[Banking] SARFAESI Act, Asset Reconstruction Company (ARC), Security Receipts (SR), QIB, DRT, Central RegistryDevendra Vishwakarma
- What is NPA?
- Debt Recovery tribunals (DRT) under SARFAESI Act?
- What is the Sarfaesi Act?
- Appeal structure
- Bank: Power to Auction
- What is ARC?
- What are Security Receipts (SR)?
- What is Qualified Institutional Buyer (QIB)?
- Foreign investment in ARC?
- ARC New Power: convert Debt into equity
- Anti-arguments: Debt to Equity conversion
- Mock Questions CSAT
What is NPA?
- Bank gives loan to a person.
- Person fails to make regular payments.
- Bank gives him notice to correct his behavior. But he doesn’t.
- Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)
- Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.
Debt Recovery tribunals?
- Prior to 90s, banks had very hard time recovering bad loans.
- Because often, borrowers (loan takers) would file frivolous cases in civil courts, then …taarikh pe taarikh, taarikh pe taarikh….. proceeding would go on for years.
- So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.
- Now borrower cannot approach civil court, they’ve to goto special Debt Recovery Tribunal (DRT).
- This led to some relief, but then DRTs clogged down by truckload of cases. (Even now, more than 60,000 cases pending with DRTs)
- In 2002, Government came up with new Act, named “SARFAESI Act”.
What is the Sarfaesi Act?
- and Reconstruction
- of Financial Assets
- and Enforcement of Security Interest Act, 2002,
Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture of Debt + equity in following way.
|Holder||Rupees in Cr.|
|Equity (IPO->Shares)||Paraajay and his family||20|
|Debt (loans, Bonds)||Business loan from SBI||40|
- Initially the company runs well and good.
- But then Mr.Paraajay doesn’t revise his MBA books often, so he forgets the business concepts. His company starts making losses.
- He fails to pay loan EMIs for many months.
- SBI gives him notice to correct his behavior.
- Still, he doesn’t start paying money.
- SBI declares this Rs.40 crores loan NPA (Non-Performing Asset).
- Once a loan is declared as non-performing asset, SBI can take actions under SARFAESI act, to recover the loan money.
Bank have following powers under SARFAESI Act
- Take possession of Mr.Paraajay’s assets without requiring court order. (Commericial or residential, fixed or moving assets.)
- Auction / Sale them.
- Change the administration/ Management of those assets.
- If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X to surrender that Asset.
- If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.
- *ARCs explained after a few paragraphs.
- SARFAESI applies only to loans above Rs.10 lakhs.
- By the way SARFAESI applies only to those assets “mortgaged/secured” to get the loan.
- E.g. if Mr.Paraajay had taken business-loan, SBI would have asked him to sign away his factory/machinary/vehicles/land etc. specific items as mortgage.
- Hence SBI can attach only ^those assets.
- But SBI cannot take away Paraajay’s personal home-furniture, expensive wrist-watch or his son’s bicycle in the name of SARFAESI.
- Similarly, Agricultural land is exempted from SARFAESI attachment.
Appeal structure in SARFAESI ACt?
The borrower (loan taker) has following options:
- Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of his properties. (He cannot file case in Civil courts.)
- Fight the case in DRT.
- If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).
- But before filing appeal with DRAT, he’ll have to deposit 50% of his pending loan money.
Bank: Power to Auction
- First SBI contacts the experts, gets valuation of Mr.Paraajay’s assets.
- Expert says “those assets are worth Rs.50 crores according to present market value of land/ building/ machinary whatever.”
- Then SBI will give advertisement in newspapers “we are auctioning xyz land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid, send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheets and school leaving certificates, duly attested by a Gazetted officer.”
- Problem: sometimes, bidders donot take interest in buying such properties, factories etc.
- To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comes to bid in the auction, Bank itself can buy that property.
Here comes the new problem:
- Suppose SBI attached a warehouse of Mr.Paraajay.
- If the land was in good urban area, SBI could open a new branch office there (or housing for its employees).
- But if plot/factory/house is in some remote area= useless for SBI’s personal business.
- Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7 years, (max 12 years with RBI’s permission).
- So ultimately SBI will have to auction it to someone. What if they don’t get better price? Critiques of the bill say, this is not clarified in the bill.
What is ARC?
- Asset reconstruction company (ARC).
- They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.
- They’ve to register with Reserve Bank of India.
- ARCIL (India’s first and largest asset reconstruction company (ARC))
- Reliance Asset Reconstruction Company Limited by Anil Ambani
- In our example, SBI has NPA worth Rs.40 crores.
- ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than nothing.)
- Besides, banks have hundreads of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no bidders are interested in auction. All the filework and donkey labour, In such cases, it’s better for bank to transfer NPA to ARC.
- But that doesn’t mean ARC will give 35 crores to the SBI from its own pocket!
- Then how will the Asset reconstruction company (ARC) arrange for the money?= via Security Reciepts.
What are Security Reciepts (SR)?
- In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.
- So ARC will issue “security reciepts (SR)” worth Rs.35 crores.
- Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).
- SR are not “bonds”, they donot carry fixed interest rate.
- ARC will promise to pay money on SR, when it gets money the bad loan.
- Although, ARC usually promise 9% profit on “security reciepts (SR)”.
- So, three possible situations:
- Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goes from QIB -> ARC -> SBI.
- SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the money to SBI).
- combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.
What is Qualified Institutional Buyer (QIB)?
These people have the expertise and the financial muscle to evaluate and invest in the capital markets.