By Darshana Rajendran, IFMR Finance Foundation
An asset becomes non-performing when it ceases to generate income for the bank. In India, a Non-Performing Asset (NPA) is broadly defined as one with interest or principal repayment instalment unpaid for more than 90 days.
There exist defined mechanisms to deal with NPAs of banks and financial institutions today. However prior to 1993, banks had to take recourse to the long legal route against defaulting borrowers, beginning with the filing of claims in the courts. A lot of time was therefore spent in the judicial process before banks could have any chance of recovery on their loans. On average, a civil suit decision took anywhere between 5 to 7 years.
Under the Recovery of Debts to Banks and Financial Institutions Act 1993, Debt Recovery Tribunals (DRTs) were set up for recovery of loans of banks and financial institutions. This led to speedy recovery of loans in about 1 year’s time as against the average time of 5 to 7 years required in civil suits. While initially the DRTs performed well, their progress suffered as they got overburdened with the huge volume of cases referred to them.
To speed up the process of recovery from NPAs, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act was enacted in 2002 for regulation of securitization and reconstruction of financial assets and enforcement of security interest by secured creditors. The SARFAESI Act empowers Banks / Financial Institutions to recover their non-performing assets without the intervention of the Court. The Act provides three alternative methods for recovery of non-performing assets, namely: -
- Asset Reconstruction
- Enforcement of Security without intervention of the court
Secured creditors are given the power to take possession of the securities in the event of default and sell such securities for the purpose of recovery of the loan. The Act provides for enforcement of Security interest by a secured creditor without intervention of the court, in cases of default in repayment of instalments and non-compliance with the notice period of 60 days after the declaration of the loan as a non-performing asset.
The Act also provides for setting up of Securitisation Companies/ Reconstruction Companies (SC/RC), which acquire the NPAs from banks and financial institutions by raising funds from Qualified Institutional Buyers (as defined by the Act) by issue of Security Receipts (As defined by the Act) representing undivided interest in such financial assets. The Act enables SC/RCs to take possession of secured assets of the borrowers including right to transfer and realize the secured assets. SC/RCs act as debt aggregators or agents of the banks or financial institutions focused in the resolution of NPAs. The SC/RCs buy the impaired assets from banks and financial institutions, thereby cleaning the balance sheets of the banks and permitting them to focus on their normal banking business.
The promulgation of the SARFAESI Act has been a benchmark reform in the Indian banking sector. The progress under this Act had been significant, as evidenced by the fact that during 2002-03 when the Act came into effect, there was an overall reduction of non-performing loans to 9.4 per cent of gross advances from 14.0 per cent in 1999-20001.
Currently, three legal options are available to banks for resolution of NPAs- the SARFAESI Act, Debt Recovery Tribunals and Lok Adalats. The SARFAESI Act has been the most important means for recovery of NPAs. The amount of NPAs recovered under the SARFAESI Act formed over half of the total amount of NPAs recovered in 2009-10. Banks have referred as many as 78,366 loan default cases by end march 2010 under the SARFAESI Act involving a loan amount of Rs. 14, 249 crores. Against this, banks managed to recover Rs. 4,269 crores representing 30% of the loans2.
Recently the ‘Report of the Working Group on the Issues and Concerns in the NBFC Sector’ laid out recommendations to extend the coverage of SARFAESI to NBFCs as well. This move will benefit NBFCs, ensuring quicker recovery of their non-performing assets. This, in turn, could encourage NBFCs to provide access to a wider range of financial products and serve better the cause of financial inclusion.
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1 – Reserve Bank of India on Trend and Progress of Banking India 2002-2003
2 – Reserve Bank of India on Trend and Progress of Banking India 2009-2010