Effect of Securitisation on NPA

M.P.BIRLA INSTITUTE OF MANAGEMENT Page1

A Dissertation in the Financial Sector

“An Exploratory study on the Impact of The Securitisation &Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 on the

Non Performing Assets in the Banking sector”

Submitted in partial fulfillment of the requirements for the award of MBA degree Of Bangalore University

Submitted By “Supriya R”

Register Number:

04XQCM6114

Under the Guidance of

Prof. Sathyanarayan

M.P.Birla Institute of Management Associate Bharatiya Vidya Bhavan

Bangalore- 560001

2006 - 2008


Declaration

I declare that this dissertation titled “An Exploratory study on the Impact of

The Securitisation & Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 on the Non Performing Assets in the Banking sector” is an original and bonafide work carried out in partial fulfillment of the requirement for the award of MBA degree of Bangalore University. No part of this presentation has been previously published or submitted as a project report for any other degree/diploma of Bangalore University or any other University.

Place: Bangalore (Supriya R) Date : Reg. No. 06XQCM6114


Principal’s Certificate

This is to certify that the Project titled “An Exploratory study on the Impact of

The Securitisation & Reconstruction of Financial Assets and Enforcement of

Security Interest Act 2002 on the Non Performing Assets in the Banking sector”

has been completed by Ms. Supriya R bearing the registration number

06XQCM 6114 under the guidance of Prof.Sathyanarayan. This study has not

formed the basis for the award of any other degree/diploma by any other university.

Place: Bangalore Date: 2.May. 2008 (Dr.Nagesh S.Malavalli)


Project Guide’s Certificate

This is to certify that the Project titled “An Exploratory study on the Impact of The Securitisation &Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 on the Non Performing Assets in the Banking sector” has been completed by Ms. Supriya R bearing the registration number 06XQCM 6114 under my guidance. The study has not formed the basis for the award of any other degree/diploma by any other university.

Place: Bangalore Date:02.May.2008 (Prof.Sathyanarayan)


ACKNOWLEDGEMENT

This Project report has been made possible through the direct and indirect co-operation of various people to whom I wish to express my deep sense of gratitude. I wish to express my sincere thanks to Prof. Sathyanarayan (Finance faculty), M.P. Birla Institute of Management, Associate Bharatiya Vidya Bhavan for providing valuable guidance and advice throughout, which has enabled me to complete the project successfully. I would also like to express my profound gratitude to all those who have been instrumental in the preparation of the project report.

Supriya R


List of Contents CHAPTER

PARTICULARS

Page No.

1

RESEARCH EXTRACT

3-11

2

INTRODUCTION

12-32

2.1

Background of the Study

2.2

Statement of problem

2.3

Need and importance of the Study

2.4

Objectives of the Study

3

REVIEW OF LITERATURE

33-38

4

METHODOLOGY

39-41

5

PRESENTATION & ANALYSIS OF

DATA AND INTERPRETION

42-54

6

FINDINGS

55-58

7

SUGGESTIONS & CONCLUSION

59-63

8

ANNEXURES

64-68


LIST OF TABLE AND GRAPHS

1 Showing main reason for NPAs in Bank

44

2

Showing the measures for the recovery of NPAs

45

3

Showing mechanisms for the recovery of NPAs Pre-Securitisation Act

46

4

Showing recovery mechanism for NPAs Post-Securitisation Act

47

5

Showing practical measures

48

6

Showing reasons for effective applicability measures

49

7

Showing Securitisation Act empowered to the Bank

50

8

Showing the impact of level of NPAs in Bank

51

9

Showing the rate of impact of Securitisation Act in the reduction of NPAs

52


CHAPTER 1

RESEARCH EXTRACT


RESEARCH EXTRACT

The term NPA refers to Non-Performing Asset. As per the Reserve Bank of India

guidelines an asset is treated as a Non Performing Asset, if interest and/or

installment of principal remain overdue for a period exceeding 90 days. NPAs are

those assets which do not generate any income to the banks; they drain off the profit

of the banks earned by the performing assets. The NPA affects the banks and

financial institutions mainly in the following ways:

At the Macro level, NPAs have choked off the supply line of credit of the potential

lenders thereby having a deleterious effect on Capital formulation and arresting the

economic activity in the country.

At the Micro level, unsustainable level of NPAs has eroded current profits of Banks.

They have led to reduction in interest income and increase in provisions and have

restricted the recycling of funds leading to various asset-liability mismatches. Besides

this, it has led to erosion in their capital base and reduction in their competitiveness.

The mounting menace of NPAs has raised the cost of credit, made Indian

businessmen uncompetitive as compared to their counterparts in other countries. It

has made Banks more averse to risks and squeezed genuine Small and Medium

enterprises from accessing competitive credit and has throttled their enterprising

spirits as well to a great extent.


While The Banking Industry in India is progressively complying with the international

prudential norms and Accounting practices, there are certain areas like recovery

management in which it does not have a level playing field as compared to other

participants in the International financial markets. Our existing legal frame work

relating to the commercial transactions has not kept pace with the changing times,

this resulted in slow pace of recovery of defaulting loan & mounting levels of NPA’s in

banks. Till 2002 neither there were any legal provisions for facilitating Securitisation

of financial assets of Banks nor was there any legal framework to take possession of

securities and sell them without the intervention of the court.

The Securitisation and Reconstruction of Financial Assets Act, 2002 was a step

in this direction. The Act has provided an enabling legal framework for setting up

of Securitisation or Reconstruction Company and the manner of acquisition of

financial Assets by such companies. This Act has been enacted to help Banks and

FIs to tackle the NPAs problem. The Securitisation Act enables the Banks and FIs to

sell off/transfer the NPAs without the intervention of court and the sale proceeds of

the assets are to be used for payment to the secured creditors for the assets taken

over from them. The Act was bound to create ripples in the corporate sector and at

the same time provide a much needed balm to the banks and financial institutions.

Hence it is quite necessary to study the impact generated by the act on banks and

financial institutions and assess how successful the Act was in the reduction of NPAs

in the banking sector

The nature of research was exploratory as well as diagnostic as the study was aimed

at exploring the impact of Securitisation Act on the Non- Performing Assets in the

banking sector. The research was also aimed at recognizing the areas of

improvement in the Act.The respondents were chosen on the basis of simple random

sampling, under this sampling design every item of the universe has an equal and fair

chance of inclusion in the sample.


The sampling unit was Banks especially the loan managers, the credit Managers and

the officers in charge of recovery department. The Banks were chosen randomly and

are from Bangalore.The total Sample size was fifty respondents for the questionnaire

and for the NPA and recovery statistics the sample size is five Public sector banks.

The Securitisation Act is a fine, comprehensive piece of legislation, it is also a

reassuring sign of Government’s commitment to reforms. Since the enactment of the

Securitisation Act, it was seen as a panacea to the entire problem of NPAs.The

banks are euphoric about the Act and are taking actions swiftly by issuing notices to

the defaulting borrowers. Defaulting borrowers who were not responding previously

started responding favourably and cash recoveries became a reality. However

nothing spectacular has happened, there are not many cases where change of

management has been affected or taking over the entire assets of a large

manufacturing unit etc. This is due to the various intricacies involved in the

implementation of the Act. After the analysis it can be concluded that overall the Act

has empowered the banks with additional powers for recovery and facilitated the

reduction of NPAs to the extent of seventy percent, however much needs to be done

by way of recovery reforms and development of market for distressed assets for the

Act to be more effective in realising its proposed objectives


CHAPTER 2

INTRODUCTION


INTRODUCTION

SECURITISATION ACT 2002

The need for the setting up an asset reconstruction company for acquiring

distressed assets from Banks and FIs with a view to develop market for

suchassets was being felt, since long. Narasimham Committee 1 &2 and the

Verma Committee on restructuring of weak Banks has strongly recommended

the setting up of Asset Reconstruction Companies (ARCs)

The business of Securitisation and Reconstruction is primarily meant for more

than one purpose:

To regulate the business of securitization and reconstruction

of the financial interest

To regulate enforcement of the security interest and for the

matters connected therewith or the matters incidental thereto.

The debt securitization is a new concept in the Indian financial markets and is

primarily meant for enhancing the liquidity of the Banks and FIs which have

extended financial assistance to the borrowers for various purposes. The debt

securitization makes available with these institutions the security papers against

the financial assets which have been created out of the financial assistance

sanctioned and disbursed by these institutions and in the case of a default by the

borrowers the secured creditors can have a recourse to either the securitization of

the financial asset or the reconstruction of the same.


What is Securitisation?

Securitisation is a process whereby the ‘originator’ of the various financial assets

including loans which are illiquid can transfer such assets to special purpose

vehicles(SPV) which issues the tradable securities against these loans and these

are issued to the investors. It is an acquisition of financial asset by any

securitization company from the ‘originator’ whether by raising of funds by such

securitization company from ‘qualified institutional buyer’ or by issue of

security receipts representing undivided interests in such financial assets or

otherwise.

Thus, there will have to be some sort of understanding between the QIBs and the

securitization company which can be ‘originator’ in the case of the banks and the

FIs which has extended the financial assistance to the ‘obligor’ who is supposed

to repay the financial assistance in instalments on some future dates as per the

agreement entered into by it with the bank. This can be referred to as the

‘security agreement. It is an instrument or any other document or arrangement

under which the ‘security interest’ is created in favour of the secured creditors

including the creation of the mortgage by the deposit of the title deeds with the

secured creditors.

Objectives of Securitisation

There are two basic objectives of securitization:

� To reduce the assets of the originator to reduce the capital

requirement

� To achieve the reduction in demand and time liability.


Once the assets go off the balance sheet the originator can thus reduce his capital

requirement, similarly on the liquidation of the assets the need for the time assets

and the demand liability comes down as these are subject to the statutory

reserves.

Securitisation as financial product

Securitisation is considered as financial product and the bonds/debentures can be

issued based on the future instalments against the financial assistance already

sanctioned and disbursed by the banks and financial institutions.

Some important terms on the concept of securitization:

1. Qualified Institutional Buyer: It can be a financial institution,

insurance company, banks, state financial corporation, state

industrial development corporation, trustee or any asset

management company making investment on behalf of any

mutual fund/ provident fund/gratuity fund/pension fund or any

foreign institutional investor which may have to be registered

with the SEBI or any other corporate body which can be

specified by SEBI.

2. Originator: The bank or the FI which offers the product is

referred to as the originator

3. Obligor: The client whose future installments are securitized is

referred to as the obligor (borrower).

4. Security receipt: is a receipt or any other security issued by a

securitization company to a QIB pursuant to a scheme,

evidencing the purchase or the acquisition by the holder

thereof, of an undivided right, title or interest in the financial


asset involved in the process.

5. Security agreement: 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 the mortgage by the deposit of the title deeds with the secured

creditors.

6. Security asset: means the property on which the security interest

Is created.

7. Secured creditor: Includes any bank or financial institutions or

any consortium or groups of banks and financial institutions.

8. Secured debt: means a debt which is secured by any security

Interest.

9. Secured interest: means right, title and interest of any kind,

whatsoever upon the property, created in favour of any secured

creditor and includes any mortgage, charge, hypothecation,

assignment etc

10. Sponsor: means any person holding not less than 10% of the

paid-up equity capital of a securitization company or

reconstruction company

11. Borrower: means any person who has been granted financial

assistance by any bank or FIs who has been given any

guarantee or created any mortgage/pledge as security for the

financial assistance granted by any bank or FI.

12. 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 ‘NPA’ in the books of account of the


secured creditor in accordance with the directions/guidelines

issued By the RBI.

13. Financial Assistance: means any loan or advance granted or

any debentures or bonds subscribed or any guarantees given or

letters of credits established or any other credit facility

extended by any bank or FI .

14. Financial Asset: means debt or receivable and includes:

� A claim to any debt or receivable or part thereof, whether

secured or not.

� Any debt or receivable secured by mortgage of or charge on

immovable property.

� Mortgage, charge, hypothecation or pledge of immovable

property.

� Any right or interest in the security whether full or part

underlying such debt or receivable.

� Any beneficial interest in property, whether immovable or

movable or in such debt, receivable whether such interest is

existing, future or accruing, conditional or contingent.

� Any financial assistance.

There may be two specific occasions when the need for the securitized asset and

its transfer may be necessitated so far as the ‘originator’ is concerned:

� To increase its liquidity

� To handle the non performing assets (NPAs) effectively

The Securitisation and Reconstruction of Financial Assets and Enforcement

of Security Interest Act, 2002 popularly called the Securitisation Act has


provided an enabling legal framework for the setting up of securitization or

reconstruction company and the manner of acquisition of financial assets by

such companies.

Commencement of The Act

The Act has been made effective from 21st June 2002, the date on which the first

securitization and reconstruction of financial assets and enforcement of security

interest ordinance, 2002 was promulgated.

This Act has been enacted to help Banks and FIs to tackle the NPA problem.

This Act can be broadly divided into four heads:

� Securitisation of assets

� Enforcement of security interest

� Setting up of Central Registry

� Establishment of an ARC

The two terms which have been used in the Act which are of special significance

are:

The security Interest

Financial Asset

The Act has explained these two terms in section 2(1) (zf) and 2(1)(L) as:

‘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.

‘Financial Asset’ means debt or receivable and includes---

� A claim to any debt or receivables or part thereof, whether

secured or unsecured.


� Any debt or receivables secured by, mortgage of, or charge on,

immovable property

� A mortgage, charge, hypothecation or pledge of movable

property

� Any right or interest in the security, whether ful or part

underlying such debt or receivables

� Any beneficial interest in property, whether movable or

immovable, or in such debt, receivables, whether such interest is

existing, future, accruing, conditional or contingent

� Any financial assistance.

Purpose of the legislation:-

Our existing legal framework relating to commercial transactions has not kept

pace with the changing commercial practices and financial sector reforms. This

has resulted in slow pace of recovery of defaulting loans and mounting levels of

non-performing assets of Banks and FIs. Narasimham committee 1&2 and

Andhyarujina Committee constituted by t e Central government for the purpose

of examining banking sector reforms have considered the need for changes in

the legal system in respect of these areas. These committees, interalia, have

suggested enactment of the said Act for the securitization and empowering banks

and FIs to take possession of the securities and to sell them without the

intervention of the court.

The provisions of the ordinance would enable banks and FIs to :

� Realise long-term assets

� Manage problem of liquidity

� Manage Asset-Liability mismatches and

� Improve recovery


These could be achieved by exercising powers to take possession of securities,

sell them and reduce NPAs by adopting measures for recovery or reconstruction.

Provisions/Highlights of the Act

The Securitisation Act contains provisions to provide for the following:

a) Registration and regulation of securitisation companies or

reconstruction companies by the Reserve Bank of India(RBI)

b) Facilitating securitisation of financial assets of banks or

reconstruction with or without the benefit of underlying

securities

c) Facilitating easy transferability of financial assets by the

securitization company or reconstruction company to acquire

financial assets of banks and FIs by issue of debentures/bonds or

any other securities in the nature of a debenture

d) Empowering securitization companies/reconstruction companies

to raise funds by issue of security receipts to qualified

institutional buyers

e) Declaration of any securitization company or reconstruction

registered with the RBI as a public financial institution for the

purpose of section 4A of the Companies Act, 1956

f) Defining “security interest as any type of security including

mortgage and charge on immovable properties given for due

repayment of any financial assistance given by any bank or FIs

g) 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. given

classification of the borrowers account as NPA in accordance

with the directions or under guidelines issued by the RBI from

time to time.

Certain provisions of this Act to apply after Central Registry is set up or

caused to be set up------‘The provisions of sub-sections (2),(3) and (4) of

section 20 and sections 21, 22,23, 24, 25, 26 and 27 shall apply after the Central

Registry is set up or caused to be set up under sub-section(10)of section 20.

No Asset Reconstruction Company or Securitisation company can commence or

carry on the business of Asset Reconstruction or Securitisation

� Without obtaining a Certificate of Registration to be

granted

under section 3 of the Securitisation Act, 2002

� Without having owned funds of not less than Rs.2 crore or such

other amounts not exceeding 15% of total financial assets

acquired or to be acquired by such company, as the RBI may

notify


All ARCs or Securitisation companies, which are in existence on the

commencement of the Act, shall make application for registration to RBI before

the expiry of 6 months from such commencement.All ARCs are to be regulated

and registered with the RBI. There will be a Central Registry and Central

Registrar, to whom details of all individual transactions are to be reported, on an

on-going basis.

BACKGROUND OF THE STUDY

General Background of Banking System

Banking system which constitutes the core of the financial sector plays a vital

role in transmitting monetary policy impulses to the economic system. Therefore

its efficiency and development are vital for enhancing growth and improving the

changes for stability. During the recent past, profits of the Bank came under

pressure due to rise in interest rates, decrease in non-interest income and

increase in provisions and contingencies.

Non Performing Assets

Globalisation, Privatisation and Liberalisation have been the buzz words from

1991. It has brought about a positive trend in all the industries not excluding the

Banking industry. But this has also brought about an increase in the NPAs of the

Banks which has affected the banks lending, liquidity and profitability.

Recovery of NPAs is one of the major goals of the banks. Non Performing Asset

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 affected under

the Banking reforms by the Government of India and RBI in terms of the two


Narasimham committee Reports in this contemporary period have been

neutralized by the ill effects of this surging threat. Despite various correctional

steps administrated 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 SBI group and All India Financial Institutions.

The concept of Asset Quality on the books of Public sector Banks and FIs came

into being when RBI introduced prudential norms on the recommendations

of the Narasimham committee in the year 92-93. The above norms have

three main criteria:

� Asset classification

� Income Recognition

� Provisioning

1. ASSET CLASSIFICATION

The loans given by the Banks are classified into performing and

non-Performing assets on the following basis:

� Performing Assets: also known as standard assets are the assets

which do not disclose any problem and which do not carry more

than the normal risk attached to the business. Performing asset

is one which generates income for the bank. It is an asset where

the interest and or principal are not overdue beyond 180 days

(modified to 90 days w.e.f.Mar 2004) at the end of the financial

year.


� Non Performing Assets: An amount is to be treated as non

performing asset when it ceases to generate income for the

Bank. An asset may be treated as Non Performing Asset (NPA),

if interest and /or installment of Principal remain overdue for a

period exceeding 180 days (modified to 90 days w.e.f. Mar

04)and Banks and FIs should not take into their Income

account, the interest accrued on such NPAs, unless it is actually

received/recovered. NPAs are further classified into:

1. Substandard Assets: Loans which are non-performing for a

period not exceeding two years, where the current net-worth of

the borrower or the current market value of the security, against

which the loan is taken, is not enough to ensure full recovery of

the debt.

2. Doubtful Assets: Loans which have remained non-

performing for a period exceeding two years and which are not

classified as loss assets by for the management or the

internal/external auditor appointed by RBI.

3. Loss Assets: Assets where loss has been identified by the

internal/external auditor of the bank or the RBI, but the amount

has not been written-off wholly or partly. These assets are

considered unrecoverable and are of little value to the lending

institution.

2. INCOME RECOGNITION

The income recognition is linked to the concept of performance of

the assets. In other words the income from performing assets only


is to be recognized. The income from non-performing assets is

recognized only to the extent of actual recovery made during the

accounting year.

3. PROVISIONING

The amount of provision required to be created for each asset

depends on the classification of the assets, availability/value of

security, other guarantee available, the age of the NPA etc.

From the foregoing, it may be observed that the Prudential norms

have twin effect on the profitability of the Banks: The income from

the non-performing assets cannot be recognized except to the extent

of actual recovery. Bank is required to create provision for the non-

performing assets. Both these have a negative impact on the

profitability of banks.

IMPACT OF NON PERFORMING ASSETS

At the Macro level, NPAs have chocked off the supply line of credit

of the potential lenders thereby having a deleterious effect on Capital

formulation and arresting the economic activity in the country.

At the Micro level, unsustainable level of NPAs has eroded current

profits of Banks. They have led to reduction in interest income and

increase in provisions and have restricted the recycling of funds

leading to various asset-liability mismatches. Besides this, it has led to

erosion in their capital base and reduction in their competitiveness.

The mounting menace of NPAs has raised the cost of credit, made

Indian businessmen uncompetitive as compared to their counterparts

in other countries. It has made Banks more averse to risks and

squeezed genuine Small and Medium enterprises from accessing


competitive credit and has throttled their enterprising spirits as well to

a great extent.

General causes for Non Performing Assets

In priority sector advances-

� Directed and pre-approved natures of loans sanctioned under

sponsored programmers.

� Mis-utilisation of loans and subsidies.

� Diversion of funds.

� Absence of security.

� Lack of effective follow-up (post-sanction supervision&

control).

� Absence of bankruptcy and foreclosure laws.

� Decrepit legal system.

� Cost in-effective legal recovery measures.

� Difficulty in execution of decrees obtained.

� Lack of marketing support

In Non Priority Sector Advances:

� Improper and inadequate credit appraisal.

� Demand recession.

� Frequent changes in Government’s policies.

� Industrial sickness and labour problems.

� Antiquated legal & judicial system.

� Lack of legal reforms (Bankruptcy Foreclosure laws).

� Diversion of funds.

� Willful default.

� Technology obsolescence.


� Incompetence-Management failures.

� Fear psychosis among Banks & lack of effective follow-up

(policing of assets by Banks)y

� Political compulsion and corruption.

Measures to tackle the Non performing assets

� Lok Adalats: Lok Adalats have been set up for recovery of

dues in accounts falling in the Doubtful and loss category with

outstanding balance upto 5 lakhs, by way of compromise

settlement. PSBs filed 109558 cases involving Rs.645.63 crores

upto Dec. 2001. They have been able to recover Rs.49.77 crores

only upto 30th Sept.2001. This mechanism has, however proved to

be quite effective for speedy justice and recovery of small loans.

� Debt Recovery Tribunal(DRT): 22 DRTs have been set up

in the country during the last half a decade. DRTs have not been

able to deliver, as expected as they got swamped under the burden

of large number of cases filed with them since their inception. Out

of this 3049 cases involving Rs.42989 crores were still pending as

on 30th Sept. 01. However, DRTs could decide only 9814 cases

involving Rs.6264 crores pertaining to PSBs till 30.09.01. The

amount recovered in respect of such cases amounted to Rs.1864

crores.


� One Time Settlement Schemes (OTSS): One Time Settlement

Schemes launched in May’99&July’00 has enabled Banks to

recover Rs.668 crore and Rs.2600 crores respectively by Sept.

2001. One more OTSS for outstanding amount in default upto 10

crores has been introduced in the month of Feb’03 its results will

be seen in due course.

� Corporate Debt Restructuring(CDR): CDR is an non-

statutory mechanism institutionalized in the year 2001 to provide

timely and transparent system for restructuring corporate debts of

Rs.20 crores and above, of viable entities financed by Banks and

FIs under consortium or multiple banking arrangements. It is a

voluntary system based on debtor -creditor agreement (DCA) and

inter creditor agreement (ICA). At present 10 FIs and 49 Public and

Private sector Banks are the members of the CDR mechanism.

CDR system is applicable to the standard and sub-standard loan

accounts. However as per latest modifications, viable doubt- full

assets can also be taken up for restructuring based on the consensus

among atleast 75% of the lenders. Reference to CDR could be

triggered by:

a) Any one or more of the secured creditors who have minimum

20% share either in working capital or term finance.

b) By the concerned Corporate, if supported by Banks and FIs

having stake as in (a) above.

Structure:

CDR has the following 3-tier structure:

1. CDR standing forum: It is a representative general body of


all Banks and FIs participating in the CDR system. It is a self-

empowered body, which evolves broad policy guidelines and

guides and monitors the progress of CDR.

2. CDR empowered group: This group examines and takes

decisions on the proposals recommend to it by the CDR cell

for restructuring of the corporate debts.

3. CDR cell: It makes initial scrutiny of the proposals received

from the borrowers/lenders. Initially the borrower approaches

his Lead Bank/FI with a request to restructure debt, which in

turn puts up the proposed to the CDR cell. BIFR, DRT

referred, willful defaults, unviable doubtful and loss accounts

and suit filed cases are outside the preview of CDR. No

banker/borrower can take recourse to any legal action during

the stand-still period of 90-180 days, Once the reference is

made to CDR mechanism.

4. Super Majority Concept: In case, any restructuring is

approved by CDR by not less than 75% of the secured

creditors it becomes binding on all secured creditors even if

minority secured creditors have different mandate. However,

RBI recently fine-tuned CDR guidelines in this regard and

has now given the lenders the option to exit from the

package by selling their exposure to either the existing or

fresh lenders at an appropriate price to be decided

mutually .This move has given Private Banks, Foreign Banks

and PSBs,who have minority share in consortium a big

breather, as they were not comfortable with the mandatory

system. The new lenders will rank on par with other lenders


for repayment and servicing of dues, since they have taken

over the existing dues.

CDR is not applicable to accounts involving only one Bank or

one FI, even though it has an exposure over Rs.20 crores or

more. While the arrangements under the CDR scheme seem to be

feasible from debt restructuring perspective, its success depends

upon the cooperation extended by the borrowers and the bankers

on one hand and understanding among Banks and FIs on the

other.Presently the CDR scheme is its infancy stage, but if

implemented in its entirety with support from all the aggrieved

parties and the Government, it can help facilitate speedier

recovery of NPAs. Mechanism like debt for equity swap could

prove to be effective in solving the NPA problem, especially in

cases of unwillful default, wherein despite strong fundamentals,

the company defaults due to some extraneous factors.


STATEMENT OF PROBLEM

�While The Banking Industry in India is progressively complying

with the international prudential norms and Accounting practices,

there are certain areas like recovery management in which it does

not have a level playing field as compared to other participants in

the International financial markets

� Our existing legal frame work relating to the commercial

transactions has not kept pace with the changing times, this

resulted in slow pace of recovery of defaulting loan & mounting

levels of NPA’s in Banks.

� The Securitisation Act was seen as a panacea to the entire

problem of NPAs.


NEED AND IMPORTANCE OF THE STUDY

� The Banks and Financial Institutions have been burdened with

ever increasing Non Performing Assets. Till 2002 neither there

were any legal provisions for facilitating Securitisation of

financial assets of Banks nor was there any legal framework to

take possession of securities and sell them without the


� The Securitisation and Reconstruction of Financial Assets Act,

2002 was a step in this direction. The Act was bound to create

ripples in the corporate sector and at the same time provide a much

needed balm to the banks and financial institutions.

OBJECTIVES OF THE STUDY

Primary objectives:

� To gain insight into the various provisions of the Act with

special emphasis on reduction of NPAs in Banks.

� To assess the effectiveness of the Act in realising the proposed

objectives.

Secondary objective:

� To identify the loopholes in the Act, if any and to make

suggestions to plug the same.


CHAPTER 3

REVIEW OF LITERATURE


PURPOSE OF REVIEW OF LITERATURE

The purpose of review of literature was to identify the problem

statement, understand the secondary data that has been gathered in this

field of study and to make new findings on the problem statement.

METHODOLOG Y OF THE REVIEW OF LITERATURE

Methodology of literature review encompasses different facets of

information sources concerning Non-performing assets and the

Securitisation Act

Sources of information for the literature review are as follows

�Banking magazines

�Internet

�Newspaper, publications and articles.


Conclusion SC verdict on Securitisation Act — More bark than bite?

By Padmalatha Suresh

Bankers abhor them. Balance-sheets detest them. Borrowers (at least most of

them) do not want to be part of them. They are those dreaded three letters, NPA,

standing for `Non Performing Assets', euphemism used to describe difficult-to-

recover bank loans.

Therefore, when the Supreme Court upheld the constitutional validity of the

Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002 (the Securitisation Act) on April 8, bankers breathed

a sigh of relief. The ruling would al1ow banks and financial institutions to take

possession of the security given by the defaulting borrowers and sell these assets

without having to go through protracted legal procedures.

The court, however, ruled as unconstitutional the provision that required

aggrieved borrowers to make an upfront deposit of 75 per cent of the dues

claimed in case they preferred to go on appeal again the lender's action.

The Securitisation Act aims to achieve two objectives: Make adequate

provisions for the recovery of loans and also to foreclose the security. The

Act was welcomed by the banking community, but resisted by the borrower

community. Understandably so. The validity was challenged in various courts on

the ground that it was predominantly in favour of lenders. Hence, lenders were


unable to enforce the provisions in full. The salient provisions of the

Securitisation Act state that the lender can take possession of the asset in case

the borrower does not discharge his liabilities within 60 days of the demand

notice from the lender. The lender can then manage the assets with a right to

transfer them by way of lease, assignment or sale. Are banks today equipped for

this? Imagine banks having thousands of such seized assets of various

descriptions and values in their physical possession.The sheer cost of

maintaining such assets in marketable form could be formidable. Borrowers

would know that their assets are in jeopardy if they do not deliver on their

promises or take the lenders into confidence in respect of their business risks.

The change would be in the attitude. And this change would go a long way in

enhancing the quality of the banking system's asset.


Securitisation—will they Act

By Hindustan times.com

Some in India Inc. may have had a bad year, thanks to the Securitisation Act but

almost all top bankers and financial institution honchos experienced relief wit

the passing of this Act. Having got armed under the Act to take possession of the

assets of defaulters, the past few weeks saw several banks send notices to

defaulters for recovery of their sticky assets. Be it a hotel, a factory, office or

residential premises, defaulters long habituated to making merry on borrowed

money are already finding the going tough.

The new Act is expected to arrest the mounting NPAs and help banks

improve their bottomlines.

MCCI welcomes Securitisation Act

THE Madras Chamber of Commerce and Industry (MCCI) has spoken in a

refreshingly different voice, from that of most others in the industry. It has

welcomed the Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Act, 2002, (or, the Securitisation Act), calling it

"a step in the right direction". In a note, the chamber has said: "The fact is, not

all businesses succeed and when a business does not succeed, the only exit

available for the lender is to securitise the assets and claim those margins, which

protect the money lender". At a press conference in Chennai, one member did

point out a "practical difficulty" in a bank taking over a piece of hypothecated

machinery and its ability to protect/sel it, but agreed that this question did not

come up with the Securitisation Act — it was there even before.


CONCLUSION

The literature review has been very useful and informative as it has thrown light

on the research and articles that have been written on the growing problems of

Non Performing Assets in the banking sector, its adverse effects on the

functioning of the banks and the various mechanisms available for recovery of

the NPAs with special reference to the recently enacted Securitisation Act.

Moreover it has helped in identifying the degree of research that has already

been done on the subject. It has narrowed the scope of repetition and has formed

the basis of secondary data for this study.

Benefits derived from the Review of Literature:

� Helps to identify the problem statement

� Helps to focus on the specific line of research

� Helps a layman understand what is a non-performing asset and

the role of the Securitisation Act in the reduction of NPAs

� Recognizes the key issues in the implementation of the

Securitisation Act

� Literature review gives us an insight on the objectives of the

Act and the impact it has generated in the reduction of NPAs

in the banking sector

� Throws light on the areas where the Act is rendered

ineffective

� Helps in the identification of the loopholes in the

securitization act and facilitates to make recommendations for

plugging the same.


CHAPTER 4

METHODOLOGY


METHODOLOGY The steps followed for undertaking the research study are presented below

TYPE OF RESEARCH:

The nature of research was exploratory as well as diagnostic as the

study was aimed at exploring the impact of Securitisation Act on the

Non- Performing Assets in the banking sector. The research was also

aimed at recognizing the areas of improvement in the Act.

SAMPLING TECHNIQUE:

The respondents were chosen on the basis of simple random sampling.

Simple random sampling is also known as probability sampling or

chance sampling, under this sampling design every item of the

universe has an equal and fair chance of inclusion in the sample.

SAMPLING UNIT:

The sampling unit was Banks especial y the loan managers, the credit

Managers and the officers in charge of recovery department. The

Banks were chosen randomly and are from Bangalore.

SAMPLE SIZE:

The total Sample size was 50 respondents for the questionnaire and for

the NPA and recovery statistics the sample size is five banks.


TOOLS FOR COLLECTION OF DATA:

Sources of data:

The data consisted of both primary data and secondary data

Primary sources of data:

Personal interviews with the help of Questionnaire with the Credit

managers, loan officers of various Banks.

Secondary sources of data:

� Bare Act book on Securitisation Act, 2002

� RBI/IBA bulletins and journals

� Financial magazines

� Financial statements/Annual reports of the Banks

� Internet


CHAPTER 5

PRESENTATION AND

ANALYSIS OF DATA AND

INTERPRETATION


HYPOTHESIS

H0: The Securitisation Act is not successful in the reduction of

NPAs in the banking sector.

H1: The Securitisation Act is successful in the reduction of NPAs

in the banking sector.

STATISTICAL DESIGN

Statistical tools used for analysis were:

� Z- test

� Percentage method

� Graphs

LIMITATIONS OF THE STUDY:

� The study is subject to the views and statistics as expressed by

the concerned officials of the Banks.

� The study is limited to a few Public sector banks only

� Limited sample size of 50 within the area of Bangalore only.

� No access to legal bodies like DRTs etc.

� The actual identity of the Banks is kept confidential due to the

sensitive nature of the topic.


ANALYSIS OF QUESTIONNAIRE

1. What are the main reasons for NPAs in the Bank? REASON'S Numbers

Improper Credit Appraisal 20

Lack of effective follow up 22

Diversion of funds 28

Absence of security 10

Management failures 6

Cost in-effective legal measures 8

Difficult in execution of decrees 12

Wilful default 12

Demand recession 0

Decrepit legal system 0

Graph showing the main reasons for NPAs in the bank

Interpretation:From the table it is clear that the main reason for NPAs in banks is

diversion of funds, improper credit appraisal and willful default followed by cost ineffective legal

measureand difficulty in the execution of decrees.


2. Measures for the recovery of NPAs adopted by the Bank

PREFERENCE Numbers

Legal Measures 22

Non legal Measures 2

Both 20

Other 0

Graph showing the measures undertaken by the bank for recovery of NPAs

Interpretation:

From the graph it can be interpreted that 45% of the respondents said that they take both

legal & non-legal measures for the recovery of NPAs, while 50% said they take only legal

measures and 5% said that they take only non-legal measures


3. Which of the following recovery mechanisms are adopted by the bank for NPAs pre-Securitisation Act?

RECOVERY MECHANISM Numbers

Lok Adalats 2

Civil Courts 14

Corporate Debt Re-Structuring 6

Debt Recovery Tribunal 16

One time settlement schemes 6

Others 0

Interpretation

14% of the respondents said they adopt one time settlement schemes as a recovery mechanism

for NPAs pre–securitisation act, 23% said Debt recovery tribunals 32% said

Asset Reconstruction Companies, 5% said Civil courts, 5% said corporate debt reconstruction and

23% said Lok Adalats.


4. Which of the following recovery mechanisms are adopted by the bank for NPAs

post-Securitisation Act?

RECOVERY MECHANISM Numbers

Lok Adalats 10

Civil Courts 2




Asset reconstruction/securitisation

Companies 14

Others 0

Interpretation:

14% of the respondents said they adopt one time settlement schemes as a recovery mechanism for

NPAs post –securitisation act, 23% said Debt recovery tribunals 32% said

Asset Reconstruction Companies, 5% said Civil courts, 5% said corporate debt reconstruction and

23% said Lok Adalats.


5. Which of the measures for recovery are practical?

PREFERENCE Numbers

Lok Adalats 10

Civil Courts 2




Asset reconstruction/securitisation Companies 14

Interpretation: 9% of the respondents said that One Time Settlement scheme is the mosteffective recovery mechanism,

while 23% said Lok Adalats, 32% said Asset reconstruction companies, 27% said debt recovery

tribunals and 9% said corporate debt restructuring.


6. Which of the measures for recovery are effective?

REASON'S Numbers

Fast 20

Default less 12

Bound by Law 4

Simple 8

Interpretation: 45% of the respondents said that fast scheme is the most effective recovery mechanism, While 27% said default less, 10% said bound by law, % said debt recovery tribunals and 18%

Said simple method


7. Do you think the Securitisation Act has empowered the banks with additional powers by facilitating the

formation of Asset reconstruction/Securitisation companies?

PREFERENCE Numbers

Yes 42

No 2

Interpretation: 95% of the respondents said that the securitisation act has empowered the banks with

additional powers by facilitating the setting up of Asset reconstruction Companies securitization.


8. Has the enactment of Securitisation Act reduced the level of NPAs in the bank?

PREFERENCE Numbers

Yes 42

No 2

Interpretation: 95% of the respondents said that the enactment of the Securitisation Act has reduced

the level of NPAs in the banks, while 5% said they can’t say whether the Act helped in

the reduction of NPAs in the banks.

.


9. How would you rate the impact of the Securitisation Act in the reduction of NPAs on a

scale of 1 to 10? (One being the lowest & ten being the highest)

RATING Numbers

Below 5 2

5 & Above 42

Interpretation:

95% of the respondents rated five and above 5 the impact of Securitisation act in the

reduction of NPAs and 5% rated below 5. From this it can be interpreted that the Act

has been successful in the reduction of NPAs in the banking sector.


STATISTICAL ANALYSIS

The impact of Securitisation Act in the reduction of NPAs in the Banking sector

Standard deviation =√1451/50

─ (265/50) � = 0.96

Mean = 265/50= 5.3

Mean1= (9+12)/6=

3.5

Z = 5.3 - 3.5/ 0.96 *

√1/50

= 13.34

Table value of Z is

1.96 at 5 % level of

significance.

Rating (x)

No of Respondents(f)

f(x) fxฒ

3 3 9 27

4 3 12 48

5 26 130 650

6 12 72 432

7 6 42 294

265 1451


Interpretation

As Z value is more than the table value H0 is rejected and H1 is accepted

Therefore it can be concluded that the Securitisation Act has been

successful in

the reduction of NPAs.


CHAPTER 6

FINDINGS


FINDINGS

� An asset is treated as a Non Performing Asset, if interest and/or

installment of principal remains overdue for a period exceeding

90 days(w.e.f.1st April 2004)

� The main reasons for an account becoming a non- performing

asset are diversion of funds, improper credit appraisal and willful

default followed by cost ineffective legal measures and difficulty in

the execution of decrees.

� Before the enactment of the Securitisation Act the banker had

limited options for recovery which consisted of having an intensive

follow-up and interaction with the borrower and initiating legal

actions either through courts or Debt recovery tribunals.

� The Securitisation Act empowers Banks/FIs to change or

takeover the management/possession of secured assets of the

defaulting borrowers& sell or lease out the assets without the


� The measures to tackle the NPAs adopted by the bank post-

Securitisation Act include:

� Issuing notices as per the SRFAESI Act and waiting for 60 days

� Issue possession notice after 60 days and initiate steps to take

physical possession of securities

� Sell the securities and adjust the amount to the NPAs.

� The Act is applicable only if claim in respect of the financial

asset is made within the period of limitation prescribed under the

Limitation Act, 1963(36)


�The Securitisation Act is not applicable in case of agriculturaL

properties

� The act is not applicable to any security interest for securing

repayment of any financial asset not exceeding one lakh rupees.

� The major issues of concern with the implementation of the Act

are:

� Inability to dispose off the assets acquired under the act by

the banks due to lack of market for such assets.

� Problems in disposing of land due to the restrictions imposed

by the Land ceiling laws.

� Pricing of the acquired assets by the bank in the process of

selling them to Asset reconstruction companies which involves

huge discounts

� The provisions of the act are applicable only in the case of

doubtful and loss assets

� Parties delaying the proceedings initiated by the banks under

the act by contending in the courts/DRTs.

� Difficulty in seizing the said property with tenants and

leaseholders occupying the property

� Stays from civil courts by the parties against the action

initiated by the banks for seizure

� Another issue of concern is the quality of the securitized

asset

� Although the Securitisation Act empowers banks/FIs to

seize the secured assets of the defaulting borrowers without

the intervention of the courts, borrowers are still able to get

the proceedings under the act stayed by appealing in civil


� Despite the many issues of concerns in the implementation of

the act overal the Act has been a boon for the banking community.

� Majority of the bankers opined that the act was helpful in the

reduction of NPAs.


CHAPTER 7

SUGGESTIONS &CONCLUSION


SUGGESTIONS

The following are the suggestions to ake the Securitisation Act more

meaningful and effective.

� In India, bulk of the NPAs relate to units that are either defunct or in

sectors like steel and textiles that have become uncompetitive or obsolete

with the opening up of the economy, lowering of tariffs or introduction of

modern technology etc. Unlike other countries, where there are

specialized markets for buying out the NPAs and selling them overtime,

there is no market for distressed assets in India. Hence specialized

markets for such securitized assets must be established.

� Private investors should also be allowed to invest in securitized NPAs.

� Asset reconstruction companies resort to issuance of bonds against

assets transferred from the banks. There should be a mechanism whereby

such bonds are guaranteed.

� Banks and Asset reconstruction companies must be given sufficient legal

powers to recover the assets and dispose them off without the intervention

of the courts.

� The banks and FIs will be shareholders as well as the customers of the

ARCs and hence they have an interest in its financial performance,

therefore the ARCs have to be given operational independence.

� Banks should recognize hidden losses in transfer of NPAs to ARCs, if

banks transfer the NPAs at the market price they will have to book further

losses. Government should evolve a mechanism to quantify these losses

and arrange to recapitalise banks.

� The NPA assets must be rated by a rating agency which would facilitate

the market for such assets, this would inturn reduce the holding cost of the

seized assets to the bank.


� Recognition of the sale of property by the banks under the Securitisation

act by the Registrar.

� The act has to be made applicable to agricultural properties also, this

would help curb the level of NPAs in the priority sector lending by the

banks.

�

�

The upfront payment by the borrower for challenging the action of the

bank under the act should be re-introduced with a lesser percentage of the

claimed amount.

The lending bank should be given more powers to seize and dispose off

the security and to attach any other additional security/asset available with

the defaulting borrower and court intervention in such proceeding should

be eliminated.

� The Act has to be made applicable for recovery of all dues of banks and

FIs irrespective of the Limitations Act.

�

�

The Act has to be given same weightage on par with Revenue Recovery

Act.

The escape routes for defaulters like the interference of the Debt

Recovery Tribunal etc are to be removed.

� Bankers handling the recovery operations should be educated on the

management and disposal process of the acquired assets and should also

be provided with management expertise while taking over the operations

of the companies.

�The powers currently available to the bankers under the Act should be

explained to both the borrowers and the bankers for the effective

implementation of the Act.


CONCLUSION

The Securitisation Act is a fine, comprehensive piece of legislation, it is also a

reassuring sign of Government’s commitment to reforms. The Act empowers the

banks to change or take over the management or even take possession of

secured assets of the borrowers and sell or lease out the assets. This is the first

time that the banks can takeover the immovable assets of the defaulting

borrowers without the intervention of the courts. Banks under the act can claim

future receivables and supercede the Board of Directors of the defaulting

corporates. No court, other than the Debt Recovery Tribunal can entertain an

appeal against the action taken by the banks under this Act.

Since the enactment of the Securitisation Act, it was seen as a panacea to the

entire problem of NPAs. The banks are euphoric about the act and are taking

actions swiftly by issuing notices to the defaulting borrowers. Defaulting

borrowers who were not responding previously started responding favourably

and cash recoveries became a reality. However nothing spectacular has

happened, there are not many cases where change of management has been

affected or taking over the entire assets of a large manufacturing unit etc. This is

due to the various intricacies involved in the implementation of the act and its

consequences like interference of courts/DRTs in the proceedings initiated by the

banks under the act by way of granting stay orders, lack of market for such

securitized assets, lack of managerial expertise in case of such assets, concerns

of holding costs of such assets to the banks, the recent Supreme court decision

with regard to the striking down of the upfront payment by the borrower before

appeal warranted by the act as unconstitutional and the like.

In view of the above mentioned concerns it can be concluded, after the analysis

that overal the act has empowered the banks with additional powers for recovery


and facilitated the reduction of NPAs to the extent of 70%, however much needs

to be done by way of recovery reforms and development of market for distressed

assets for the Act to be more effective in realising its proposed objectives.

BIBLIOGRAPHY

JOURNALS / MAGAZINES

Bare Act Book on Securitisation Act, 2002

RBI/IBA bulletins and journals

Financial magazines

Financial Statements/Annual reports of the banks

Banking journals of IIB (Indian Institute of Bankers)

Web Sites visited

Search engines: google and yahoo

www.rbi.com

www.indiainfoline.com

www.iib.org.in


CHAPTER 8

ANNEXURE


QUESTIONNAIRE

I am “SUPRIYA R “ currently pursuing my M.B.A. and I am conducting a study on

the impact ofthe Securitisation Act on the non- performing assets in the Banking

sector.

Please answer the questions below. Your Responses in this regard are very

valuable for the success of my project. Also note that the information so revealed

wil be utilized without directly disclosing the identity of the concerned

Bank/officials.

1. The Main reasons for NPAs in the Bank

□ Improper credit appraisal

□ Lack of effective follow up

□ Diversion of funds

□ Absence of security

□ Management failures

□ Others, please specify

□ Decrepit legal system

□ Cost in-effective legal measures

□ Difficulty in execution of decrees

□ Willful default

□ Demand recession

2. Measures for the recovery of NPAs adopted by the Bank

□ Legal measures

□ Both legal&non legal

□ Non legal measures

□ Others, specify ___________________


3. Which of the following recovery mechanisms are adopted by the bank for

NPAs pre- Securitisation Act?

□ Lok Adalats

□ Civil courts

□ Debt Recovery Tribunal

□ One time settlement schemes

□ Corporate Debt Re-Structuring

□Others,specify____

4. Which of the following recovery mechanisms are adopted by the bank for

NPAs post-Securitisation Act?

□ Lok Adalats

□ Civil courts

□ Debt Recovery Tribunal

□ One time settlement schemes

□ Corporate Debt Re-structuring □ Asset reconstruction/securitisation

companies

□ Others, specify_____________

5. Which of the above measures is practicable and effective? and why?

___________________________________________________________

___________________________________________________________

6.

The Securitisation Act has empowered the Banks with additional powers

by facilitating the formation of Asset reconstruction/Securitisation companies.


□ Yes □ No

7. Has the enactment of Securitisation Act reduced the level of NPAs in the

Bank?

□ Yes □No □ can’t say

8. If yes, in Q6 how would you rate the impact of Securitisation Act on a scale of

1 to 10?

9. Are there any issues of concern for the Bank in the implementation of the

Securitisation Act for recovery of NPAs? If so, what are they?

_____________________________________________________

________________________________________________

10. Are there any limiting factors in the Act in its present form that hinders its

effectiveness in the recovery of NPAs? If so, what?

_____________________________________________________________

_____________________________________________________


11. Your suggestions with regard to any changes that are to be made to make

the Act more meaningful and effective? _____________________________________________________________

______________________________________________________

______________________________________________________ ____________________________________________________

--------------------- THANK YOU--------------------

Effect of Securitisation on NPA

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