Securitisation: A Boon for the Banking Sector

With advent of the Recovery of Debts Due To Banks and Financial Institutions Act, 1993 there was a great hope within the banking circle that most of the Non Performing Assets (NPA) shall be easy to recover. The banks, under the conventional system of recovery of loans, had a considerable amount of money blocked in form of unproductive assets. This act intended to provide for expeditious adjudication and recovery of debts due to banks and financial institutions. But this effort of the government was not enough. To fight the menace of the NPAs the Indian banks required more teeth. With an object to give the banks more powers and skill the government decided to bring in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

As we know the financial sector is essential to the growth of a nation and this sector has been one of the keys to the India's efforts to achieve success in rapidly developing its economy. The banking sector has been striving to achieve international standards and is progressively complying with the international prudential norms and standards. Despite all this we have various areas where we don't enjoy level playing fields with the international banks and one of them has been the Menace of NPAs. Prior to 2002 there was no provision for facilitating securitisation of financial assets and the power to take possession of securitised assets and selling them off. This act has come at a boon for the Indian banking industry and at a time when the industry was grappling with bad loans, which at that time accounted for 14 % of their advances in gross terms and net NPA's at around 7%, which roughly amounted for upto Rs. 650 billion.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (here-in-after referred to as The Securitisation Act) has been enacted with an intention to strengthen the creditors rights through foreclosure and enforcement of securities by the banks and financial institutions (here-in-after FI) by conferring on the creditors the right to seize the secured asset and sell of the same in order to recover dues promptly bypassing the costly and very time consuming legal process through courts.

The Securitisation Act empowers the banks and FIs to move on its own against a borrower whose assets are secured, and who has made some kind of default in repayment of the same. The provisions of this Act shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law . Thus after complying with the statutory provisions in the said act the banks can X Take possession of the secured assets of the borrower. This includes the right to transfer by way of lease, assignment or sale of the same for realization of the secured debt.
X Take over the management of the secured asset including the right to transfer by way of lease, assignment or sale of the same for realization of the secured debt.
X Appoint any person to manage the secured asset.

NPAs and the Classification Thereof

Section 2 (o) of the Act says:
Non Performing Asset means an asset or account of a borrower which has been classified by the bank or financial institution as sub-standard doubtful or loss asset.-
a) In case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to the asset classifications issued by such authority or body;
b) In any other case, in accordance with the directions or guidelines relating to assets classifications issued by the reserve bank.
The Reserve Bank of India has under section 2(o) (b) notified the following guidelines under the act
1. The Securitization Companies and Reconstruction Companies (Reserve bank) Guidelines and Directors, 2003.
2. Guidelines to banks / FIs on sale of Financial Assets to Securitisation Company/Reconstruction Company (created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002)and related issues 2003.

The guidelines mark out that receivables are to be treated as NPAs if the same remain overdue for a period of 180 days or more. While this is in accordance with existing RBI norms for classification of debts as NPAs, section 3(vi) of the Guidelines also states that the board of directors of a Securitisation (or Reconstruction) Company may, on default by the borrower, classify an asset as a non-performing asset even earlier that the said 180 days for the purposes of facilitating enforcement as provided for in section 13 of the Act. As per section 13, where any borrower makes a default in repayment of a secured debt and his account is classified as an NPA, the secured creditor (or as the case may be the Securitisation Company) becomes entitled to exercise the recovery rights under the Act, after providing for a 60 day notice to the borrower. The Guidelines therefore permit a Securitisation (or Reconstruction) Company to classify a debt as an NPA and proceed to give the aforesaid 60 day notice under the Act immediately upon default by the borrower, without having to wait for the aforesaid 180 day period.

Enforcement of the Act
This is one of the most important aspect of this Act which says that notwithstanding anything contained in Section 69 or Section 69A of the Transfer of Property Act , any security interest created in favour of any secured creditor may be enforced, without the intervention of any Court or Tribunal, by such creditor in accordance with the provisions of this Act. The procedure laid down, interalia, is as follows: -
(a) Where any borrower, makes any default in repayment of a secured debt or any installment thereof and his account in respect of such debt is classified by the secured creditor as a Non-Performing Asset, then, the secured creditor may require the borrower, by notice, to discharge in full his liabilities to the secured creditor within 60 days from the date of the notice failing which the secured creditor shall be entitled to exercise inter-alia all or any of the following rights:-
(i) Take possession of the secured assets;
(ii) Take over the management of the secured assets;
(iii) Appoint a Manager to manage the secured assets;
(iv) Require 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.
(b) The act passed in 2002 was pretty strict as such on the borrower. It took away all the rights of the borrower to be heard. He could not approach the Civil Court nor did the DRT come to his rescue till his property had been attached and sold off. All this has been changed substantially after the land mark judgment of the Hon'ble Supreme Court in the case of Mardia Chemicals limited and Ors Vs. Union of India which inserted Section 3-A which says that if on receiving the notice under Section 13(2) the borrower makes in any representations or raises any objections, the secured creditor shall be compelled to consider such representations and if he comes to the conclusion that the objection is not tenable , he shall communicate within 1 week the reasons in writing for the non acceptance. The Hon'ble Supreme Court held in that very case that, not to give any hearing to the borrower is not in conformity to the laws of a democratic state, being against principles of natural justice.

Thus the act now provides the borrower the right to be heard but this being, not appealable, may seem to be not enough, but the Act does not take away from the borrower the right to move High Court under Art 226 & 227 (as writ petition) and the high courts can and have taken very serious views of banks not acting Bonafide and of the reasons communicated not being reasonable and have actually struck down the move of banks to attach and sell assets of the alleged defaulters.

(c) The notice shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debt by the borrower. As regards enforcement of security in case of financing of financial asset by more than one secured creditor, it has been provided that none of them shall be entitled to exercise any rights conferred on them, unless the same is agreed upon by secured creditors representing not less than three-fourth in value of the amount outstanding as on a Record Date and such action shall be binding on all such secured creditors. It has also been provided that the dues of the workmen as per Section 529A of the Companies Act, 1956 will have to be paid in case the Company is in liquidation or being wound up after the commencement of this Act and the said amount will have to be deposited with the Liquidator.

(d) Apart from other measures regarding procedure and other methods for enforcement of security, one of the clauses which was relatively harsh on the borrower was, that, if any person including the borrower is aggrieved by any of the measures taken by the secured creditor, he may prefer an appeal to the Debt Recovery Tribunal within 45 days, only on depositing 75% of the amount claimed in the notice referred to hereinabove . Although the Debt Recovery Tribunal (DRT) has been empowered to waive or reduce the amount to be deposited for reasons to be recorded in writing, practically it was realised that it will be difficult for any DRT to reduce the amount at that stage without going into all the relevant facts and circumstances of the case of the representation/objections raised by the borrower. The Hon'ble Supreme Court in the case of Mardia Chemicals limited and Ors vs. Union of India struck down the provision under Section 17(2) as being unconstitutional as it was unreasonable and unnecessary. Thus although it may seem that the act is thoroughly in favour of the Creditor (which it practically is) its not actually against the Indian legal framework and has a lot of credibility.

Exception to The Securitization Act

But the application of this act is not absolute. It does not absolutely apply over all kinds of mortgage transactions. This Act will not apply in some of the following cases: -
(i) A lien on any goods, money or security given by or under the Indian Contract Act or the Sale of Goods Act or any other Law for the time being in force;
(ii) A pledge of movables;
(iii) Creation of any security in any aircraft and any vessel;
(iv) Any conditional sale, hire purchase or lease or any other contract in which no security interest has been created;
(v) Any security interest for securing repayment of any financial asset, not exceeding Rs. 100000/- (Rupees One lakh);
(vi) Any security interest created in agricultural land;
(vii) Any case in which the amount due is less than 20% of the principal amount and
(viii) Any rights of an un-paid seller and any property not liable to attachment or sale as per the Civil Procedure Code.

Impact on Banking Other than freeing up the blocked assets of banks, securitisation can transform banking in other ways as well. The growth in credit offtake of banks has been the highest in the last 55 years. But at the same time the incremental credit deposit ratio for the past one-year has been greater than one. What this means in simple terms is that for every Rs 100 worth of deposit coming into the system more than Rs 100 is being disbursed as credit. The growth of credit off take though has not been matched with a growth in deposits. Banks essentially have been selling their investments in government securities. By selling their investments and giving out that money as loans, the banks have been able to cater to the credit boom. This form of funding credit growth cannot continue forever, primarily because banks have to maintain an investment to the tune of 25 per cent of the net bank deposits in Statutory Liquidity Ratio (SLR) Instruments (government and semi government securities).The fact that they have been selling government paper to fund credit offtake means that their investment in government paper has been declining. Once the banks reach this level of 25 per cent, they cannot sell any more government securities to generate liquidity. And given the pace of credit off take, some banks could reach this level very fast. So banks, in order to keep giving credit, need to ensure that more deposits keep coming in.

One way is obviously to increase interest rates. Another way is Securitisation. Banks can securitise the loans they have given out and use the money brought in by this to give out more credit. A.K. Purwar , in a recent interview to a business daily remarked that bank might securitise some of its loans to generate funds to keep supporting the high credit off take instead of raising interest rates.Not only this, securitisation also helps banks to sell off their bad loans (NPAs or non performing assets) to asset reconstruction companies (ARCs). ARCs, which are typically publicly/government owned, act as debt aggregators and are engaged in acquiring bad loans from the banks at a discounted price, thereby helping banks to focus on core activities. On acquiring bad loans ARCs restructure them and sell them to other investors as PTCs, thereby freeing the banking system to focus on normal banking activities.

A recent survey by the Economist magazine on International Banking, says that securitisation is the way to go for Indian banking. As per the survey, "What may be more important for the economy is to provide access for the 92% of Indian businesses that do not use bank finance. That represents an enormous potential market for both local and foreign banks, but the present structure of the banking system is not suitable for reaching these businesses.

In Closing Securitisation is expected to become more popular in the near future in the banking sector. Banks are expected to sell off a greater amount of NPAs by 2007, when they have to shift to Basel-II norms. Blocking too much capital in NPAs can reduce the capital adequacy of banks and can be a hindrance for banks to meet the Basel-II norms. Moreover, even if the Securitisation Bill doesn't substantially reduce the amount of NPAs recovered in the near future, it will serve the objective by showing borrowers that lenders have teeth and if necessary will not hesitate to use them, thereby limiting the build-up of future NPAs.

In the interest off the industrial growth of the country, it is pertinent that the powers, in this act even if held to be constitutional should not be acted arbitrarily or in haste. The courts and the legal fraternity should step up to strike a balance between the industrial growth in consonance with the policy formulated by the financial institution and State policy on one hand and recovery of public money on the other . An educated and diligent approach can help in achieving the object of the Act to make the intention of the legislators a success.

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