lit review=npa

8/7/2019 lit review=npa

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Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution

as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classificationissued by RBI. An amount due under any credit facility is treated as "past due" when it has not been paid within 30 daysfrom the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of

technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31,

2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance wherei. Interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan,

ii. The account remains 'out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit(OD/CC),

iii. The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted,

iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding twohalf years in the case of an advance granted for agricultural purpose, and

v. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.

With a view to moving towards international best practices and to ensure greater transparency, it has been decided toadopt the '90 days overdue' norm for identification of NPAs, from the year ending March 31, 2004. Accordingly, with

effect from March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where;

i. Interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan,ii. The account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC),



iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,

iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding twohalf years in the case of an advance granted for agricultural purpose, and

v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

ASSET CLASSIFICATION:AAsssseettss aarree ccllaassssiiffiieedd iinnttoo ffoolllloowwiinngg ffoouurr ccaatteeggoorriieess::

SSttaannddaarrdd AAsssseettss::

SSuubb--ssttaannddaarrdd AAsssseettss

DDoouubbttffuull AAsssseettss

LLoossss AAsssseettss

SSttaannddaarrdd AAsssseettss::

Standard assets are the ones in which the bank is receiving interest as well as the principal amount of the loan regularlyfrom the customer. Here it is also very important that in this case the arrears of interest and the principal amount of loando not exceed 90 days at the end of financial year. If asset fails to be in category of standard asset that is amount due more

than 90 days then it is NPA and NPAs are further need to classify in sub categories.PPrroovviissiioonniinngg NNoorrmmss::

From the year ending 31.03.2000, the banks should make a general provision of a minimum of 0.40 percent onstandard assets on global loan portfolio basis.

The provisions on standard assets should not be reckoned for arriving at net NPAs.

The provisions towards Standard Assets need not be netted from gross advances but shown separately as 'ContingentProvisions against Standard Assets' under 'Other Liabilities and Provisions - Others' in Schedule 5 of the balance sheet.

Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the reasonability of the dues:11)) SSuubb--ssttaannddaarrdd AAsssseettss

22)) DDoouubbttffuull AAsssseettss

33)) LLoossss AAsssseettss

N.R. INSTITUTE OF BUSINESS MANAGEMENT 45



SSuubb--ssttaannddaarrdd AAsssseettss::

With effect from 31 March 2005, a substandard asset would be one, which has remained NPA for a period less than or equal to 12 month. The following features are exhibited by substandard assets: the current net worth of the borrowers /

guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks infull; and the asset has well-defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by

the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.PPrroovviissiioonniinngg NNoorrmmss:: A general provision of 10 percent on total outstanding should be made without

making any allowance for DICGC/ECGC guarantee cover and securities available.

DDoouubbttffuull AAsssseettss::

A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard, with the addedcharacteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditionsand values ± highly questionable and improbable. With effect from March 31, 2005, an asset would be classified as

doubtful if it remained in the sub-standard category for 12 months.PPrroovviissiioonniinngg NNoorrmmss::

100 percent of the extent to which the advance is not covered by the realisable value of the security to which the bank

has a valid recourse and the realisable value is estimated on a realistic basis.

In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 percentto 50 percent of the secured portion depending upon the period for which the asset has remained doubtful:N.R. INSTITUTE OF BUSINESS

MANAGEMENT 46 Period for

which the advance has been

considered as doubtful

Provision requirement (%)

Up to one year 20One to three years 30

More than three years:(1) Outstanding stock of NPAs as on

March 31, 2004.(2) Advances classified asÄdoubtful more than three years onor after April 1, 2004.

60% with effect from March 31,2005. 75% effect from March 31,

2006. 100% with effect from March31, 2007.

Additional provisioning consequent upon the change in the definition of doubtful assets effective from March 31, 2003has to be made in phases as under:

i. As on31.03.2003, 50 percent of the additional provisioning requirement on the assets which became doubtful onaccount of new norm of 18 months for transition from sub-standard asset to doubtful category.

ii. As on 31.03.2002, balance of the provisions not made during the previous year, in addition to the provisionsneeded, as on 31.03.2002.

Banks are permitted to phase the additional provisioning consequent upon the reduction in the transition period fromsubstandard to doubtful asset from 18 to 12 months over a four year period commencing from the year ending March 31,2005, with a minimum of 20 % each year.

LLoossss AAsssseettss::A loss asset is one which considered uncollectible and of such little value that its continuance as a bankable asset is notwarranted- although there may be some salvage or recovery value. Also, these assets would have been identified as Äloss

assets by the bank. or internal or external auditors or the RBI inspection but the amount would not have been written-off wholly.

PPrroovviissiioonniinngg NNoorrmmss::



The entire asset should be written off. If the assets are permitted to remain in the books for any reason, 100 percent of

the outstanding should be provided for..

R EASONS FOR AN ACCOUNT BECOMING NPA:1. Internal factors

2. External factors

Internal factors:

1) Funds borrowed for a particular purpose but not use for the said purpose.

2) Project not completed in time.

3) Poor recovery of receivables.

4) Excess capacities created on non-economic costs.

5) In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets.

6) Business failures.

7) Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns.

8) Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-appropriation etc.

9) Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delaying settlement of payments\ subsidiaries by government bodies etc.,

External factors:

1) Sluggish legal system ±

Long legal tangles

Changes that had taken place in labour laws

Lack of sincere effort.

2) Scarcity of raw material, power and other resources.

3) Industrial recession.

4) Shortage of raw material, raw material\input price escalation, power shortage, industrial recession, excess capacity,

natural calamities like floods, accidents.

5) Failures, nonpayment\ over dues in other countries, recession in other countries, externalization problems, adverseexchange rates etc.




6) Government policies like excise duty changes, Import duty changes etc.,

The RBI has summarized the finer factors contributing to higher level of NPAs in the Indian banking sector as:

Diversion of funds, which is for expansion, diversification, modernization, undertaking new projects and for helpingassociate concerns. This is also coupled with recessionary trends and failures to tap funds in capital and debt markets.

Business failures (such as product, marketing etc.), which are due to inefficient management system, strained labour relations, inappropriate technology/ technical problems, product obsolescence etc.

Recession, which is due to input/ power shortage, price variation, accidents, natural calamities etc. Theexternalization problems in other countries also lead to growth of NPAs in Indian banking sector.

Time/ cost overrun during project implementation stage.

Governmental policies such as changes in excise duties, pollution control orders etc.

Willful defaults, which are because of siphoning-off funds, fraud/ misappropriation, promoters/ directors disputes etc.

Deficiency on the part of banks, viz, delays in release of limits and payments/ subsidies by the Government of India.

EAR LY SYMPTOMS: By which one can recognize a performing asset turning in to non-

performing asset Four categories of early symptoms:-

1) Financial:

Non-payment of the very first installment in case of term loan.

Bouncing of cheque due to insufficient balance in the accounts.

Irregularity in installment.Irregularity of operations in the accounts.

Unpaid overdue bills.

Declining Current Ratio.

Payment which does not cover the interest and principal amount of that installment.

While monitoring the accounts it is found that partial amount is diverted to sister concern or parent company.

2) Operational and Physical:



If information is received that the borrower has either initiated the process of winding up or are not doing thebusiness.

Overdue receivables.

Stock statement not submitted on time.



Use for personal comfort, stocks and shares by borrower.




Avoidance of contact with bank.

Problem between partners.

4) Others:

Changes in Government policies.

Death of borrower.Competition in the market.




PR EVENTIVE MEASUR EMENT FOR NPA:EEaarrllyy RReeccooggnniittiioonn ooff tthhee PPrroobblleemm::

Invariably, by the time banks start their efforts to get involved in a revival process, its too late to retrieve the situation-both in terms of rehabilitation of the project and recovery of banks dues. Identification of weakness in the verybeginning that is : When the account starts showing first signs of weakness regardless of the fact that it may not havebecome NPA, is imperative. Assessment of the potential of revival may be done on the basis of a techno-economic

viability study. Restructuring should be attempted where, after an objective assessment of the promoters intention,banks are convinced of a turnaround within a scheduled timeframe. In respect of totally unviable units as decided by the

bank, it is better to facilitate winding up/ selling of the unit earlier, so as to recover whatever is possible through legalmeans before the security position becomes worse.

IIddeennttiiffyyiinngg BBoorrrroowweerrss wwiitthh GGeennuuiinnee IInntteenntt::

Identifying borrowers with genuine intent from those who are non- serious with no commitment or stake in revival is achallenge confronting bankers. Here the role of frontline officials at the branch level is paramount as they are the oneswho have intelligent inputs with regard to promoters sincerity, and capability to achieve turnaround. Based on thisobjective assessment, banks should decide as quickly as possible whether it would be worthwhile to commit additional

finance. In this regard banks may consider having ³Special Investigation´ of all financial transaction or businesstransaction, books of account in order to ascertain real factors that contributed to sickness of the borrower. Banks may

have penal of technical experts with proven expertise and track record of preparing techno-economic study of the projectof the borrowers. Borrowers having genuine problems due to temporary mismatch in fund flow or sudden requirement of additional fund may be entertained at branch level, and for this purpose a special limit to such type of cases should be

decided. This will obviate the need to route the additional funding through the controlling offices in deserving cases, and

help avert many accounts slipping into NPA category. N.R. INSTITUTE OF BUSINESS MANAGEMENT 55



TTiimmeelliinneessss aanndd AAddeeqquuaaccyy ooff rreessppoonnssee::

Longer the delay in response, grater the injury to the account and the asset. Time is a crucial element in any restructuringor rehabilitation activity. The response decided on the basis of techno-economic study and promoters commitment, has

to be adequate in terms of extend of additional funding and relaxations etc. under the restructuring exercise. The packageof assistance may be flexible and bank may look at the exit option.

FFooccuuss oonn CCaasshh FFlloowwss::

While financing, at the time of restructuring the banks may not be guided by the conventional fund flow analysis only,which could yield a potentially misleading picture. Appraisal for fresh credit requirements may be done by analyzing

funds flow in conjunction with the Cash Flow rather than only on the basis of Funds Flow.

MMaannaaggeemmeenntt EEffffeeccttiivveenneessss::

The general perception among borrower is that it is lack of finance that leads to sickness and NPAs. But this may not bethe case all the time. Management effectiveness in tackling adverse business conditions is a very important aspect thataffects a borrowing units fortunes. A bank may commit additional finance to an aling unit only after basic viability of

the enterprise also in the context of quality of management is examined and confirmed. Where the default is due to deeper malady, viability study or investigative audit should be done ± it will be useful to have consultant appointed as early as

possible to examine this aspect. A proper techno- economic viability study must thus become the basis on which anyfuture action can be considered.

MMuullttiippllee FFiinnaanncciinngg::During the exercise for assessment of viability and restructuring, a Pragmatic and unified approach by all thelending banks/ FIs as also sharing of all relevant information on the borrower would go a long way toward overall success

of rehabilitation exercise, given the probability of success/failure.




In some default cases, where the unit is still working, the bank should make sure that it captures the cash flows

(there is a tendency on part of the borrowers to switch bankers once they default, for fear of getting their cash flows

forfeited), and ensure that such cash flows are used for working capital purposes. Toward this end, there should be regular flow of information among consortium members. A bank, which is not part of the consortium, may not be allowed to offer credit facilities to such defaulting clients. Current account facilities may also be denied at non-consortium banks to suchclients and violation may attract penal action. The Credit Information Bureau of India Ltd.(CIBIL) may be very useful

for meaningful information exchange on defaulting borrowers once the setup becomes fully operational.

In a forum of lenders, the priority of each lender will be different. While one set of lenders may be willing to wait for a longer time to recover its dues, another lender may have a much shorter timeframe in mind. So it is possible that the

letter categories of lenders may be willing to exit, even a t a cost ± by a discounted settlement of the exposure. Therefore,any plan for restructuring/rehabilitation may take this aspect into account.

Corporate Debt R estructuring mechanism has been institutionalized in 2001 to provide a timely and transparent

system for restructuring of the corporate debt of Rs. 20 crore and above with the banks and FIs on a voluntary basis andoutside the legal framework. Under this system, banks may greatly benefit in terms of restructuring of large standardaccounts (potential NPAs) and viable sub-standard accounts with consortium/multiple banking arrangements.




PR OCEDUR ES FOR NPA IDENTIFICATION AND R ESOLUTION IN INDIA:1. Internal Checks and Control

Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance. Though most banks have Early Warning Systems (EWS) for identification of potential NPAs, the actual processes followed, however, differ from bank to bank. The EWS enable a bank to identify theborrower accounts which show signs of credit deterioration and initiate remedial action. Many banks have evolved and

adopted an elaborate EWS, which allows them to identify potential distress signals and plan their options beforehand,accordingly. The early warning signals, indicative of potential problems in the accounts, viz. persistent irregularity in

accounts, delays in servicing of interest, frequent devolvement of L/Cs, units' financial problems, market relatedproblems, etc. are captured by the system. In addition, some of these banks are reviewing their exposure to borrower

accounts every quarter based on published data which also serves as an important additional warning system. These earlywarning signals used by banks are generally independent of risk rating systems and asset classification norms prescribedby RBI. The major components/processes of a EWS followed by banks in India as brought out by a study conducted byReserve Bank of India at the instance of the Board of Financial Supervision are as follows:

Designating Relationship Manager/ Credit Officer for monitoring account/s

Preparation of ̀ know your client' profile

Credit rating system

Identification of watch-list/special mention category accountsMonitoring of early warning signals

R elationship Manager/Credit Officer

The Relationship Manager/Credit Officer is an official who is expected to have complete knowledge of borrower, hisbusiness, his future plans, etc. The Relationship Manager has to keep in constant touch with the borrower and report all

developments impacting the N.R. INSTITUTE OF BUSINESS MANAGEMENT 58



borrowable account. As a part of this contact he is also expected to conduct scrutiny and activity inspections. In the credit

monitoring process, the responsibility of monitoring a corporate account is vested with Relationship Manager/CreditOfficer.

K now your client' profile (K YC)

Most banks in India have a system of preparing `know your client' (KYC) profile/credit report. As a part of `KYC' system,visits are made on clients and their places of business/units. The frequency of such visits depends on the nature and needs

of relationship.Credit R ating System

The credit rating system is essentially one point indicator of an individual credit exposure and is used to identify measureand monitor the credit risk of individual proposal. At the whole bank level, credit rating system enables tracking thehealth of banks entire credit portfolio. Most banks in India have put in place the system of internal credit rating. While

most of the banks have developed their own models, a few banks have adopted credit rating models designed by rating

agencies. Credit rating models take into account various types of risks viz. financial, industry and management, etc.associated with a borrowable unit. The exercise is generally done at the time of sanction of new borrowable account andat the time of review renewal of existing credit facilities.

Watch-list/Special Mention Category

The grading of the bank's risk assets is an important internal control tool. It serves the need of the Management to identifyand monitor potential risks of a loan asset. The purpose of identification of potential NPAs is to ensure that appropriate

preventive / corrective steps could be initiated by the bank to protect against the loan asset becoming non-performing.Most of the banks have a system to put certain borrowable accounts under watch list or special mention category if performing advances operating under adverse business or economic conditions are exhibiting certain distress signals.

These accounts generally exhibit weaknesses which are correctable but warrant banks' closer attention. The categorization

of such accounts in watch list or special mention category N.R. INSTITUTE OF BUSINESS MANAGEMENT 59



provides early warning signals enabling Relationship Manager or Credit Officer to anticipate credit deterioration and take

necessary preventive steps to avoid their slippage into non performing advances. Early Warning Signals It is important inany early warning system, to be sensitive to signals of credit deterioration. A host of early warning signals are used bydifferent banks for identification of potential NPAs. Most banks in India have laid down a series of operational, financial,

transactional indicators that could serve to identify emerging problems in credit exposures at an early stage. Further, it is

revealed that the indicators which may trigger early warning system depend not only on default in payment of installmentand interest but also other factors such as deterioration in operating and financial performance of the borrower, weakening

industry characteristics, regulatory changes, general economic conditions, etc. Early warning signals can be classified intofive broad categories viz.a) Financial

b) Operational

c) Banking

d) Management and

e) External factors.

Financial related warning signals generally emanate from the borrowers' balance sheet, income expenditure statement,statement of cash flows, statement of receivables etc. Following common warning signals are captured by some of thebanks having relatively developed EWS. Financial warning signals

Persistent irregularity in the account

Default in repayment obligation

Devolvement of LC/invocation of guarantees

Deterioration in liquidity/working capital positionSubstantial increase in long term debts in relation to equity

Declining sales

Operating losses/net losses




Rising sales and falling profits

Disproportionate increase in overheads relative to sales

Rising level of bad debt losses Operational warning signals

Low activity level in plant

Disorderly diversification/frequent changes in plan

Nonpayment of wages/power bills

Loss of critical customer/sFrequent labor problems

Evidence of aged inventory/large level of inventory

Management related warning signals

Lack of co-operation from key personnel

Change in management, ownership, or key personnel

Desire to take undue risks

Family disputes

Poor financial controls

Fudging of financial statements

Diversion of funds

Banking related signals

Declining bank balances/declining operations in the account

Opening of account with other bank

Return of outward bills/dishonored cheques

Sales transactions not routed through the account

Frequent requests for loan

Frequent delays in submitting stock statements, financial data, etc.

Signals relating to external factors

Economic recession

Emergence of new competition

Emergence of new technology




Changes in government / regulatory policies

Natural calamities

2. Management/Resolution of NPAs

A reduction in the total gross and net NPAs in the Indian financial system indicates a significant improvement in

management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past whichinclude the SR FAESI Act, one time settlement schemes, setting up of the CDR mechanism, strengthening of DRTs. From

the data available of Public Sector Banks as on March 31, 2003, there were 1,522 numbers of NPAs as on March 31, 2003which had gross value greater than Rs. 50 million in all the public sector banks in India. The total gross value of theseNPAs amounted to Rs. 215 billion. The total number of resolution approaches (including cases where action is to beinitiated) is greater than the number of NPAs, indicating some double counting. As can be seen, suit filed and BI FR are

the two most common approaches to resolution of NPAs in public sector banks. Rehabilitation has been considered/adopted in only about 13% of the cases. Settlement has been considered only in 9% of the cases. It is likely to have beenadopted in even fewer cases. Data available on resolution strategies adopted by public sector banks suggest thatCompromise settlement schemes with borrowers are found to be more effective than legal measures. Many banks have

come out with their own restructuring schemes for settlement of NPA accounts. State Bank of India, HDFC Limited, M/s.

Dun and Bradstreet Information Services (India) Pvt. Ltd. and M/s. Trans Union to serve as a mechanism for exchange of information between banks and FIs for curbing the growth of NPAs incorporated credit Information Bureau (India)Limited (CIBIL) in January 2001. Pending the enactment of CIB Regulation Bill, the RBI constituted a working group to

examine the role of CIBs. As per the recommendations of the working group, Banks and FIs are now required to submitthe list of suit-filed cases of Rs. 10 million and above and suit filed cases of willful defaulters of Rs. 2.5 million and aboveto RBI as well as CIBIL. CIBIL will share this information with commercial banks and FIs so as to help them minimizeadverse selection at appraisal stage. The CIBIL is in the process of getting operationalised. N.R. INSTITUTE OF

BUSINESS MANAGEMENT 62



3. Willful Defaulters

RBI has issued revised guidelines in respect of detection of willful default and diversion and siphoning of funds. As per these guidelines a willful default occurs when a borrower defaults in meeting its obligations to the lender when it has

capacity to honor the obligations or whenfunds have been utilized for purposes other than those for which finance wasgranted. The list of willful defaulters is required to be submitted to SEBI and RBI to prevent their access to capital

markets. Sharing of information of this nature helps banks in their due diligence exercise and helps in avoiding financingunscrupulous elements. RBI has advised lenders to initiate legal measures including criminal actions, wherever required,

and undertake a proactive approach in change in management, where appropriate.

4. Legal and Regulatory RegimeDebt R ecovery Tribunals

DRTs were set up under the Recovery of Debts due to Banks and Financial Institutions Act, 1993. Under the Act, twotypes of Tribunals were set up i.e. Debt Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT). TheDRTs are vested with competence to entertain cases referred to them, by the banks and FIs for recovery of debts due to

the same. The order passed by a DRT is appealable to the Appellate Tribunal but no appeal shall be entertained by theDRAT unless the applicant deposits 75% of the amount due from him as determined by it. However, the Affiliate

Tribunal may, for reasons to be received in writing, waive or reduce the amount of such deposit. Advances of Rs. 1million and above can be settled through DRT process. An important power conferred on the Tribunal is that of making

an interim order (whether by way of injunction or stay) against the defendant to debar him from transferring, alienating or otherwise dealing with or disposing of any property and the assets belonging to him within prior permission of theTribunal. This order can be passed even while the claim is pending. DRTs are criticized in respect of recovery madeconsidering the size of NPAs in the Country. In general, it is observed that the defendants approach the High Country

challenging the verdict of the Appellate Tribunal which leads to further delays in recovery. Validity of the Act is often

challenged in the court which hinders the progress N.R. INSTITUTE OF BUSINESS MANAGEMENT 63



of the DRTs. Lastly, many needs to be done for making the DRTs stronger in terms of infrastructure.

Lokadalats

The institution of Lokadalat constituted under the Legal Services Authorities Act, 1987 helps in resolving disputes

between the parties by conciliation, mediation, compromise or amicable settlement. It is known for effecting mediation

and counseling between the parties and to reduce burden on the court, especially for small loans. Cases involving suitclaims up to Rs. l million can be brought before the Lokadalat and every award of the Lokadalat shall be deemed to be a

decree of a Civil Court and no appeal can lie to any court against the award made by the Lokadalat.S

everal people of particular localities various social organizations are approaching Lokadalats which are generally presided over by two or

three senior persons including retired senior civil servants, defense personnel and judicial officers. They take up caseswhich are suitable for settlement of debt for certain consideration. Parties are heard and they explain their legal position.They are advised to reach to some settlement due to social pressure of senior bureaucrats or judicial officers or socialworkers. If the compromise is arrived at, the parties to the litigation sign a statement in presence of Lokadalats which is

expected to be filed in court to obtain a consent decree. Normally, if such settlement contains a clause that if the

compromise is not adhered to by the parties, the suits pending in the court will proceed in accordance with the law andparties will have a right to get the decree from the court. In general, it is observed that banks do not get the full advantageof the Lokadalats. It is difficult to collect the concerned borrowers willing to go in for compromise on the day when the

Lokadalat meets. In any case, we should continue our efforts to seek the help of the Lokadalat.

Enactment of SR FAESI Act

The "The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act" (SR FAESI)

provides the formal legal basis and regulatory framework for setting up Asset Reconstruction Companies (ARCs) in India.In addition to asset reconstruction and ARCs, the Act deals with the following largely aspects, N.R. INSTITUTE OF

BUSINESS MANAGEMENT 64



Securitization and Securitization Companies

Enforcement of Security Interest

Creation of a central registry in which all securitization and asset reconstruction transactions as well as any creationof security interests has to be filed.

The Reserve Bank of India (RBI), the designated regulatory authority for ARCS has issued Directions, Guidance Notes,

ApplicationF

orm and Guidelines to Banks in April 2003 for regulating functioning of the proposed ARCS

and theseDirections/ Guidance Notes cover various aspects relating to registration, operations and funding of ARCS and resolutionof NPAs by ARCS. The RBI has also issued guidelines to banks and financial institutions on issues relating to transfer of assets to ARCS, consideration for the same and valuation of instruments issued by the ARCS. Additionally, the Central

Government has issued the security enforcement rules ("Enforcement Rules"), which lays down the procedure to befollowed by a secured creditor while enforcing its security interest pursuant to the Act. The Act permits the securedcreditors (if 75% of the secured creditors agree) to enforce their security interest in relation to the underlying securitywithout reference to the Court after giving a 60 day notice to the defaulting borrower upon classification of the

corresponding financial assistance as a non-performing asset. The Act permits the secured creditors to take any of thefollowing measures:

Take over possession of the secured assets of the borrower including right to transfer by way of lease, assignment or

sale;

Take over the management of the secured assets including the right to transfer by way of lease, assignment or sale;Appoint any person as a manager of the secured asset (such person could be the ARC if they do not accept anypecuniary liability); and

Recover receivables of the borrower in respect of any secured asset which has been transferred. After taking over

possession of the secured assets, the secured creditors are required to obtain valuation of the assets. These secured assetsmay be sold by using any of the following routes to obtain maximum value.

By obtaining quotations from persons dealing in such assets or otherwise interested in buying the assets;

By inviting tenders from the public;




By holding public auctions; or

By private treaty.

Lenders have seized collateral in some cases and while it has not yet been possible to recover value from most suchseizures due to certain legal hurdles, lenders are now clearly in a much better bargaining position vis-a-vis defaultingborrowers than they were before the enactment of SR FAESI Act. When the legal hurdles are removed, the bargaining

power of lenders is likely to improve further and one would expect to see a large number of NPAs being resolved in quick time, either through security enforcement or through settlements. Under the SR FAESI Act ARCS can be set up under theCompanies Act, 1956. The Act designates any person holding not less than 10% of the paid-up equity capital of the ARCas a sponsor and prohibits any sponsor from holding a controlling interest in, being the holding company of or being in

control of the ARC. The SR FAESI and SR FAESI Rules/ Guidelines require ARCS to have a minimum net-owned fund of not less than Rs. 20,000,000. Further, the Directions require that an ARC should maintain, on an ongoing basis, aminimum capital adequacy ratio of 15% of its risk weighted assets. ARCS have been granted a maximum realization timeframe of five years from the date of acquisition of the assets. The Act stipulates several measures that can be undertaken

by ARCs for asset reconstruction. These include:

Enforcement of security interest;

Taking over or changing the management of the business of the borrower;

The sale or lease of the business of the borrower;

Settlement of the borrowers' dues; andRestructuring or rescheduling of debt.

ARCS are also permitted to act as a manager of collateral assets taken over by the lenders under security enforcement

rights available to them or as a recovery agent for any bank or financial institution and to receive a fee for the discharge of these functions. They can also be appointed to act as a receiver, if appointed by any Court or DRT..

Institution of CDR Mechanism

The RBI has instituted the Corporate Debt Restructuring (CDR) mechanism for resolution of NPAs of viable entities

facing financial difficulties. The CDR mechanism instituted in India is broadly along the lines of similar systems in theUK, Thailand, Korea and Malaysia. The objective of the CDR mechanism has been to ensure timely and transparentrestructuring of corporate debt outside the purview of the Board for Industrial and Financial Reconstruction (BIFR),

DRTs or other legal proceedings. The framework is intended to preserve viable corporate affected by certain

internal/external factors and minimize losses to creditors/other stakeholders through an orderly and coordinatedrestructuring programme. RBI has issued revised guidelines in February 2003 with respect to the CDR mechanism.Corporate borrowers with borrowings from the banking system of Rs. 20crores and above under multiple banking

arrangement are eligible under the CDR mechanism. Accounts falling under standard, sub-standard or doubtful categoriescan be considered for restructuring. CDR is a nonstatutory mechanism based on debtor-creditor agreement and inter-creditor agreement. Restructuring helps in aligning repayment obligations for bankers with the cash flow projections asreassessed at the time of restructuring. Therefore it is critical to prepare a restructuring plan on the lines of the expected

business plan along with projected cash flows. N.R. INSTITUTE OF BUSINESS MANAGEMENT 67



The CDR process is being stabilized. Certain revisions are envisaged with respect to the eligibility criteria (amount of

borrowings) and time frame for restructuring. Foreign banks are not members of the CDR forum, and it is expected thatthey would be signing the agreements shortly. However they attend meetings. The first ARC to be operational in India-Asset Reconstruction Company of India (ARGIL) is a member of the CDR forum. Lenders in India prefer to resort to

CDR mechanism to avoid unnecessary delays in multiple lender arrangements and to increase transparency in the process.

While in the RBI guidelines it has been recommended to involve independent consultants, banks are so far resorting totheir internal teams for recommending restructuring programs.

Compromise Settlement Schemes1) One Time Settlement Schemes

NPAs in all sectors, which have become doubtful or loss as on 31st March 2000. The scheme also covers NPAs classifiedas sub-standard as on 31st March 2000, which have subsequently become doubtful or loss. All cases on which the bankshave initiated action under the SR FAESI Act and also cases pending before Courts/DRTs/BIFR, subject to consent decree

being obtained from the Courts/DRTs/BIFR are covered. However cases of willful default, fraud and malfeasance are notcovered. As per the OTS scheme, for NPAs up to Rs. 10crores, the minimum amount that should be recovered should be100% of the outstanding balance in the account.2) Negotiated Settlement Schemes

The RBI/Government has been encouraging banks to design and implement policies for negotiated settlements,particularly for old and unresolved NPAs. The broad framework for such settlements was put in place in July 1995.

Specific guidelines were issued in May 1999to public sector banks for one-time settlements of NPAs of small scale sector.

This scheme was valid until September 2000 and enabled banks to recover Rs 6.7 billion from various accounts. Revisedguidelines were issued in July 2000 for recovery of NPAs of Rs. 50 millionand less. These guidelines were effective until

June 2001 and helped banks recover Rs. 26 billion. N.R. INSTITUTE OF BUSINESS MANAGEMENT 68



Increased Powers to NCLTs and the Proposed R epeal of BIFR

In India, companies whose net worth has been wiped out on account of accumulated losses come under the purview of theSick Industrial Companies Act (SICA) and need to be referred to BIFR. Once a company is referred to the BIFR (andeven if an enquiry is pending as to whether it should be admitted to BIFR), it is afforded protection against recoveryproceedings from its creditors. BIFR is widely regarded as a stumbling block in recovering value for NPAs. Promoters

systematically take refuge inS

ICA - often there is a scramble to file a reference in BIF

R so as to obtain protection fromdebt recovery proceedings. The recent amendments to the Companies Act vest powers for revival and rehabilitation of companies with the National Company Law Tribunal (NCLT), in place of BIFR, with modifications to addressweaknesses experienced under the SICA provisions. The NCLT would prepare a scheme for reconstruction of any sick

company and there is no bar on the lending institution of legal proceedings against such company whilst the scheme isbeing prepared by the NCLT. Therefore, proceedings initiated by any creditor seeking to recover monies from a sick company would not be suspended by a reference to the NCLT and, therefore, the above provision of the Act may not havemuch relevance any longer and probably does not extend to the tribunal for this reason. However, there is a possibility of

conflict between the activities that may be undertaken by the ARC, e.g. change in management, and the role of the NCLTin restructuring sick companies. The Bill to repeal SICA is currently pending in Parliament and the process of staffing of NCLTs has been initiated.

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