We all know the fact that financial sector plays a very vital role in progress of a nation. This sector has been one of the key to gain success in rapid development of the economy. In this we have the banking sector which is striving for reaching a level like that of the international banking norms and standards. Amidst the chase to achieve that there was a huge challenge that the Indian banking sector was facing which was management of Non-performing assets (NPA’S). Hearing this term for the first time?
According to Investopedia, Non-performing assets are,
“A classification used by financial institutions that refer to loans that are in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset”
They were critiqued for their helplessness to regulate and control their escalating bad debts. The root cause for the increasing NPA’s piling up in the bank was the difficulty for the lenders to take control of the collateral/security. The rights for the creditors were very weak as the bankers could not effectively utilize the recovery procedures intended for bankrupt companies. These situations prompted the arrival of the Recovery of Debts Due To Banks and Financial Institutions Act, 1993. With this act there was great hope among the banking circle that recovery of loans could now be possible quickly. But soon their hopes were dashed as this system too seemed ineffective as it did not speed up the recovery of bad loans. The situation so worsened that every fifth borrower was a default, this pressurized the government to undertake necessary provisions to recover the loan and foreclose the security (forcing the sale of the asset used as the collateral for the loan). Hence came into picture The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( SARFAESI Act).
Before we learn about this act lets understand what securitization is. It is the process of conversion of the prevailing assets or future cash flows into marketable securities. So in simple words it refers to converting the assets which are not marketable into marketable ones. The main purpose is setting up the reconstruction and securitization companies who would take over the NPA’s that have been accumulated with the financial institutions and banks. Through this it would be easy for the creditors to recover the dues from the defaulters in a much simpler and quicker way than before. With the securitization act it would authorize the Financial Institutions and Banks to move ahead on their own against a borrower, whose has made default in repayment and whose assets are secured. This article is aimed to scan through the scope of the securitization act in relation to the recovery of dues, issues with the act and Impact on Banking
Recovery of Debt under the Securitization Act
The Securitization Act makes provisions to recover the NPA’s through the following methods:
According to the Securitization Act only financial institutions and banks can securitize their financial assets. Consider this example where GNB Bank gives out loans to customers known as the obligors. This will be maintained on its balance sheet as assets, collecting principal and interest. The bank will hold on to these assets until maturity and hence the funds of the bank are blocked in these loans. Now in order to meet the increasing requirement of the fund bank would have to raise more funds from the market. Securitization is the method to unlock these blocked funds. It is done by transferring the assets from the originator which is GNB Bank in this case to the Special purpose vehicle (SPV). You must be wondering what is an SPV and its role here. An SPV is a distinct entity that has been formed absolutely for the purpose of facilitating the securitization process and provides funds to the originator. Also another thing which needs to be considered is that the assets that are being transferred to the SPV need to be similar in terms of its maturity, risk profile and underlying asset. The SPV will act as an intermediary who divides the assets of the originator into marketable securities. These securities are issued to the investors by the SPV which are known as pass through certificates (PTC’s). The investors in such PTC’s are banks, mutual funds, other financial institutions, government etc. In India specifically it’s only the Qualified Institutional Buyers (QIB’s) who have the financial capacity and ability to take risks are allowed to invest in PTC’s. Now what does the SPV get in this transaction? The difference between the interest payable by the obligor and the return to the investors is the service fee that the SPV earns. These securities are rated by the credit rating agencies which are used to inform the investor about the quality of the security and the risk involved. After the assets have been securitized, they are removed from the books of the bank and the cash flows from the securitization can be used to give new loans. So for GNB bank securitization is an effective option to corporate debt or equity to meet their cash requirement.
2. Asset Reconstruction
After the securitization act had been endorsed it led to the birth of Asset reconstruction companies (ARC’s) in India. These ARC’s are basically the government owned who acquire bad loans from the bank at a reduced price hence helping the banks to focus on their primary activities and cleaning their balance sheets. The Act allows ARC’s to take ownership of secured assets of the borrowers including right to transfer and realize the secured assets. They then sell the secured assets to other investors through PTC’s.
3. Exemption from Registration of Security Receipt
According to this when securitization and asset reconstruction companies issue receipts, the holder of those receipts is eligible to undivided interests in the financial assets and there is no need of registration unless and otherwise it is compulsory under the Registration Act 1908. However, the registration of the security receipt is required in the following cases: There is a transfer of receipt. The security receipt is creating, declaring, assigning, limiting, extinguishing any right title or interest in an immovable property.
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Prominent features of Securitization Act
Incorporation & Registration of Special Purpose Vehicles
Securitization act intends to securitize and reconstruct the financial assets through two special purpose vehicles (SPV’s) Securitization Company and Reconstruction Company. Both of these companies have to be incorporated under the Companies act, 1956 and also having them as the main purpose. It is a requirement for the Securitization Company and the reconstruction company to be registered compulsorily with the RBI before commencing their business operations.
Enforcement of security interest
The main aim of the Securitization act is to make available the enforcement of security interest which is to take possession of the assets that have been given as security for the loan. In the event of default by a borrower, this act authorizes the lender to issue a demand notice to both the borrower and guarantor to pay off the dues within 60 days from the date of the notice. Even after which the borrower fails to make the payment the lender (Bank or financial institution) could resort to any of the following: (i) Take ownership of the security; (ii) Sale or lease or assign the right over the security; (iii) Employ Manager to manage the security; (iv) Ask any debtors of the borrower to pay any sum due to the borrower. In situations where there are more than one secured creditors the provisions of this act will be valid only when 75% of them agree on the decision.
Impact of Securiti zation on Banking
The announcement of the SARFAESI Act has been a standard reform in the Indian banking sector. This act has grown progressively which can be seen with the decrease in the non-performing assets. At present there are three legal options which are available for the purpose of NPA’s which is the SARFAESI Act, Debt Recovery Tribunals (DRT) and Lok Adalats. Among the three, SARFAESI Act has been the most significant and effective in recovery of NPA’s. According to the RBI’s Report on Trend and Progress of Banking in India, 2012-13, banks have recovered Rs 18,500 crore through the SARFAESI route. NPAs recovered through this Act accounted for about 80 per cent of the total amount of NPAs.
Challenges to the Securitization act
Sale of security
After taking the control of property, generally it has been found that the banks find it difficult to take steps in order to sell them. Since there are no specific provisions to attain the property for its own, the bank can hold ownership without recourse to wipe of the liability from its books. The creditor with the permission of the court can also take part in the auction and acquire the secured property. The securitization act fails to provide any specific provisions and rules regarding the same.
Interference of Court
High courts often interfere in the SARFAESI act proceedings by accepting the writs filed by the distressed parties. Although the decisions of the Supreme Court are effective only after the remedies in the respective statute are exhausted, petitions are filed in many matters. This often causes a lot of delay when it comes to recovery of the loan.
One more issue that remains in the securitization market is the legislation which lags behind. Although SARFAESI Act has helped banks in order to wipe out bad loans, there are certain legal changes which are required in order to facilitate banks to securitize and sell good loans. Currently the laws related to transfer of property are old and outdated which require updating. The occurrence of stamp duty on property which varies across states hampers the development of securitization. Also the existing tax laws do not have any provision that has been made specifically with only to securitization. Hence new legislation would be required in order to resolve these issues.
Securitization has been perceived majorly as facilitator of asset recovery and reconstruction. There are various measures that the government undertook in order to confront the sickness among financial institutions and bank. With time, the situation in banks with respect to the menace of NPA’s has improved. Blockage of capital in NPA’s shrinks the capital adequacy ratio of the banks and to improve this they have to either raise more capital or free up the tied capital from their NPA’s through securitization. Hence with this and supportive amendments, scope of Securitization act is sure to expand in future years.
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