - Since the word used is „may?, such notice is not mandatory and the transfer or acquisition will be valid even if such notice is not given. Thus, notice may be given to borrowers as well as guarantors.
7. Effect of the notice
Once such a notice is given, the obligor shall make all subsequent payments to the securitisation or reconstruction company and not to Bank/Fl, to discharge obligation in relation to financial asset specified in the notice. Such payment shall be full discharge to the obligor making the payment from all liability in respect of such payment [Section 6(2)]. This transaction will be similar to „Pay through Certificate?. If such notice is not given by Bank/Fl, the obligor (borrower) may make payment to the Bank/FT. Any payment made by the obligor to Bank/Fl after acquisition of financial asset by securitisation or reconstruction company, will be held by such Bank/Fl in trust for the benefit of and on behalf of the securitisation or reconstruction company. Such payment will be delivered by Bank/Fl to securitisation or reconstruction company or its duly authorised agent [Section 6(3)].
8. Arbitration Mandatory
If there is any dispute between securitisation or reconstruction company and Bank/Financial Institution or Qualified Institutional Buyers (QIBs), in respect of securitisation or reconstruction or non-payment of any amount including interest, it shall be settled by conciliation or arbitration as provided in the Arbitration and Conciliation Act, 1996 only, as if the parties have agreed in writing to Arbitration
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[Section 11]. Thus, dispute between securitisation or reconstruction company, Bank/FI and QIB cannot be taken to civil court.
9. Protection to secured creditor for acts in good faith
No suit, prosecution or other legal proceedings shall lie against secured creditor or any of his officers or manager exercising any of the rights of secured creditor or borrower for any thing done or omitted to be done in good faith [Section 32]. - In other words, action can be taken only if malafide is alleged and established. - Since the securitisation or reconstruction company is „secured creditor? as per definition of section 2(1)(zd), the protection is available to the securitisation or reconstruction company.
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Central Registry
The Act proposes to establish a „Central Registry? with its own seal for purpose of registration of transactions of securitisation or reconstruction of financial assets and creation of security interest [Section 20(1)]. The Head Office will be at place determined by Central Government and its branches may also be set up [Section 20(2)]. Central Registry means the registry set up or caused to be set up u/s 20(1) of the Act [Section 2(1)(g)]. Registration with Central Registry will be in addition to and not in derogation of provisions of Companies Act, Merchant Shipping Act, Patents Act, Motor Vehicles Act, Designs Act or any other law requiring registration of charges. Hence, registration of charge as required under those Acts will be required in addition to registration with „Central Registry?. In fact, priority and validity of charge will be as per provisions of those Acts and not as per registration with „Central Registry? [Section 20(4)]. „Central Registrar? will be appointed for purpose of registration of transactions relating to securitisation, reconstruction of financial assets and security interest created over properties. [Section 2 1(1)] Other suitable officers can also be appointed [Section 21(2)].
1. Maintenance of Central Register
A Central Register will be kept at HO of Central Registry for entering particulars of transactions relating to securitisation of financial assets, reconstruction of financial assets and security interest created over properties [Section 22(1)]. Register can be kept in computer floppies, diskettes or in any other electronic form subject to safeguards as may be prescribed [Section
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22(2)]. Central Government can make rules providing safeguards subject to which the records maybe maintained in electronic form. [Section 38(2)(c)]. The Register will be under control and management of Central Registrar [Section 22(4)]. Particulars of every transaction relating to securitisation, reconstruction of financial assets and security interest created over properties shall be filed with Central Registrar within 30 days after date of transaction on payment of prescribed fees. Late filing upto further 30 days may be made on payment of additional fees [Section 23]. The manner in which the particulars of transaction shall be filed u/s 23 and fees for filing shall be prescribed by rules by Central Government [Section 38(2)(d)]. Modification of terms and conditions will be filed [Section 24].
2. Satisfaction or payment of security interest
Satisfaction or payment in full of security interest will be intimated within 30 days. [Section 25(1)] On receipt of such intimation, notice may be given to securitisation or reconstruction company or secured creditor as to why the payment or satisfaction should not be recorded. [Section 25(2)] If no cause is shown within 14 days, the intimation will be recorded. [Section 25(3)] If cause is shown (i.e. objection is raised), it will be noted. [Section 25(4)]
3. Inspection of Central Register
The Central Register will be open for inspection during business hours on payment of fees as may be prescribed [Section 26(1)] Register maintained in electronic form will be available for inspection through electronic media on payment of pre scribed fees. [Section 26(2)] Fees will be prescribed by Central Government by rules. [Section 38(2)(e) in respect of register in book form and section 38(2)(f) in respect of register in electronic form].
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4. Penalty for default
If default is made in filing particulars u/s 23, sending particulars of modification u/s 24 or sending intimation for satisfaction u/s 25, every company and every officer who is in default shall be punishable with fine upto Rs 5,000 for every day during which the default continues. [Section 27] The offence can be tried by any Court not inferior to that of a Metropolitan Magistrate or Judicial Magistrate of First Class. [Section 30] If offence is committed by a company (the term includes partnership firm or association of individuals), every person who was in-charge of or was responsible to affairs of the Company/firm is deemed to be guilty. Normally, a Managing Director (partner in case of firm) or other person specially authorised is deemed to be in-charge. However, such person can prove that offence was committed without his knowledge or he had taken due care to prevent the offence [Section 33(1)]. In addition, if it is proved that the offence in relation to Company is committed with consent or connivance of, or due to neglect on part of any director, manager or Secretary or other officer of Company, such person shall be deemed to be guilty [Section 33(2)]. Difference between provisions of section 33(1) and 33(2) is that in former case, the person in charge is deemed to be guilty and burden of proof is on him to prove that he had no knowledge; while in later case, burden of proof is on prosecution to prove that offence was committed with knowledge or connivance of the director, manager, secretary or other officer. A director/partner as well as the Company/firm can be prosecuted. Of course, Company/firm can only be fined, while the guilty officers/ partners can be imprisoned and personal fine also can be imposed. In some cases, it has been held that a director can be prosecuted even if company itself is not prosecuted.
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5. Provisions to apply only after Central Registry is setup
Provisions of sections 20 to 27 will apply only after Central Registry is setup u/s 20(1). [Section 39]. It may be noted that the registration with „Central Registry? is in addition to registration that may be required under any other Act.
6. All security interest created to be registered?
Section 2 that „creation of security interest? should be registered with Central Registrar. As per section 2(zf), „security interest? includes mortgage, charge, hypothecation, assignment excluding those specified u/s 31 etc. Thus, by strict legal interpretation, all mortgages, charges, hypothecation deeds executed by all secured creditors all over India will have to be registered. This seems to be practically impossible and very costly task. It appears that the intention is to register only transactions relating to securitisation and asset reconstruction. This aspect must be looked into and clarified/amended.
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Enforcement of security interest
We saw above the pre-conditions for taking action to enforce security interest. If these requirements are satisfied, the secured creditor can send a written notice to the borrower to discharge in full his liabilities within 60 days from date of notice failing which the secured creditor shall be entitled to exercise all his rights u/s 13(4) [Section 13(2)].
1. Requirements of notice
As clarified in section 13(2), the notice must be in writing, giving the borrower time of 60 days to discharge his liabilities. Notice must specify that the secured creditor (Bank/Fl) will be entitled to exercise any of his right as specified in section 13(4). The notice shall give details of amount payable by the borrower and the secured asset intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower [Section 13(3)]. If loan is foreclosed, entire amount becomes due immediately. Hence, notice should cover entire loan, including installments not due, and interest payable upto date of notice. It should be specified that future interest will also be payable till date of repayment.
2. Mode of Serving Notice
Secured creditor has to issue „demand notice? u/s 13(2). „Demand notice? means a notice in writing u/s 13(2). [Rule 2(b) of Security Interest (Enforcement) Rules, 2002]. As per rule 3 of Security Interest (Enforcement) Rules, 2002, demand notice u/s 13(4) is required to be issued either by secured creditor or by his authorised officer. Notice can be served by delivering or transmitting at the place where borrower or his agent, empowered to accept notice or documents on behalf of borrower resides or carries on business or personally works for gain. Notice can be sent
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by registered post with AD or speed post or by courier or even by fax or e-mail [Rule 3(1)]. As per rule 3(2), if the borrower or his agent is trying to avoid the service of notice, or if notice cannot be served for any other reason, notice can be served by affixing its copy on door or some conspicuous place in house or building where borrower or his agent ordinarily resides or carries on business or personally works for gain. If the borrower is body corporate, demand notice can be served on registered office or at any of the branches as specified in rule 3(1). [Rule 3(3) of Security Interest (Enforcement) Rules, 2002] - - Thus, a notice can be served at registered office or even at factory / administrative office where the body corporate is carrying on business. If there are more than one borrowers, demand notice shall be served on all borrowers. [Rule 3(4) of Security Interest (Enforcement) Rules, 2002]
3. Provision when joint financing is involved
In cases where financing of asset is by more than one secured creditor or there is joint financing of a financial asset, an individual secured creditor cannot take any action as contemplated u/s 13(4), unless exercise of such right is agreed upon by secured creditors representing at least 75% of the amount outstanding on record date. If 75% of creditors agree to the action, that decision will be binding on all remaining secured creditors. [Section 13(9)] As per explanation to section 13(9), „record date? means the date agreed upon by secured creditors representing not less than seventy five percent of the amount outstanding. „Amount outstanding? shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor. Though there is no clear provision, it is apparent that once 75% secured
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creditors agree, notice u/s 13(2) can be sent by any one of secured creditor. It is futile to send notice u/s 13(2) unless creditors holding 75% of outstanding amount consent. It may be advisable to send joint notice or to specifically authorise one of the banks/FI to avoid possible challenge to the notice. Of course, notice should specify the total amount payable to all secured creditors and not only to the secured creditor issuing the notice. Consent Of 75% Secured Creditor Of Only Particular Asset Are Required - The joint financing envisaged in section 13(9) relates to financing of „financial asset? by more than one secured creditors. Thus, consent of only those creditors who have financed against the specific asset is required. For example, if A, B and C secured creditors hold security in respect of fixed assets while D, E and F secured creditors hold security in respect of current assets, consent of only A, B and C (or those having 75% outstanding) is sufficient to issue notice in respect of fixed assets. Similarly, consent of D, E and F (or those having 75% outstanding) is sufficient to issue notice in respect of current assets. In other words, the 75% outstanding amount is qua assets and not qua the borrower.
4. Measures that can be taken
If the borrower pays entire amount within 60 days, no question arises and no further action can be taken. However, if he fails to pay full amount within specified period (which will happen in most of the cases), the secured creditor can take one or more of the following measures to recover his secured debt [Section 13(4)] (a) Take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset (b) Takeover the management of secured asset of the borrower including the right to transfer by way of lease, assignment or sale and realise the secured
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asset (c) Appoint any person (hereafter referred to as the manager) to manage the secured assets the possession of which has been taken over by the secured creditor (d) Require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt. Can Management of Business of Borrower be Taken Over? - Interestingly section 13(4) makes no provision for taking over management of business of a borrower, though section 15 provides for manner and effect of takeover of management. However, in absence of any specific power to takeover management of business of borrower, it is doubtful if such power can be exercised.
5. Cost and expenses can be recovered from borrower
If the secured creditor takes any action as specified u/s 13(4) (taking over assets or management of assets, selling it etc.), he can recover from the buyer all costs, charges and expenses properly incurred by him or any expenses thereto. If the secured creditor receives some amount (by sale of asset etc.), he will first apply them for payment of such costs, charges and expenses and secondly in discharge of dues of the secured creditor. If any amount is left (of course chances are negligible), it shall be paid to the person entitled thereto, in accordance with his rights and interests. [Section 13(7)]. Thus, the secured creditor can recover expenses of safe keeping of assets, expenses of manager who might be appointed to look after assets, incidental expenses and expenses incurred for selling/transferring the asset.
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6. Excess amount to be refunded to borrower
If any excess amount is left after adjusting all dues and expenses, normally it will be payable to borrower. Payment of interest on excess amount not necessary - If asset is sold, the amount recovered may exceed the dues receivable. In such case, there is no statutory obligation on part of SFC to pay interest to the defaulter on the excess amount received. Interest can be awarded by Court on equitable grounds only.
7. Secured creditor can proceed against borrower for balance amount
If dues of secured creditor are not fully satisfied with the sale proceeds of the secured asset, the secured creditor can proceed against the borrower for balance amount by filing application to Debt Recovery Tribunal having jurisdiction, or the competent court, for recovery of balance amount from borrower. [Section 13(10)] Section 38(2)(a) of Act authorises Central Government to make rules to prescribe the form and manner in which an application may be filed u/s 13(10). As per rule 11 of Security Interest (Enforcement) Rules, 2002, application for recovery of balance amount shall be made to DRT in the form given in Appendix VI of the Rules. Application shall be accompanied by fees as provided in rule 7 of DRT (Procedure) Rules, 1993. Interim order can be prayed for in same application. Index in duplicate of documents relied upon shall be submitted. Secured creditor can proceed against guarantor or sell pledged assets - The secured creditor can proceed against guarantor without first taking any of the measures specified in section 13(4)(a) to 13(4)(d). Similarly, secured creditor
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can sell the pledged assets without first taking any of the measures specified in section 13(4)(a) to 13(4)(d). [He can do so as the assets are already in his possession, as these are pledged to him]. [Section 13(11)]
8. How the secured creditor can exercise his right
The rights of e secured creditor can be exercised by one or more of his officers authorised in the manner as may be prescribed. [Section 13(12)] Section 38(2)(b) authorises Central Government to make rules for this purpose. Security Interest (Enforcement) Rules, 2002 issued under these powers make provisions for procedure to be followed. The secured creditor is required to appoint an „authorised officer?.
9. Restrictions on borrower after receipt of notice
Once borrower receives notice from secured creditor u/s 13(2), he cannot transfer any of his secured assets referred to in the notice by way of sale, lease or otherwise (other than in ordinary course of business). [Section 13(13)] Thus, the borrower can continue to sale, lease or otherwise deal with the current assets which may have been hypothecated to Bank/Fl.
10. Effect of transfer of asset to third person
As per section 13(4)(a), the secured creditor can lease, assign or sell the asset to any person. Section 13(6) provides that such transfer shall vest in the transferee all rights in, or in relation to, the secured asset transferred, as if the transfer had been made by the owner of such secured asset.
11. Significance OF ‘AS IF TRANSFER IS MADE BY OWNER OF ASSET’
One major problem is that as per section 13(6), if the assets taken over by Bank/FI are transferred, all rights are vested in the transferee as if the transfer
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has been made by owner of such asset. Thus, the buyer cannot get a title better than what original owner had. In other words, the transferee gets the asset saddled with all liabilities which the original owner had. The liabilities may be pertaining to (a) Labour (b) Past electricity dues (without which electricity supply may not be restored) (c) Earlier taxation dues relating to excise, sales tax etc. - - Strictly legally, the transferee is getting only assets of the company and not the company as such. However, quite possibly, these liabilities will haunt him. If so, the price the secured creditor may get will be much lower. Clear legal provision that the transferee will get asset without past liabilities will ensure that the transferee can start using the asset acquired by him without any apprehensions about past liabilities. Presently, there is no such assurance to the transferee who is acquiring the property from secured creditor.
12. Payment of amount by Borrower any taking back possession
The borrower can pay the amount due along with costs, charges and expenses incurred by secured creditor any time before the date fixed for transfer of the asset. If he makes such payment, the secured asset shall not be sold or transferred [Section 13(8)]. Entire amount of debt, including installments which were not due, will have to be paid It is not specifically mentioned, but it is implied that the asset will be handed over back to the borrower, if he makes full payment. It is also implied that once asset is sold/transferred by secured creditor, the borrower has no remedy other than filing appeal and claiming compensation u/s 19, if he can prove that the possession of secured asset by secured creditor was wrongful. Even after assets are taken over by secured creditor, if borrower makes full payment of debt, the management of business shall be restored to him. [Section 15(4)]
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13. Time limit for taking action after serving of notice
The secured creditor can take action u/s 13(4) any time after expiry of 60 days? notice. There is no time limit. However, it has been consistently held that when no time limit has been prescribed, action must be taken within reasonable time. Thus, the secured creditor must take action within reasonable time. The notice given u/s 13(2) cannot be said to be perpetually valid. In particular, if the secured creditor does an act which is contrary to intention of notice (e.g. reschedules loans or gives further time for repayment), it can be argued that the notice has abated and no action can be taken against such stale notice. Even otherwise, Limitation Act is applicable, and no action can be taken u/s 13(4) unless the claim is made within period of limitation prescribed under Limitation Act [Section 36].
14. Jurisdiction of civil court barred
Civil Court is barred from entertaining any suit or proceeding where Debt Recovery Tribunal is empowered to determine. No injunction shall be granted by any Court or other authority in respect of any action taken in pursuance of any power conferred under the Act [Section 34]. Of course, writ jurisdiction of High Court remains unaffected, as that power is conferred under Constitution of India and cannot be taken away by any Parliamentary Act. It may be noted that appeal to DRT can be filed only after possession or management of asset is taken over by the secured creditor.
15. Protection to secured creditor for acts in good faith
No suit, prosecution or other legal proceedings shall lie against secured creditor or any of his officers or manager exercising any of the rights of secured creditor or borrower for any thing done or omitted to be done in good faith. [Section 32]. - - In other words, action can be taken only if malafide is alleged and established.
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16. Can Secured Creditor take action if matter is with DRT / Civil Court?
The Act makes no provision whether action can be taken if the matter is already pending with DRT/Civil Court. There is neither specific permission nor prohibition. Section 13(10) provides that secured creditor can proceed against the guarantor for balance amount due. Hence, it can be argued that secured creditor can take action u/s 13 even if matter is pending with DRT. However, since the matter is sub judice, it will be highly advisable to seek permission of DRT before taking action u/s 13. It will be advisable to make specific provision in the Act to avoid disputes.
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Taking Over of Assets
1. Assistance of Magistrate to take over possession
The secured creditor can take over possession of assets 60 days after giving notice. Where the possession of assets is required to be taken or if any asset is required to be sold or transferred and if secured creditor expects resistance, he can request in writing, the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction the assets or the documents are located, to take possession of the assets or documents. On such request, Chief Metropolitan Magistrate or the District Magistrate shall take possession of such assets and documents relating thereto and forward such assets and documents to secured creditor [Section 14(1)]. Since the word used is „shall?, it is mandatory for Chief Metropolitan Magistrate or the District Magistrate to take possession once written request is received. The Chief Metropolitan Magistrate or the District Magistrate can use necessary force to take over possession [Section 14(2)]. Action of the Chief Metropolitan Magistrate or the District Magistrate pursuant to this section is fully protected and cannot be questioned in court or before any authority [Section 14(3)].
2. Change of directors/appointment of administrator
When the management of business of the borrower is taken over, the secured creditor can change the directors of borrower company if borrower is a company and appoint administrator if borrower is not a company. He may publish notice in newspaper published in English as well as regional language circulating iii the place where principal office of borrower is situated. [Section 15(1)]. (The word used is „may?, really advertisement must be published, if management is to be changed). Note that these provisions are applicable only when management of business
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is taken over and not when merely assets are taken over. Can management of business of borrower be taken over? - Interestingly section 13(4) of Act makes no provision for taking over management of business of a borrower, though section 15 of Act provides for manner and effect of takeover of management. However, in absence of any specific power to take over management of business of borrower, it is doubtful if such power can be exercised. However, these powers can be exercised by Asset Reconstruction Company or Securitisation Company u/s 9(a).
3. Effect of the notice
Publishing of such notice has following effect: [Section 15(2)] ? Earlier directors/authorised persons cease to hold office - On publishing of such notice, the earlier directors (in case of company) and persons holding any office of power of superintendence (if borrower is not a company e.g. partnership firm, proprietary firm etc.) shall be deemed to have vacated their office. [Section 15(2)(a)] ? Contract of management is terminated - Any contract of management which borrower had with any director or manager of borrower holding office as such shall be deemed to be terminated. [Section 15(2)(b)] ? New director/administrator can take over - The new directors / administrator appointed by secured creditor will take over in custody or control all the property, effects or actionable claims to which the business of borrower is, or appears to be entitled. Effects of business of borrower shall be deemed to be in custody of new directors/administrator. [Section 1 5(2)(c)] ? New directors/administrator to exercise all powers - The new directors / administrator shall alone be entitled to exercise all the powers of
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superintendence, direction and control of business of business of borrower, whether such powers are derived from Memorandum or Articles of the company or any other source whatsoever. [Section 1 5(2)(d)]
4. Effect of takeover of management
The takeover of management has following effect ? Shareholders cannot appoint directors - After the takeover of assets, shareholders of company cannot appoint or nominate any director of the company. [Section l5(3)(a)] ? No resolution without consent of secured creditors - Any resolution passed by shareholders will be effective only if approved by secured creditor [Section 1 5(3)(b)]. ? No proceeding for winding up - No proceeding for winding up of such company or appointment of receiver shall lie in any court, without the consent of secured creditor [Section 1 5(3)(c)] ? No compensation for loss of office - Any Managing Director or Director of the borrower shall not be entitled to compensation for loss of office or for premature termination of any contract of agreement with the borrower [Section 16(1)]. However, the MD or director or manager shall be entitled to any other money receivable, other than compensation [Section 16(2)].
5. Guidelines for exercise of power
Guidelines on how to use the powers are contained in Security Interest (Enforcement) Rules, 2002. These are briefly discussed below: ? Appointment of authorised officer - The secured creditor is required to appoint an authorised officer to exercise rights of secured creditor under the
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Act. He should not be below „Chief Manager? of a public sector bank or equivalent. “Authorised Officer” can be appointed by Board of Directors or Board of Trustees of secured creditor or any other person or authority exercising powers of superintendence, direction or control over business of secured creditor [rule 2(a) of Security Interest (Enforcement) Rules, 2002]. ? Serving of demand notice - The demand notice should be served on borrower as prescribed in rule 3 of Security Interest (Enforcement) Rules, 2002, as explained earlier.
a) Procedure in respect of movable secured asset
If movable property is taken over, the authorised officer shall prepare a „Panchanama? in presence of two witnesses. The „Panchanama? shall be signed by two witnesses and be in form as near as possible to Appendix I of Security Interest (Enforcement) Rules, 2002 [rule 4(1) of Security Interest (Enforcement) Rules, 2002]. The authorised officer will make or cause to be made an inventory of property of the borrower in form given in Appendix II of Security Interest (Enforcement) Rules, 2002. Copy of the inventory shall be given to the borrower or person entitled to receive it on behalf of borrower [rule 4(2) of Security Interest (Enforcement) Rules, 2002]. The property will be taken in custody of authorised person or any authorised person. Care shall be taken as an owner of ordinary prudence would take. The asset should be properly preserved, protected and insured [rule 4(3) and rule 4(4) of Security Interest (Enforcement) Rules, 2002]. Property Subject to Decay - If the property is subject to speedy and natural decay, or the expense of keeping the property in custody is likely to exceed its value, authorised person may sale it at once [proviso to rule 4(3) of
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Security Interest (Enforcement) Rules, 2002] Debt Not Secured By Negotiable Instrument - The debts of borrower may have been hypothecated to the secured creditor. - - If such debt is not secured by any negotiable instrument, the authorised officer can direct the debtor to pay the dues directly to him instead of paying to the borrower. Rule 4(5)(a) of Security Interest (Enforcement) Rules, 2002]. [If such debt was secured by a negotiable instrument, the authorised officer can enforce the same]. Shares in a Body Corporate - The borrower may have provided shares of a body corporate as security. In such case, the authorised officer can send notice to the borrower as well as to body corporate not to transfer the shares in favour of any person other than secured creditor [rule 4(5)(b) of Security Interest (Enforcement) Rules, 2002]. Other Movable Property Not In Possession Of Borrower - Some property belonging to the borrower may not be in his possession. For example, it may be in possession of job worker, consignment agent, transporter or godownkeeper. In such case, the authorised officer can take possession of such property in the same manner in which possession of other property is taken. [Such possession would not be possible if such other person (like transporter, job worker, consignment agent, godown keeper etc.) has lien over the goods or movables are pledged or he is unpaid seller, as in such cases, provisions of Act do not apply in view of clear provisions of section 31]. Moreover, authorised officer cannot take possession if the assets are in custody of Court or any like authority [rule 4(5)(c) of Security Interest (Enforcement) Rules, 2002] Possession of Assets ny Possession of Documents of Title – The authorised officer can take possession of movable secured assets by taking
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possession of document evidencing title in such secured assets [rule 4(5)(iv) of Security Interest (Enforcement) Rules, 2002]. Valuation of Movable Secured Asset - After the assets are taken over, the authorised officer shall obtain estimated value of assets and then, if considered necessary, fix a reserve price of assets to be sold, in consultation with secured creditor, to ensure maximum realization of dues [rule 5 of Security Interest (Enforcement) Rules, 2002]. It is not indicated how he will obtain „estimated value?. It is not provided that estimated value should be obtained from approved valuer only, as is provided in case of immovable assets. - - There is no provision to consult borrower or involve him in the process of valuation. In fact, fixing reserve price itself is at the option of authorised officer. However, in case of immovable property, valuation by approved valuer and fixing of reserve price is mandatory. Sale of Movable Secured Assets - The movable assets can be sold by any of the following methods - (a) Obtaining quotations from parties dealing in secured assets or those who may be interested in buying such asset (b) Inviting tenders (c) Holding public auction or (d) By private treaty [rule 6(1) of Security Interest (Enforcement) Rules, 2002]. A 30 day notice is required to be given to the borrower for sale of movable secured assets. If sale is by public auction or tenders, secured creditor shall put up a public notice in two leading newspapers, one in vernacular language, by setting out term of sale, which may include (a) Details about borrower and secured creditor (b) Description of assets with identification marks or numbers if any (c) Reserve price if any and time and manner of payment (Thus, fixing reserve price is not mandatory in case of movable assets) (d) Time and place of public auction or time after which sale by any other mode will be completed
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(e) Earnest money deposit (f) any other material details as considered essential by authorised officer. [Proviso to Rule 6(2) of Security Interest (Enforcement) Rules, 2002] Sale by methods other than public auction or public tender shall be on such terms as may be agreed upon [rule 6(3)]. If the buyer does not pay for the asset within time as per agreed terms, the movable asset can be offered for sale again. Transfer of Mortgage, Hypothecation or Pledge of Movable Property or Right or Interest in Security - „Financial asset? means normally „debts or receivables?. However, the definition of financial asset is inclusive and it includes a mortgage, charge, hypothecation or pledge of movable property [section 2(l)(l)(iii)] and any right or interest in the security, whether full or part, underlying the debt or receivables. [Section 2(1)(l)(iv)]. Rule 7(3) of Security Interest (Enforcement) Rules, 2002 states that sale of asset covered u/s 2(1)(iii) or 2(l)(l)(iv) shall be as if it is a sale of movable secured asset and provisions of rules as applicable to sale of movable assets applies. Wide Flexibility in Sale of Assets - It can be seen that wide flexibility has been provided to the secured creditor. Certificate of Sale - On receipt of sale price, the authorised officer shall issue a certificate of sale in form prescribed in Appendix Ill. Thereafter, the sale shall be absolute. The certificate of sale shall be prima facie evidence of title of purchaser [rule 7(2) of Security Interest (Enforcement) Rules, 2002]. - - The certificate is not „conclusive evidence?. The reason is that the purchaser cannot get a title better than what the borrower has. This is also clarified in section 13(6) of the Act which states that transfer of asset by secured creditor shall vest in the transferee all rights as if the transfer had been made by the
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borrower. Thus, a title better that what borrower had cannot be transferred to purchaser.
b) Procedure in respect of immovable secured asset
If immovable property is taken over, the authorised officer shall take possession by delivering possession notice to the borrower. The possession notice shall be in form as near as possible to Appendix IV of Security Interest (Enforcement) Rules, 2002. Copy of such possession notice shall also be affixed on outer door or at a conspicuous place of the property. [Section 8(1) of Security Interest (Enforcement) Rules, 2002] Possession receipt is also required to be published in two leading newspapers in locality, one of which should be in vernacular language of the locality Provisions in respect of panchanama or inventory, as applicable to taking over of movable assets, are not applicable for taking over of immovable assets. The property will be taken in custody of authorised person or any authorised person. Care shall be taken as an owner of ordinary prudence would take. The immovable asset should be properly preserved and protected and insured. [Rule 8(3) and rule 8(4) of Security Interest (Enforcement) Rules, 2002] Valuation Of Immovable Secured Asset - After the assets are taken over, the authorised officer is required to obtain estimated value of assets and fix a reserve price of assets to be sold from an approved valuer, in consultation with secured creditor, to ensure maximum realization of dues. [Rule 8(5) of Security Interest (Enforcement) Rules, 2002] There is no provision to consult borrower or involve him in the process of valuation. In case of immovable assets, valuation by approved valuer and fixing of reserve price is mandatory.
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Approved valuer means a valuer as approved by Board of Trustees or Board of Directors of the secured creditor. [Rule 2(d) of Security Interest (Enforcement) Rules, 2002]. Thus, appointment of approved valuer is the prerogative of secured creditor. Sale of Immovable Secured Assets - The immovable assets can be sold by any of the following methods - (a) Obtaining quotations from parties dealing in secured assets or those who may be interested in buying such asset (b) Inviting tenders (c) Holding public auction or (d) By private treaty. [Rule 8(5) of Security Interest (Enforcement) Rules, 2002]. 30 day notice is required to be given to the borrower for sale of immovable secured assets [Rule 8(6) of Security Interest (Enforcement) Rules, 2002]. Notice of sale shall also be fixed on a conspicuous part of immovable property and may be put on website of the secured creditor on internet. [Rule 8(7)] If sale is by public auction or tenders, secured creditor shall put up a public notice in two leading newspapers, one in vernacular language, by setting out term of sale, which shall include (a) Description of immovable property to be sold, including encumbrances known to secured creditor (b) Secured debt for recovery of which property is to be sold (c) Reserve price below which the property may not be sold (d) Time and place of public auction or time after which sale by any other mode will be completed (e) Earnest money deposit (f) any other material details as considered essential by authorised officer. [Proviso to Rule 8(6) of Security Interest (Enforcement) Rules, 2002] Sale by methods other than public auction or public tender shall be on such terms as may be agreed upon. [Rule 8(8) of Security Interest (Enforcement) Rules, 2002]
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Sale of immovable property shall not take place before expiry of 30 days from date on which public notice of sale is published in newspapers or notice of sale has been served on the borrower. [Rule 9(1) of Security Interest (Enforcement) Rules, 2002] The sale shall be confirmed in favour of highest bid or tender, but shall be subject to confirmation by the secured creditor. Sale cannot be confirmed if the offer is below the reserve price. However, if authorised officer is unable to obtain price higher than reserve price, he may sale at price lower than reserve price with consent of the borrower and secured creditor. [Rule 9(2) of Security Interest (Enforcement) Rules, 2002] [Interestingly, consent of borrower is required for sale below the reserve price]. The buyer is required to deposit 25% of sale price immediately. If he does not pay the deposit, the immovable asset shall be offered for sale again. [Rule 9(3) of Security Interest (Enforcement) Rules, 2002] - - Meaning of „immediately? is not clear. Certainly, it is not expected that an intending buyer will keep so much idle cash in bank accounts. Balance amount of purchase price should be paid within 15 days of confirmation of sale of immovable property on such extended period that may be agreed upon in writing. If the buyer fails to pay the balance consideration, the 25% deposit shall stand forfeited and the property shall be sold again. The defaulting purchaser will forfeit all claim to the property or to any part of sum for which the immovable property may be subsequently sold. [Rule 9(5) of Security Interest (Enforcement) Rules, 2002] Wide Flexibility in Sale of Immovable Assets - It can be seen that wide flexibility has been provided to the secured creditor. This may not be held as over delegation, as in State Financial Corporation v. Jagdamba Oil Mills 2002 AIR SCW 500 = 4 CLA-BL Supp 32 (SC 3 member bench), it was held that any mode of sale of assets can be adopted. The only requirement is that it
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should be fair and transparent. Provision in respect of immovable property subject to encumbrances The provision in respect of encumbrances is really a very good V e and welcome provision in the rules. - - Section 13(6) of the Act states that transfer of asset by secured creditor shall vest in the transferee all rights as if the transfer had been made by the borrower. Thus, a title better than what borrower had cannot be transferred to purchaser. - - Proviso to rule 8(6) provides that all encumbrances known to the secured creditor must be disclosed in the advertisement published. Authorised Officer may allow the purchaser to deposit with him the money required to discharge the encumbrances together with such amount as may be sufficient to meet the contingencies of further cost, expenses and interest as may be determined by authorised officer. On deposit of such amount, the authorised officer will issue notices to the persons entitled to receive the money deposited and take steps to make payments accordingly. [Rule 9(8)] The authorised officer shall deliver the property to the purchaser free from any encumbrances known to the secured creditor on deposit of money. The certificate shall specify that the asset is free from encumbrances known to secured creditor. It should be noted that paying encumbrances through authorised officer is optional and in fact at the option of authorised officer. Moreover, the certificate is only in respect of encumbrances known to the secured creditor. Meaning of Encumbrance - This word has not been defined in the Act. Encumbrance means a claim, lien, liability attached to property, as mortgage etc. Encumbrance means a burden, impediment, a mortgage or other charge on property. [Oxford Dictionary]
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Securitisation Act – A New Landmark in the Indian Financial Sector
Tenancy right is an encumbrance which will not go even if immovable property is transferred. One doubt is whether past electricity dues or past tax dues can be termed as „encumbrance?. Legally, a view is possible that these are not „encumbrances?. However, practically, they may be so, as explained below. Past Electricity and Tax Dues - Normally, a purchaser faces problems in beheld respect of past electricity dues, past tax demands etc. Strictly legally, the transferee is getting only assets of the company and not the company as such. However, quite possibly, the past liabilities in respect of electricity dues, tax dues etc. will haunt him. Appointment of Manager for secured assets - As per rule 10(1) of Security Interest (Enforcement) Rules, 2002, the Board of Directors or Board of Trustees of secured creditor may appoint a „Manager? in consultation with borrower to manage the secured assets. The Manager so appointed shall be deemed to be an agent of borrower. The borrower shall be solely responsible for commission or omission of acts of Manager, unless such commission or omission are due to improper intervention of secured creditor or the authorised officer. The Manager shall have power to recover any money from any person who has acquired secured assets from the borrower, which is due or may become due to the borrower. The Manager shall give a valid discharge to person making payment as if he has made payment to the borrower. [Rule 10(5) of Security Interest (Enforcement) Rules, 2002] The Manager shall apply the money received by him in payments in accordance with section 13(7) of the Act. [Rule 10(6) of Security Interest (Enforcement) Rules, 2002] As per this section, if the secured creditor
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Securitisation Act – A New Landmark in the Indian Financial Sector
receives some amount (by sale of asset etc.), he will first apply them for payment of such costs, charges and expenses and secondly in discharge of dues of the secured creditor. If any amount is left (of course chances are negligible), it shall be paid to the person entitled thereto, in accordance with his rights and interests. Manager is a Novel Idea - Appointment of „Manager? in consultation with borrower is an innovative idea. If the borrower and secured creditor agree, a „Manager? can be appointed to look after secured assets taken over by the secured creditor. Naturally, he will be someone associated with the borrower (maybe even an employee of borrower). Advantage of the idea is that for an outsider, managing assets taken over is not an easy task, particularly if he has to face hostile employees of the borrower all over the place. The „Manager? who is having confidence of borrower will be in a much better position to do so. Of course, the idea will work only if borrower agrees. It is doubtful if the Manager can be thrust upon him. The borrower may or at least should normally agree, as a person who has knowledge of affairs of the undertaking can certainly manage assets better than an outsider who has no knowledge of the working of the undertaking. In other words, the assets will continue to be under indirect supervision and control of the borrower himself, but he acts as trustee of the secured creditor. This is a practical idea, as for an outsider, it is indeed difficult to manage assets taken over Note that this provision applies only when secured assets of the borrower are taken over and not when management of business is taken over. Consultation or Concurrence? - It is interesting to note that only consultation with borrower is required for appointment of Manager, which is different from „concurrence?. Thus, even if the borrower does not agree to
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appointment of a person as Manager, he will be liable for his acts. This seems rather hard and strange. How can you appoint a person as agent against will of the Principal and still hold Principal liable for acts of the Agent, who is thrust upon him without his ascent? It is doubtful if such provision can stand in any Court of Law. The word „consultation? has different shades of meaning. The word „consult? as understood in ordinary parlance means to ask or seek advice on the view of a person on any given subject, i.e. to take counsel from another, but it does not convey that the consultant is bound by the advice. When Courts may interfere - Though section 34 of the Act bars jurisdiction of civil court, writ jurisdiction of High Court remains unaffected. Supervisory powers of High Court under Article 227 of Constitution are also unaffected.- No doubt, matters will go to High Court.
c) Effect of Winding up proceedings
In many cases, winding up proceedings might have already commenced, when Bank/Financial Institution decides to take measures u/s 13(4) of the Act. The Act does make some provisions, but some disputes seem possible. It will be advisable to make clear and explicit provisions. Enforcement of security if company is under winding up - Provisos to section 13(9) of the Act state as follows - [Really, these provisos are placed at wrong place in the Act, and some litigation on this count is possible.] Disbursement of Proceeds as Per Company Law Provisions - In case of company under liquidation, the amount realised from sale of secured assets shall be disbursed in accordance with section 529A of Companies Act. [First proviso to section 13(9)]
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Secured Creditor to Retain Sale Proceedings - In case of company being wound up, the secured creditor who opts to realise his security instead of relinquishing his security and proving his debt u/s 529(1), may retain the sale proceeds of his secured assets, after depositing the workmen?s dues with liquidator as per provisions of section 529A of Companies Act. [second proviso to section 13(9)] - - What this implies is that secured creditor can realise his security by remaining outside the winding up proceedings and realise his debt, subject to the condition that he deposits part of the proceedings as per section 529A with liquidator. Liquidator to Inform Quantum of Workmen’s Dues - The liquidator shall inform the secured creditors about workmen?s dues. [Third proviso to section 13(9)] If Workmen’s Dues Cannot be Ascertained - If the workmen?s dues cannot be ascertained, the liquidator shall intimate the estimated amount and the secured creditor shall deposit such estimated amount with liquidator. [Of course, as per provisions of section 529A, though not specifically stated] [Third proviso to section 13(9)] If such amount is deposited and if actual quantum is more, the secured creditor will have to pay the difference. Similarly, if actual amount is less, he can receive the excess amount deposited with official liquidator. [Fourth proviso to section 13(9)] The secured creditor is required to furnish undertaking to the liquidator to pay the balance of workmen?s dues, if any. [Fifth and last provisos to section 13(9)] Provision in respect of workmen’s dues - As per proviso to section 529(1) of Companies Act, security of secured creditor is deemed to be pari passu with workmen?s dues. Thus, Workmen?s dues are given same priority as secured creditors. This debt ranks pari passu with secured creditors.
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If the secured creditor stands outside liquidation and enforces his security, following provisions apply – (a) Liquidator is entitled to represent workmen and enforce the pari passu charge in favour of workmen (b) If liquidator realises any amount by enforcement of the charge, it will be distributed ratably (pro rata) for discharge of workmen?s dues (c) In view of pari passu charge in favour of workmen, it is possible that the secured creditor may not be able to realise his full debts. In such cases, the debt short recovered is given top priority in distribution, to the extent of workmen?s portion of his security. [Proviso to section 529(1) of Companies Act] However, the top priority is given only to the extent of workmen?s portion of security e.g. assume that (a) Value of security of a secured creditor is Rs one lakh (b) Total amount of workmen?s dues as per definition are Rs one lakh (c) Debt due from company to secured creditor is Rs 3 lakhs. In such case, „workmen?s portion of security? is 25% (one lakh out of four lakhs total secured debt). Hence, workmen will get 25% of security i.e. Rs 25,000. [Illustration to section 529(3)(c) of Companies Act] If workmen get security of Rs 25,000, the secured creditor will get priority in respect of only Rs 25,000 from other assets of the company. However, if value of security is Rs 3.6 lakhs, secured creditor will get Rs 2.70 lakhs, workmen will get Rs 90,000. In that case, the secured creditor will get priority only for balance Rs 30,000 from other assets as total dues to him are only Rs. 3 lakhs. [Section 529A of Companies Act]
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What are workmen’s dues - Only dues of „workmen? as defined under Industrial Disputes Act are covered. Thus, employees in supervision and managerial category are not entitled to any priority. Following amounts payable get position of „secured charge? [Section 529(3) of Companies Act] i. Wages and salaries in respect of services rendered to company and any compensation payable under Industrial Disputes Act to any workman ii. All accrued holiday remuneration becoming payable to any workman on termination of his employment before or by effect of winding up. In case of death, the amount payable to any other person as his right also gets secured status. iii. All amounts due in respect of compensation or liability for compensation to workmen under Workmen?s Compensation Act in respect of death or disablement of the workmen. This amount does not get status of secured debt, if the amount is insured or if the company being wound up voluntarily merely for purpose of reconstruction or amalgamation with another company. iv. All sums due to workman from provident fund, pension fun gratuity fund or any other fund for welfare of workmen maintained by the company. Permission of Company Court required after winding up order made - It is true that a secured creditor can remain outside winding up. However, in case of company where winding up order has been made or provisional liquidator has been appointed, the assets are in custody of official liquidator, as per section 456(1) of Companies Act. All property and effects of the company shall be deemed to be in custody of Company Court from date of winding up order, as per Section 456(2) of Companies Act. The provisos to section 13(9) of Securities Act, 2002 do not make any specific
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provision on the issue. In fact, section 37 of the Act states that the provisions of Act are in addition to provisions of Companies Act, SCRA, SEBI Act, RDDBFIA Act and other laws. Thus, no overriding provision has been given to the Act and hence, permission of Company Court will have to be obtained by secured creditor to take possession, sale or transfer the asset, if provisional liquidator has been appointed or winding up order has been issued by Company Court. No winding up proceedings if management of business of borrower is taken over - Once management of business of borrower is taken over by secured creditor, no proceeding for winding up of such company or appointment of receiver shall lie in any court, without the consent of secured creditor. [Section 16(3)(c)] However, in case of company where winding up order has been made or provisional liquidator has been appointed, the assets are in custody of official liquidator, as per section 456(1) of Companies Act. All property and effects of the comp shall be deemed to be in custody of Company Court from date of winding up order, as per 456(2) of Companies Act. In such cases, the secured creditor cannot take over business of borrower without permission of Company Court.
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Appeals and Penalties
1. Appeal against action of secured creditor
Provisions have been made to file appeal with Debt recovery Tribunal (DRT) against action of Banks / FI taken u/s 13(4) of Act.
2. Appeal to DRT
Any person (including borrower) aggrieved by any measure taken by secured creditor or his authorised officer u/s 13(4) may prefer appeal to DRT having jurisdiction in the matter, within 45 days from date on which such measure has been taken. [Section 17(1)] What this implies is that no appeal can be filed at the stage when notice has been given by secured creditor u/s 13(2). Appeal can be filed only after action u/s 13(4) [of taking possession of asset, takeover of management business of borrower, appointment of person to manage secured asset, etc.] is already taken by secured creditor. DRT will dispose off appeals as per the provisions of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and rules made thereunder. [Section 17(3)] Deposit of partial dues: When an appeal is filed by a borrower, the appeal shall not be entertained, unless the borrower deposits 75% of the amount claimed in the notice by secured creditor. The DRT can waive or reduce the amount required to be deposited [Section 17(2)]. [The amount will include even installments which were not due as per loan agreement.] The amount is not required to be deposited at the time of filing appeal, but appeal will not be heard till the amount is deposited.
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3. Appeal to Appellate Tribunal
Any person aggrieved by any order made by the Debts Recovery Tribunal under section 17 may prefer an appeal to an Appellate Tribunal within thirty days from the date of receipt of the order of Debts Recovery Tribunal.[Section 18(1)] Save as otherwise provided in this Act, the Appellate Tribunal shall, as far as may be, dispose of the appeal in accordance with the provisions of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and rules made thereunder.[Section 18(2)]
4. Right of Borrower to Receive Compensation and Costs for Wrongful Action
If the Debts Recovery Tribunal or the Appellate Tribunal, as the case may be, on an appeal filed under section 17 or section 18, holds the possession of secured assets by the secured creditor as wrongful and directs the secured creditor to return such secured assets to the concerned borrower, such borrower shall be entitled to payment of such compensation and costs as may be determined by such Tribunal or Appellate Tribunal. It is however, not clear whether the Tribunal can direct return of asset, if the secured creditor has already sold or transferred the asset.
5. Reliefs that can be granted
If the DRT or the Appellate Tribunal holds that possession of assets by the secured creditor was wrongful and directs the secured creditor to return the asset to the concerned borrower, the borrower shall be entitled to compensation and costs as shall be determined by the DRT or Tribunal.
6. Only compensation, no damages
It may be noted that Tribunal can award compensation and costs, but not
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damages. If the borrower intends to claim damages, he may have to try his luck in civil court.
7. Punishment
The act provides a general punishment of imprisonment upto one year and/or fine, if a person contravenes or attempts to contravene any provision of the Act [Section 29]. The penalty can be imposed by Court not lower than Metropolitan Magistrate of First Class [Section 30]. If offence is committed by a company (the term includes partnership firm or associate of individuals), every person who is in-charge of or was responsible to the affairs of the company/firm, is deemed to be guilty. Normally, a managing director, or another person specially authorised is deemed to be in-charge. However, such person can prove that offence was committed without his knowledge, or he had taken due care to prevent the offence [Section 33(1)].
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Chapter Four
Punjab National Bank – A Case Study
Punjab National Bank – A Case Study
Research Methodology
For the purpose of understanding the loan recovery process under the provisions of the act, I decided to study a case example of successful implementation of the process of enforcement of security interest. Also, I prepared a questionnaire (Annexure 1) and posed it to experts from the banking sector to get their views on the new act.
Collection of data
Primary Sources
Primary data has been collected through a meeting with the following managers of Punjab National Bank who provided me with the required information: ? ? ? Mr. Anil Bhan, Chief Manager, Credit Risk Management Department Mr. Avinash Vaidya, Senior Manager, Credit Risk Management Department Mr. T. V. K. Subramanian, Senior Manager, Credit Risk Management Department ? Mrs. Padmaprabha, Senior Manager, Credit Risk Management Department
Secondary Sources
Secondary data has been collected from news papers, magazines, books and the internet. These sources have been outlined in the Bibliography.
About Punjab National Bank
Established in 1895 at Lahore, undivided India, Punjab National Bank (PNB) has the distinction of being the first bank to have been started solely with Indian capital. From its modest beginning, the bank has grown in size and stature to
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Punjab National Bank – A Case Study
become a front-line banking institution in India at present. During its existence of over one-hundred years, Punjab National Bank has faced many a trials of strength including the trauma of partition of India in 1947 at the time of independence. However, due to its inherent strengths and resilience, the bank not only withstood such adversities but established itself still firmly on the Indian subcontinent. The bank was nationalised in July 1969 along with 13 other banks. The bank's strength lies in its corporate belief of growth with stability. With its presence in virtually in all the important centres of the country, Punjab National Bank offers a wide variety of banking services which include corporate and personal banking, industrial finance, agricultural finance, financing of trade and international banking. Among the clients of the bank are multinational companies, Indian conglomerates, medium and small industrial units, exporters and non-resident Indians. The large presence and vast resource base have helped the bank to build strong links with trade and industry. At the same time, the bank has been conscious of its social responsibilities by financing agriculture and allied activities and small scale industries (SSI). Considering the importance of small scale industries bank has established 16 specialised branches to finance exclusively such industries. With its long tradition of sound banking and in-depth knowledge of Indian economy, the bank has been able to help its clients in their projects. Punjab National Bank is ranked 416 among the biggest banks in the world by Bankers' Almanac (July 2002) London. Strong correspondent banking relationship which Punjab National Bank maintains with 200 leading international banks all over the world enhances its capabilities to handle transactions world-wide. Besides, bank has Rupee Drawing Arrangements with exchange companies in the Gulf. Bank is a member of the
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Punjab National Bank – A Case Study
SWIFT and 85 branches of the bank are connected through its computer-based terminal at Bombay. With its state-of-art dealing rooms and well-trained dealers, the bank offers efficient forex dealing operations in India. The bank has been focussing on expanding its operations outside India and has identified some of the emerging economies which offer large business potential. Bank has set up a representative office at Almaty, Kazakhktan w.e.f. 23rd October 1998. Keeping with its tradition of excellence in customer service PNB has adopted a quality movement "Alliance with Quality". Under this as many as 364 offices of the bank have been awarded the coveted ISO 9002 certification. The bank is committed to maintaining the highest standards of service and will be covering more offices under this quality movement. Bank has its corporate office at New Delhi and 18 zonal offices which in turn supervise 65 regional offices under which the branches function. The delegation of powers is decentralised upto the branch level to facilitate quick decision making. It has 4038 branches spread across the length and breadth of India. ? ? ? ? ? A professionally managed bank with a successful track record of over 108 years. Largest branch network in India - 4038 branches and 426 Extension Counters spread throughout the country. Strategic business area covers the large Indo-Gangetic belt and the metropolitan centres. Ranked as 416th biggest bank in the world by Bankers Almanac (July 2002), London. Strong correspondent banking relationships with more than 217 international banks of the world.
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Punjab National Bank – A Case Study
? ? ?
More than 50 renowned international banks maintain their Rupee Accounts with PNB. Well equipped dealing rooms; 20 different foreign currency accounts are maintained at major centres all over the globe. Rupee drawing arrangements with M/s UAE Exchange Centre, UAE, M/s Al Fardan Exchange Co. Doha, Qatar, M/s Bahrain Exchange Co, Kuwait, M/s Bahrain Finance Co, Bahrain, M/s Thomas Cook Al Rostamani Exchange Co. Dubai,UAE, and M/s Musandam Exchange, Ruwi, Sultanate of Oman.
?
In 2002-03, the bank made a profit of Rs. 240.54 crore (up from Rs. 152.11 crore in 2001-02) on a turnover of Rs. 2,318.18 crore (up from Rs. 1,928.53 crore in 2001-02).
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Government of India holding in Punjab National Bank reduced from 100% in 2001-02 to 80% in 2002-03.
Services provided by the bank Punjab National Bank operates in all major segments of the Indian Financial sector. It has a wide array of customers, right from the smallest retail clients to some of the largest corporates in India. The services of the bank can be classified into three main categories: ? Personal (Retail) Banking: This includes a vast array of services like operation of Savings and Current Accounts, maintaining Fixed Deposits and Recurring Deposits for varying time periods, Locker facilities, Issue of Drafts and Cash orders, Electronic Funds Transfer, Debit and Credit Cards, Tax Collections and Depository Services. These facilities can be availed through its vast network of branches and ATMs or electronically through the internet. The bank also provides its retail
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Punjab National Bank – A Case Study
customers the option of tele-banking and SMS-banking. ? Corporate Banking: This category includes the services provided by the bank to its corporate clients, which includes short term finance, term loans (long term finance), advisory services and financial management services. The bank also provides EXIM finance, trader loans, Loan against Future Lease Rentals and Cash Management Services. ? Personal Loans: The bank provides various loans such as Housing Loans Car Finance, Consumer Finance, Personal Loans, Professional Loans, Vidya Laksyapurti (Education Loan scheme), Krishi Cards for farmers, Loans against mortgage of property, Scheme for House wives and other women and Mahila Udyam Nidhi Scheme for women entrepreneurs.
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Interpretation of data
The answers provided to the questionnaire yielded the following information:
Process of recovery under enforcement of security interest
Mr. Avinash Vaidya, who is in charge of handling the NPA cases through Securitisation Act at Punjab National Bank, provided the following basic guidelines which need to be followed: NPA Classification: The bank follows the RBI guidelines for classification of NPAs. These guidelines have been outlined in the Annexure. Account monitoring initiated: Once an account is classified as doubtful, regular, continuous and stringent monitoring of the account is initiated by the bank. At this stage, any steps, if possible to reduce the further account deterioration, if possible, are taken. Analysis of security charge: Before initiating any recovery procedures, an analysis of the expected yield of the account through the initiation of proceedings, is done. Only if the security is found to be of significant value, are the proceedings initiated. Notice to the defaulter for a period of 60 days: The bank gives the defaulting borrower a notice of 60 days to repay the dues, in accordance with the provisions of the Act. Possession notice (10 days): If the borrower is unable or unwilling to repay the dues, the bank will give him another notice of 10 days before taking action to takeover the secured assets. At this stage, if the borrower decides to co-operate with the bank, the bank may be willing to negotiate a settlement on a case-tocase basis. Also, in this case, the bank may not initiate any legal proceedings against the defaulter.
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If the borrower does not co-operate with the bank representative, and creates obstructions in the smooth takeover of the assets, the bank may approach the Chief metropolitan magistrate or the District magistrate who shall then take over possession of the assets and documents relating to the assets and hand them over to the bank. The bank may also request police security for its representative for providing the formal possession notice to the defaulter. Publication of possession notice: The bank is mandated by law to publish the notice in newspapers, one of which must be a local language. Sale of assets: The following procedure is followed by Punjab National Bank to sell of the taken over assets: i. Valuation: Firstly, a valuation of the asset is carried out to find out the optimum sale price. ii. Advertisements for sale: The bank publishes advertisements in various leading newspapers in order to attract a number of interested buyers so that the best possible amount is received for the sale. iii. Sale negotiations, Tenders, Quotations: The bank may follow any suitable method for sale of assets. Legal action if recovery not complete: The bank may decide to pursue the case further if the above proceedings do not result in complete/satisfactory recovery. Besides possession and sale of secured assets, the bank has the following options under the provisions of the act: ? ? Takeover of management Sale to Asset Reconstruction Company
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Punjab National Bank – A Case Study
Example of recovery through enforcement of security interest
Highlights of the case
Defaulter: Amount Defaulted: Amount Recovered: Initiation of Recovery Process: Completion of Recovery Process:
Silverline Technologies Not Disclosed More than 80% 3rd December, 2002 6th June, 2003
About Silverline Technologies At the time of financing by the bank, Silverline Technologies was doing quite well. Silverline Technologies was a global IT services company providing end-to-end IT solutions in the following areas: ? ? ? ? ? ? Custom Development Application Management Enterprise Application Integration Data Warehousing eBusiness Customer Relationship Management
However, its condition deteriorated. Silverline Technologies Ltd posted a net loss of Rs 6.47 crore for the quarter ended September 30, 2002, compared to a net profit Rs 13.88 crore in the quarter ended September 30, 2001. Total income of
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Punjab National Bank – A Case Study
the company decreased from Rs 50.12 crore in the year-ago period to Rs 6.23 crore in the quarter ended September 30, 2002. Silverline Technologies, facing severe financial crisis, sold some assets owned by its subsidiary Silverline Technologies Inc, to Cognizant Technology Solutions US Corporation. It was facing cash crunch and had not been able to pay salaries to its US employees for the last few months. Further, the increase in receivable cycles amid global economic slowdown had affected its working capital position. About the financing Punjab National Bank had opened a Letter of Credit (LC on Documents against Acceptance) at the request of Silverline Technologies for import. However, Silverline could not arrange for the payment of the imported products at the end of the period of credit provided by the exporter. The LC was devolved and Punjab National Bank was forced to pay the amount. This amount was recoverable against thee mentioned security from Silverline. Primary security: The company had provided primary security which consisted of software and hardware. On the face of it, the value of this security was adequate; however there were some flaws, which need to be understood. ? The software was a highly customized package which had been developed for a specific client. Hence it had no application, except for the client of the company. ? Computer hardware becomes obsolete very fast. For example, a computer bought today will become outdated within a year. Hence the value of hardware goes down very fast and hence does not form a very good security
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for a loan Secondary security: Looking at the above problems of the security provided by Silverline Technologies, the loan appraisal department of Punjab National Bank asked for a secondary security before approving the FLC. Hence, the company provided the bank with a secondary security which consisted of 16 flats and a property in Thane. Enforcement process Once the account was classified as an NPA, the bank initiated recovery proceedings against the company. The steps undertaken by the bank for the loan recovery are underlined below. (The general steps to be followed, as mandated by the Act are detailed in Section 3 of the project) ? Issue of notice: The bank issued a notice to the company, under the provisions of the Securitisation act, on 3rd December, 2002. The notice mainly outlined the balance yet to be received from the company by the bank and gave the company a period of 60 days to repay the amount. If the company did not repay the amount within the above noted period, the bank could attach the security provided by the company. The notice issued has been attached as part of the annexure. ? Notice for taking possession of security: The bank gave a further 10 day notice to the company. It stated that if the amount was not repaid within 10 days, the bank would initiate attachment proceedings. ? No response by the company: The company failed to respond within the allotted period of 60 days as well as the additional period of 10 days. ? Attachment process started: The bank sent an authorized person to take
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possession of the primary security. However, the bank
realized that the
primary security could not repay the entire amount under default. ? Negotiation: At this time, the company also came to the bank to negotiate some more time to pay off the loan and also offered to transfer the secondary security to the bank. The bank gave the company one month?s time, but did not write off any part of the loan. ? Transfer of property: As the company did not repay the default amount, the bank insisted that the company transfer the property in its name. The company agreed to this in principal. ? Winding up proceedings initiated: With the company delaying in transferring the property, the bank decided to apply pressure by initiating winding up proceedings against the company. ? Defaulter’s attempt to leave the country: At this moment the directors of the company attempted to leave the country. But the bank displayed its alertness and applied for the cancellation of their passports and requested a stay against them from leaving the country. ? Transfer and Registration of flats completed on 6th June, 2003: Due to the mounting pressure, the company transferred the flats in the bank?s name and the registration papers were signed on 6th June, 2003.
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Chapter Five
Benefits, Problems and Recommendations
Conclusion – Benefits, Problems and Recommendations
Benefits of the Act
The bankers feel that the current Act will greatly improve the recovery climate in the country. They feel that this act can prove as a major deterrent to the willful defaulters, who will now have to think twice before taking the banks and the financial institutions for a ride. Till now, the bankers did not have any weapon to take action against such defaulters and were found incapable of even threatening them with action. However this case has greatly improved after the passing of the act. As has already been seen from the preceding example, the banks can use the Act to pressurize the defaulters, in order to recover their money. Also, the defaulters have been given very little opportunity to put hindrances in the recovery process, as can be seen in the Mardia Chemicals vs. ICICI Bank case. In this case, the defaulter, Mardia Chemicals, approached the Supreme Court to get a stay against the banks, which had sent them a notice for taking possession of the secured asset. Here, the appeal was turned down and the banks were allowed to take over the management of the company. The bankers also feel that the time of recovery proceedings will come down greatly, from the present 1-10 years to just a few months. This will greatly improve the NPA position of banks. Development of ARCs will bring in professionalism into the recovery process. These ARCs will help the banks, as the banks can transfer their NPAs to them, thereby recovering their locked up funds quickly and efficiently. Finally, banks are highly optimistic about the future of the act. Punjab National bank is targeting an improved recovery rate of 40% in the next 5 years as compared to 22 – 23% today. A number of other banks have also come out with
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press releases about optimistic future guidelines. A number of banks have already recovered substantial amounts by carrying out proceedings under the provisions of the Act.
Problems Envisaged
The bankers I talked to, feel that a number of minor and major hindrances are still present which need to be tackled. The Act is an effort to tackle NPA from the terminal end. Its provisions are operative only when an account has turned bad and transferred as NPA. There are no remedial steps contemplated to arrest NPA at source. This is possible only by change in "habits" or practices followed by both the Banks and the borrowers. A relevant point with regards to taking over the management of defaulting units is brought out by the bankers as another handicap. The bigger amounts, where defaulters may show no sign of loosening up, can be realised by encashing the secured assets in the form of huge real estate, plant and machinery. As a senior law official with IFCI Ltd points out, there are, however, two provisions - section 13(4) and section 9 - that need clarification before banks and FIs move in a big way towards management control. Section 9, for instance, allows a securitisation or asset reconstruction company to take over the management of a company of "the business of the borrower" or bring in change of management. Section 13(4), though, permits a "secured creditor" to take over the management of the secured assets of the borrower. It is apparent the act is intended to allow asset reconstruction companies to take over the "management of the business" of a company, whereas a secured creditor can only take over the "management of the secured assets" and not
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bring in any change in management. With the task of setting up and getting the asset reconstruction companies functional still incomplete, prospects of takeover of defaulters' assets right away seem remote. ? Internal Problems of banks Without solving the internal problems of the banks related to credit appraisal and recovery, any other measures taken to reduce NPAs will be useless and will not provide the desired results. ? No difference between willful and normal business default The Act, in no way differentiates between willful defaulters, against whom stern action is required, and genuine defaults which may occur in the normal course of business and may require restructuring. ? Sections 35 and 37 contradict each other Section 37 of the Act states that the provisions of Act are in addition to the provisions of Companies Act, SCRA, SEBI Act, RDDBFIA Act and other laws. Thus, no overriding provision has been given to the Act. However, Section 35 makes exactly contrary provision that the provisions of the Act override provisions of all other laws in force. Thus, sections 35 and 37 are contradictory provisions. It appears that section 35 is meant for provisions in respect of enforcement of security interest and Asset Reconstruction Company, while section 37 is meant for provisions in respect of securitisation. However, there is no such clarification and interpretation of these contradictory provisions will be very difficult.
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Conclusion – Benefits, Problems and Recommendations
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Joint financing In cases where financing of asset is by more than one secured creditor or there is joint financing of a financial asset, an individual secured creditor cannot take any action as contemplated u/s 13(4), unless exercise of such right is agreed upon by secured creditors representing at least 75% of the amount outstanding on record date. If 75% of creditors agree to the action, that decision will be binding on all remaining secured creditors. [Section 13(9)] This can create a number of problems in the recovery process. Firstly, according to Mr. Anil Bhan (Chief Manager, NPA Department, Punjab National Bank), there are a number of conflicts of interests due to the fact that different lenders have different security charges with different priority of charges. As a result, each lender does not want to provide approval for taking action, as it may result in lower recoveries for his organization and would aid the recovery of other lenders. Also, different lenders have different recovery records of the borrower, resulting in them wanting to take different approaches to the recovery process.
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Management cannot be taken over Section 13(4) makes no provision for taking over management of business of a borrower, though section 15 provides for manner and effect of takeover of management. However, in absence of any specific power to takeover management of business of borrower, it is doubtful if such power can be exercised. Also, takeover of management is not a viable option for banks, as the
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Conclusion – Benefits, Problems and Recommendations
defaulters may be operating in extremely diverse sectors and the banks may not have the people who can professionally handle the day-to-day operations of such a large number of firms. ? Secured Creditor may require permission to take action if matter is with DRT/Civil Court The Act makes no provision whether action can be taken if the matter is already pending with DRT/Civil Court. There is neither specific permission nor prohibition. Section 13(10) provides that secured creditor can proceed against the guarantor for balance amount due. Hence, it can be argued that secured creditor can take action u/s 13 even if matter is pending with DRT. However, since the matter is sub judice, it will be highly advisable to seek permission of DRT before taking action u/s 13. It will be advisable to make specific provision in the Act to avoid disputes. This will only result in delays for the implementation of the recovery procedure. ? Major chunk of financial market left out The definition of „financial institution? [Section 2(l)(m)(iv)] makes it clear that it does not include NBFC (though these can be included by issuing a notification by Central Government). If so, one major chunk of financial market is outside the provisions of Act, as many NBFCs are involved in housing finance, hire purchase finance, car loans etc. ? Approach to BIFR by defaulter If the defaulter approaches the BIFR and the company is entered into restructuring under this act, the lender may find it difficult to take any action under the Securitisation Act.
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Conclusion – Benefits, Problems and Recommendations
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Security sell off in the notice period This is a problem being faced by a number of banks who have initiated proceedings under the provisions of the act. The defaulters, on receiving the notice under the act, get a period of 60 days before any further action can be taken by the lender. During this period, the defaulter may sell off a part or the entire security, thus providing the lenders with no opportunities to recover the amount. This is especially true when liquid assets such as stocks have been provided as security.
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Valuation problems Generally, banks tend to find that there is a major gap in the valuation of the security, as carried out at the time of providing the loan and at the time of loan recovery. The value of the security has generally deteriorated over the period, and according to experts, it may further deteriorate by almost 10-50% in quick action is not taken for its immediate sale.
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Liabilities attached to the property transferred on takeover This can prove as a major deterrent in getting an optimal price for the secured asset. The lender has to take care of all attached liabilities before a sale can be affected. These liabilities can form a major chunk of the value of the asset, thereby reducing the recovery from sale of asset manifold.
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Problems in taking possession The lender may face various problems in taking possession of secured assets, especially if they are unmovable property. The bank may have to apply forceful tactics to take possession and may have to take the help of the Metropolitan Magistrate and police.
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Conclusion – Benefits, Problems and Recommendations
Recommendations
The bankers are of the opinion that a number of Amendments are required to make the Act foolproof. They also feel that a number of fundamental changes in the functioning of the financial sector as a whole are needed to tackle the problem of NPAs effectively. ? No super-priority rights to the government The government and its various agencies enjoy super priority rights. For example, if Sales Tax or other duties are outstanding, these agencies have a first right to recover the amount. In the case of a borrower, this right can hamper recovery. On taking over an asset, the lender has to first pay these dues before a sale of the asset can be made. I am of the opinion that this right should not be provided to the government. The government and its agencies should be at par with the unsecured creditors and should follow the normal recovery process to recover its dues. They should also be willing to take a hit, as is the case with the other secured and unsecured creditors. ? No priority / weighted average method in calculation of charge As we have already seen the problems created due to priority of security charge, I recommend that a weighted average method should be used when more than one creditor have a charge on the same security. Under this method, the creditor with the first charge should be given a higher weight, based on the amount of credit, and a mutual understanding between the different creditors, while the creditors with second or third charge may be given a lower weight.
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Conclusion – Benefits, Problems and Recommendations
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Market of ARC to be developed Currently, there are no ARCs in India. This area needs to be looked at. A large number of ARCs should be allowed to operate to facilitate competition, which would improve pricing and the quality of services. Also, it is preferable that the ARCs set up should not be subsidiaries of banks, but different companies, this would ensure that the process is followed in legality as well as spirit. This would reduce the possibilities, that bad loans are not just transferred from one balance sheet to the other, and actual recovery takes place.
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ARCs should be developed on industry basis only ARCs are specialized agencies which will be managing the taken over companies of the borrowers. These securitisation companies, therefore, should be experts in the area of operations of the borrowers to successfully manage them. This can be made possible if an industry – wise bifurcation is done for the creation of securitisation companies and they function in only one specialized area.
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Securitisation should be without-recourse only Securitisation under the act can be with or without recourse. Under with recourse securitisation, the securitisation or reconstruction company can approach the banks and ask them to pay the balance amount, if they are not able to recover the full amount from the borrower. Under without recourse securitisation, the securitisation or reconstruction company does not have any such right. According to Mr. Anil Bhan, with recourse securitisation nullifies the entire benefit of transfer of NPAs to these companies. Also, since these companies are not willing to share any profits made with the banks, they should be willing to take the risks involved in the transaction.
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Conclusion – Benefits, Problems and Recommendations
It is the policy of Punjab National Bank to recover the highest amount in the shortest possible time. For example, a securitisation company offers the following two different options for the securitisation transaction; one, where the securitisation company is willing to pay only 50% of the loan amount immediately, and two, wherein the securitisation company will pay 20% upfront and will share any profits on the recovery with the banks in a 60-40 ratio. Punjab National Bank would accept the first option even if there is a high possibility of recovering a higher amount in the second instance. ? Political interference should be reduced Political interference in the day – to – day functioning of public sector banks creates a number of problems for them. The populist policies of the national level politicians, such as waiver in repayment of loans should be curbed and the banks should be allowed to function as normal commercial organizations. ? Transactions relating to the secured asset after the issue of notice to be considered void To solve the problem of the sale of secured assets during the notice period, an amendment should be made, whereby, all transactions related to the secured asset by the borrower like sale, lease, etc. will be considered as void, and the secured creditor will have first right to take over the asset and sell it to recover his dues.
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Annexure
Questionnaire
Part A
1. 2. 3. 4. What are the main reasons for huge NPAs in the banking industry? What are the statutory guidelines of RBI in relation to NPAs? What percentage of total loan disbursements turn into NPAs? Do you have a separate department for dealing with NPAs? If so, what is the procedure followed for dealing with NPAs? 5. 6. What are the major problems faced in loan recovery? Over the years, what steps has the government taken to assist the finance sector for reducing NPAs? 7. What were the problems with the above steps i.e. why has the industry not been able to reduce NPAs?
Part B
8. How, in your opinion, will the recently introduced concept of securitization help in reducing NPAs? 9. 10. What are your views on the new Securitisation Act? What benefits of securitisation do you envisage over other methods of loan recovery? 11. Have you initiated proceedings against defaulters under the provisions of the act?
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Conclusion – Benefits, Problems and Recommendations
12. 13. 14.
If so, what has been your experience? Have you faced any problems? Do you feel that the act has any shortcomings or loopholes? What amendments do you think would be a step in the direction to remove these shortcomings?
15.
What other features not covered by present legislations would you like to be included?
16.
Which points should be included in a framework, which would be effective in curbing NPAs?
17.
Besides legislations, what can the government and the banks themselves do to reduce NPAs?
18.
Do you think, the act sends a strong enough message to habitual defaulters which will check them in repeating this in future?
19.
Today, banks can opt for Debt Recovery Tribunals or Securitisation for recovery of NPAs. In your opinion, which is a better tool for recovery? What are the pros and cons of each tool?
20.
Do you think that proceedings under the securitisation act have impacted the PR of the bank? If so, has the impact been positive or negative?
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Conclusion – Benefits, Problems and Recommendations
Possession Notice [Rule 8(1)]
(For immovable property) Whereas The undersigned being the authorised officer of the …… (name of the Institution) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and in exercise of powers conferred under section 13(12) read with rule 9 of the Security Interest (Enforcement) Rules, 2002 issued a demand notice dated …… calling upon the borrower Shri …… / M/s …… to repay the amount mentioned in the notice being Rs ….. (in words ……… ) within 60 days from the date of receipt of the said notice. The borrower having failed to repay the amount, notice is hereby given to the borrower and the public in general that the undersigned has taken possession of the property described hereinbelow in exercise of powers conferred on him/her under section 13(4) of the said Act read with rule 9 of the said rule on this ……day of…… of the year …… The borrower in particular and the public in general is hereby cautioned not to deal with the property and any dealings with the property will be subject to the charge of the …… (name of the Institution) for an amount Rs …… and interest thereon.
Description of the Immovable Property
All that part and parcel of the property consisting of Flat No …… / Plot No …… In Survey No …… / City or Town Survey No …… / Khasra No …… within the registration Sub-district …… and District …… Bounded: On the North by On the South by On the East by On the West by Sd/Authorised Officer (Name of the Institution) Date: Place:
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Conclusion – Benefits, Problems and Recommendations
SALE CERTIFICATE [Rule 9(6)]
(For immovable property) Whereas The undersigned being the authorised officer of the …… (name of the Institution) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and in exercise of the powers conferred under section 13 read with rule 12 of the Security Interest (Enforcement) Rules, 2002 sold on behalf of the …… (name of the secured creditor/institution) in favour of …… (purchaser), the immovable property shown in the schedule below secured in favour of the …… (name of the secured creditor) by ……… (the names of the borrowers) towards the financial facility …… (description) offered by …… (secured creditor). The undersigned acknowledge the receipt of the sale price in full and handed over the delivery and possession of the scheduled property. The sale of the scheduled property was made free from all encumbrances known to the secured creditor listed below on deposit of the money demanded by the undersigned.
Description of the Movable Property
All that part and parcel of the property consisting of Flat No …… /Plot No …… In Survey No …… /City or Town Survey No …… /Khasra No …… Within the registration sub-district …… and District …… Bounded: On the North by On the South by On the East by On the West by List of encumbrances
1. 2.
Sd/ Authorised Officer (Name of the Institution) Date: Place:
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Conclusion – Benefits, Problems and Recommendations
RBI Norms for Classification of NPAs
Definition of NPAs An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A „non performing asset? was defined as a credit facility in respect of which the interest and / or installment of principal had remained „past due? for a specified period of time. The specified period was reduced in a phased manner as under: Year ending March 31 1993 1994 1995 Onwards Specified period Four Quarters Three Quarters Two quaters
An amount due under any credit facility is treated as „past due? when it has not been paid within 30 days from the due date. Due to the improvements in the payment and settlement systems, recovery climate, upgradation of technology in the banking sector, etc, it was decided to dispense with the „past due? concept, with effect from 31st March, 2001. Accordingly, as from that date, a NPA shall be an advance where, i. Interest and/or installment of principal remain overdue for a period of more than 180 days in respect of a term loan ii. The account remains „our of order? for a period of more than 180 days, in respect of an overdraft/cash credit iii. Interest and/or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agriculture purposes iv. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.
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Conclusion – Benefits, Problems and Recommendations
With a view to move towards international best practices, it has been decided to adopt the ?90 days? overdue norm for identification of NPAs, from 31 st March, 2004. ‘Out of Order’ Status An account should be treated as „out of order? if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for six months as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as „out of order?. ‘Overdue’ Any amount due to the bank under any credit facility is „overdue? if it is not paid on the due date fixed by the bank. Classification of NPAs Banks are required to classify NPAs further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues: i. Sub-standard Assets: A sub-standard asset is one which has remained NPA for a period less than or equal to 18 months. In such cases, the current net worth of the borrower, or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. Such assets will have well defined credit weakness that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the bank will sustain a loss. ii. Doubtful Assets: A Doubtful Asset which has remained NPA for a period
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Conclusion – Benefits, Problems and Recommendations
exceeding 18 months. It has all the weaknesses inherent to a substandard asset with the added characteristic that the collection or liquidation in full – on the basis of currently known facts – is highly questionable and improbable. iii. Loss Assets: A loss asset is one where a loss has been identified by the bank or, internal or external auditors but the amount has not been written off wholly. Guidelines for Classification of NPAs Broadly speaking, classification should be done taking into account the degree of well defined credit weaknesses and the extent of dependence on collateral security for realization of dues. Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts. ? Accounts with temporary deficiencies: These should be classified based on the past recovery records. ? Accounts regularize near about the balance sheet date: These accounts should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness based on available data, it should be deemed as an NPA. ? Asset classification should be borrower-wise and not facility-wise: If a single facility to a borrower is classified as NPA, others should also be classified the same way, as it is difficult to envisage only a solitary facility becoming a problem credit and not others.
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Conclusion – Benefits, Problems and Recommendations
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Advances under consortium arrangements: Classification here should be based on the recovery record of the individual member banks.
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Accounts where there is erosion in the value of the security: If there is a significant (i.e. the realizable value of the security is less than 50% of that assessed by the bank during acceptance) the account may be classified as NPA.
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Conclusion – Benefits, Problems and Recommendations
Bibliography
Books
“Taxmann?s Law Relating to Securitisation, Reconstruction of Financial Assets & Enforcement of Security Interest” by V. S. Datey “Securitisation, Asset Reconstruction & Enforcement of Security Interest” by Vinod Kothari
Reports
“Trend and Progress of Banking in India 2001-02” by RBI “Prudential Norms for Classification of NPAs” by RBI
Newspapers and Magazines
The Economic Times The Times of India The Financial Express Business Today RBI Bulletin
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