NPAs and Securitization

8/2/2019 NPAs and Securitization

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Non performing assets


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Classification of Assets asNon-Performing An asset becomes non-performing when it ceases

to generate income for the bank.

Earlier an asset was considered as non-performingasset (NPA) based on the concept of 'Past Due'.

A non performing asset (NPA) was defined as

credit in respect of which interest and/ orinstallment of principal has remained past due for

a specific period of time.

An amount was considered as past due, when itremained outstanding for 30 days beyond the duedate. However, with effect from March 31, 2001 thepast due concept has been dispensed with and

the period is reckoned from the due date ofa ment.


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Non performing Assets

With a view to moving towards international bestpractices and to ensure greater transparency, '90days' overdue norms for identification of NPAshave been made applicable from the year ended

March 31, 2004. Thus, a NPA shall be a loan or anadvance where:

Interest and/or installment of principal remainoverdue for a period of more than 90 days in

respect of a Term Loan. The account remains 'Out of order for a period of

more than 90 days, in respect of an Overdraft/CC.

The bill remains overdue for a period of more than

90 days in the case of bills purchased anddiscounted,


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Over due and out of order

Any amount due to the bank under any creditfacility, if not paid by the due date fixed by the bankbecomes overdue

An account should be treated as 'out of order' if the

outstanding balance remains continuously inexcess of the sanctioned limit / drawing power. Incases where the outstanding balance in theprincipal operating account is less than the

sanctioned limit/drawing power, but there are nocredits continuously for 90 days or credits are notenough to cover the interest debited during thesame period, these accounts should be treated as'out of order.


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Asset Classification

Banks should classify their assets into the followingbroad groups, viz

Standard Assets

Sub-standard Assets

Doubtful Assets

Loss Assets

Standard Assets

Standard Asset is one which does not disclose anyproblems and which does not carry more thannormal risk attached to the business. Such anasset should not be an NPA.


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Sub Standard Assets

With effect from March 31, 2005 an asset would beclassified as sub-standard if it remained NPA for aperiod less than or equal to 12 months. In suchcases, the current net worth of the borrowers/

guarantors or the current market value of thesecurity charged is not enough to ensure recoveryof the dues to the banks in full.

An asset where the terms of the loan agreement

regarding interest and principal have been re-negotiated or rescheduled after commencement ofproduction, should be classified as sub-standardand should remain in such category for at least 12months of satisfactory performance under the re-

negotiated or rescheduled terms.


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Doubtful and loss Assets

With effect from March 31, 2005, an asset isrequired to be classified as doubtful, if it hasremained NPA for more than 12 months. A loanclassified as doubtful has all the weaknesses

inherent as that classified as sub-standard, with theadded characteristic that the weaknesses makecollection or liquidation in full, on the basis ofcurrently known facts, conditions and values, highlyquestionable and improbable.

A loss asset is one where loss has been identifiedby the bank or internal or external auditors or bythe RBI inspection but the amount has not beenwritten off, wholly or partly. In other words, such an

asset is considered un-collectible.


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Provisioning for NPAs

Banks have to keep aside extra funds, calledprovisioning in banking parlance, for standardassets as well. As per the norms, banks have tomake a general provision of 0.40% for all loans and

advances except that given towards agricultureand small and medium enterprise (SME) sector.

In case of NPAs, provisioning needs to be done asper the NPA category. For substandard loans, a

general provisioning of 10% on the totaloutstanding amount is made if the loan is secured,for unsecured loans the total provisioning thatneeds to be done is 20% on the outstandingbalance.


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Recovery and sale of NPAs

Under the Securitisation and Reconstruction of FinancialAssets and Enforcement of Security Interest (SARFAESI) Act,the banks can take legal recourse to recover their dues. If aborrower makes any default in repayment and his account isclassified as NPA, then the secured creditor has to issue

notice to the borrower giving him 60 days to pay his dues. Ifthe dues are still not paid, the bank can take possession ofthe assets and can also give it on lease or sell it.

A bank can sell NPA from its books to asset reconstructioncompanies such as ARCIL only if it has remained NPA for at

least two years. Such sale can take place only on cash basis.The purchasing bank has to keep the accounts in its books atleast for a period of 15 months before it is sold to other banks.The purchased NPA may be classified as 'standard' in thebooks of the purchasing bank for a period of 90 days from the

date of purchase.


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The Securitisation andReconstruction of Financial

Assets and Enforcement ofSecurity Interest Act


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SARFAESI

The legal framework for securitisation in India withthe enactment of theThe Securitisation and

Reconstruction of Financial Assets AndEnforcement of Security Interest Act, 2002. Its

purpose is to promote the setting up of assetreconstruction/securitisation companies to takeover the Non Performing Assets (NPA)accumulated with the banks and public financialinstitutions. The Act provides special powers tolenders

and securitisation/ asset reconstruction companies,to enable them to take over of assets of borrowerswithout first resorting to courts.


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SARFAESI -Objectives

The Act deals with three aspects.

1. Enforcement of Security Interest by securedcreditor (Banks/Financial

Institutions)

2. Transfer of non- performing assets to AssetReconstruction Company, which will then disposeof those assets and realise the proceeds.

3. To provide a legal framework for securitisation of

assets.


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Securitization

Securitisation is the process of conversion ofexisting assets or future cash flows intomarketable securities.

the conversion of existing assets intomarketable securities is known as asset-backed securitisation and the conversion offuture cash flows into marketable securities isknown as future-flows securitisation.

Some of the assets that can be securitised

are loans like car loans, housing loans, etc.and future cash flows like ticket sales, creditcard payments, car rentals or any other formof future receivables.


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Process and Participants

Section 5 of the Securitisation andReconstruction of Financial Assets andEnforcement of Security Interest Act,2002, mandates that only banks and

financial institutions can securitise theirfinancial assets.

A bank maintains a loan as an asset on

its balance sheet and monitors it forcollection.

Securitization helps in unblocking thefunds otherwise locked in loans given.


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Contd..

Bank in this case is the originator. The customer taking loan is the obligor. SPV -a separate entity formed

exclusively for the facilitation of the

securitisation process and providingfunds to the originator.

These securities issued by the SPV tothe investors and are known as pass-

through-certificates (PTCs). The difference between rate of interest

payable by the obligor and returnpromised to the investor investing in

PTCs is the servicing fee for the SPV.


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Contd..

The investors can be banks, mutual funds,other financial institutions, government etc. InIndia only qualified institutional buyers (QIBs)who posses the expertise and the financial

muscle to invest in securities market areallowed to invest in PTCs.

QIB - Mutual funds, financial institutions (FIs),scheduled commercial banks, insurance

companies, provident funds, pension funds,state industrial development corporations etc.

The rating agency rates the securitisedinstruments on the basis of asset quality, and

not on the basis of rating of the originator.


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Contd..

The administrator or the servicer isappointed to collect the paymentsfrom the obligors. The servicer follows

up with the defaulters and uses legalremedies against them.

Once assets are securitised, theseassets are removed from the bank's

books and the money generatedthrough securitisation can be used forother profitable uses, like for givingnew loans.


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Benefits

Securitisation also helps banks to sell off theirbad loans (NPAs or non performing assets) toasset 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 adiscounted price, thereby helping banks to focuson core activities.

On acquiring bad loans ARCs restructure themand sell them to other investors as PTCs,

thereby freeing the banking system to focus onnormal banking activities. Asset Reconstruction Company of India Limited

(ARCIL) was the first (till date remains the onlyARC) to commence business in India.

NPAs and Securitization

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