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[Economy] SARFAESI Act, AssetReconstruction Company (ARC), SecurityReceipts (SR), QIB, DRT, Central Registry

1. What is NPA?2. Debt Recovery t ribunals (DRT)?3. What is the Sarfaesi Act?

1. Appeal structure2. Bank: Power to Auct ion

4. What is ARC?1. What are Security Receipts (SR)?2. What is Qualif ied Inst itut ional Buyer (QIB)?3. Foreign investment in ARC?4. ARC New Power: convert Debt into equity

5. Ant i-arguments: Debt to Equity conversion6. What is Central Registry?7. Misc.Amendments8. Summary9. Mock Quest ions CSAT

10. Boring details11. Commit tees

What is NPA?Bank gives loan to a person.Person fails to make regular payments.Bank gives him not ice to correct his behavior. But he doesn’t .Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)Current ly Indian banks have NPAs worth more than Rs. 1 lakh crores.

Debt Recovery tribunals?Prior to 90s, banks had very hard t ime recovering bad loans.Because of ten, borrowers (loan takers) would f ile f rivolous 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 RecoveryTribunal (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?Securit isat ionand Reconstruct ion

of Financial Assetsand Enforcement of Security Interest Act, 2002,

Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He f inanced this, via mixture ofDebt + equity in following way. (make sure you understand debt vs Equity, if not click me)

Holder Rupees in Cr.

Equity (IPO->Shares)Paraajay and his family 20Juntaa (public) 30

Debt (loans, Bonds) Business loan from SBI40Bonds 10

Total 100

Init ially the company runs well and good.But then Mr.Paraajay doesn’t revise his MBA books of ten, so he forgets the businessconcepts. His company starts making losses.He fails to pay loan EMIs for many months.SBI gives him not ice to correct his behavior.St ill, 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 act ions under SARFAESIact, to recover the loan money.

Bank have following powers under SARFAESI Act

1. Take possession of Mr.Paraajay’s assets without requiring court order. (Commericial orresident ial, f ixed or moving assets.)

2. Auct ion / Sale them.3. Change the administrat ion/ Management of those assets.4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X

to surrender that Asset.5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.

*ARCs explained af ter 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 hisfactory/machinary/vehicles/land etc. specif ic items as mortgage.Hence SBI can at tach only ^those assets.But SBI cannot take away Paraajay’s personal home-furniture, expensive wrist-watch orhis son’s bicycle in the name of SARFAESI.Similarly, Agricultural land is exempted from SARFAESI at tachment.

Appeal structureThe borrower (loan taker) has following opt ions:

Get a stay order f rom Debt Recoverty t ribunal (DRT) against the auct ion/sale of hispropert ies. (He cannot f ile 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 f iling appeal with DRAT, he’ll have to deposit 50% of his pending loan money.

Bank: Power to AuctionFirst SBI contacts the experts, gets valuat ion of Mr.Paraajay’s assets.Expert says “they’re worth Rs.50 crores according to present market value of land/ building/machinaries whatever.”Then SBI will give advert izement in newspapers “we are auct ioning xyzland/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid,send us applicat ion along with Rs.50,000 as deposit , and their class 10, 12 marksheetsand school leaving cert if icates, duly at tested by a Gazetted of f icer.”Problem: sometimes, bidders donot take interest in buying such propert ies, factories etc.To f ix this problem, Amendment bill of 2011, makes a new provision: if noone else comesto bid in the auction, Bank itself can buy that property.

Here comes the new problem:Suppose SBI at tached the a warehouse of Mr.Paraajay.If the land was in good urban area, SBI could open a new branch of f ice there (or housingfor its employees).But if plot /factory/house is in some remote area= no useless for SBI’s personal business.Under the Banking regulat ion Act, a bank cannot keep such immovable property beyond 7years, (max 12 years with RBI’s permission).So ult imately SBI will have to auct ion it to someone. What if they don’t get better price?Crit iques of the bill say, this is not clarif ied in the bill.

What is ARC?Asset reconstruct ion company (ARC).They buy NPA (Bad loans) f rom Banks and try to extract maximum money out of it=prof it .They’ve to register with Reserve Bank of India.

Examples:

1. ARCIL (India’s f irst and largest asset reconstruct ion company (ARC))2. Reliance Asset Reconstruct ion Company Limited by Anil Ambani

In our example, SBI has NPA worth Rs.40 crores.ARC will buy the NPA f ile f rom 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 t ime or manpower topursue individual case, somet imes no bidders are interested in auct ion. All the f ilework anddonkey labour, In such cases, it ’s better for bank to t ransfer NPA to ARC.But that doesn’t mean ARC will give 35 crores to the SBI f rom its own pocket!Then how will the Asset reconstruct ion company (ARC) arrange for the money?= viaSecurity Reciepts.

What are Security Reciepts (SR)?In above example, ARC needs Rs.35 crores to buy a Non performing asset f rom SBI.So ARC will issue “security reciepts (SR)” worth Rs.35 crores.Only Qualif ied Inst itut ional buyers (QIB) can buy these security reciepts (SR).SR are not “bonds”, they donot carry f ixed interest rate.ARC will promise to pay money on SR, when it gets money the bad loan.

Although, ARC usually promise 9% prof it on “security reciepts (SR)”.So, three possible situat ions:

1. Qualif ied inst itut ional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goesfrom QIB -> ARC -> SBI.

2. SBI itself recieves SR worth Rs.35 crores for f ree. (that means ARC will gradually pay themoney to SBI).

3. combinat ion 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 expert ise and the f inancial muscle to evaluate and invest in the capitalmarkets.

Examples: (click on each to read previous art icles on them)

1. Scheduled Commericial Banks2. Foreign Inst itut ional Investor3. Mutual Funds4. Venture Capital Investors5. Insurance Companies6. Pension/ Providend Funds

Foreign investment in ARCARC =buy bad loans from banks.ARC =arrange money from QIBs to buy bad loans from banks.Problem= Indian QIBs do not invest much in ARCs.Therefore ARC’s capacity to buy NPA= very low.And bank themselves don’t have enough expert ize or manpower to dispose those NPAsquickly.Previously Foreign investors could invest only upto 49% in ARC=minorityshareholder=cannot inf luence company decisions.Now, Government also increased foreign investment limit in ARCs. This would at t ractmore investment in ARCs and help in quicker purchase and disposal of NPAs.

Foreign investment in ARC%Earlier 49%Now (December-24-2012) 74%

Anyways, back to the topic, let ’s recap:

1. SBI had NPA. First solut ion: auct ion the property. Did not work out.2. Second solut ion: sell it to ARC.

So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).

ARC’s aim= extract maximum money out of this investment. But how?

1. Auct ion the assets fully or part ially. (sell the machinary now, rent the building and wait forland prices to go up for two years and then sell it .)

2. Sell the property in combinat ion with other NPA propert ies of other defaulters. (similar to“buy one large pizza and get 20% discount on any medium sized pizzas”).

3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per

month.4. Change the Management of that asset, appoint its own directors/of f icers.5. Order Mr.Paraajay to outsource or lease his business to a another company.

^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power tothe ARC.

ARC New Power: convert Debt into equityBefore reading further, Make sure you know the pros and cons of Debt Vs. Equity (alreadydiscussed in an old art icle click me)

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully orpart ially).

Share holding Before:Shares Rupees Cr.%Paraajay and his family20 40%Juntaa 30 60%Total shares worth 50 100%

Share holding AfterShares Rupees Cr.Approx. %Paraajay and his family20 22%Juntaa 30 33%ARC 40* 44%Total shares worth 90 100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARCpurchased it @Rs.35 crores.

Anyways, This leads to two situat ions:

1. If company starts making more prof it in future, ARC will receive more share f rom thatprof it . (because more prof it=more dividend to shareholders.)

2. If price of company’s shares go up in the sharemarket, ARC can sell those shares to thirdparty and make decent prof it .

Anti-arguments: Debt to Equity conversionCrit iques says this “debt to equity”provision will be abused. This provision is made to help badcorporates. How so? Well consider following:

Bank’s lossSBI gave Rs.40 crores loan to Mr.ParajaayHe refuses to pay loan=bad loan/NPA.Then SBI sells this bad loan f ile to an ARC company @Rs.35 crores.Hence, SBI’s loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible

interest rate that he would have paid, if he had not defaulted. And loss f igure will bedif ferent if he had paid a few installments earlier. Anyways, let ’s keep the loss at 5 crorefor the moment.)

ARC’s profitNow ARC owns the NPA assets. (their investment Rs 35 crores)Paraajay of fers Rs.37 crores and ask ARC to sell the assets to his relat ive, f riend or proxy.Hence, ARC’s prof it is 37-35=Rs.2 crores.And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to payRs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)Few years back, CVC had held a meet ing with Bank chairmans and CBI of f icers. Theyalleged ^this type of mischief going on, in many loan default cases.

Now under the new provision: if ARC converts its debt into equity (shares), then what willhappen?

1. It is very unlikely that Parajaay’s company will start making huge prof its (otherwise itwouldn’t be in bad loan problem in the f irst place!)

2. It is very unlikely that share-price of Parajaay’s company will go up in sharemarket.(because it has negat ive publicity due to NPA).

Hence it is very unlikely that ARC will make huge prof it out of this “Equity”.

Then Mr.Parajaay can simply of fer them a way out : “sell those shares to me, in myfriend,relative,driver or peon’s name @Rs.37 crores.”

And ARC would agree, because 37-35=Rs.2 crores prof it !

Side questionHow would Mr.Parajaay arrange those Rs.37 crores?

Ans. If Mr.Parajaay is “totally awesome” then he wouldn’t give 37 crores f rom his own pocket.He’d just open another company, get new loan from second bank, issue IPOs to get moneyfrom juntaa. Then Iski topi uske sar pe.

^This is (one of the many) reasons why Mr.Ratan Tata said following thing:

Overseas people go bankrupt or companies go bankrupt. Here they never do–theycont inue to be sick and st ill operate. Then they are operat ing to kill you with destruct ivecompet it ion (using predatory pricing etc.)(Airline business) is proliferated by many operators, some of them in f inancial t rouble.I would hesitate to go into the (airline) sector today in the sense that the chances arethat you would have a great deal of compet it ion which would be unhealthy compet it ion.

Bank Employee unions are also against the “Debt to Equity” clause of SARFAESI amendment.(When they had gone on strike to oppose Banking Amendment bill, they also cited this Debt-equity reason as well.)

Central RegistryPreviously, borrowers used to forged property documents and get loans from mult iplebanks by giving them duplicate property documents as security.So when borrower refuses to pay up loan, many banks would make claim for the same

property!To f ix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, underSARFAESI.This central registry has details of all propert ies against which loans have been taken.Any person or bank can inspect records of this registry to make sure the mortgagedproperty is genuine.Off icial name: Central Registry of Securitisation Asset Reconstruction and Security Interestof India (CERSAI)

Misc.Amendments1. In public interest , Union Government can issue not if icat ion that xyz provision of

SARFAESI act may not apply or may apply with modif icat ions to a class or classes ofbanks or f inancial inst itut ions. Suppose many text ile exporters have taken loans frombanks but due to global recession they are not receiving payments and hence unable torepay loans. In that case, Government can order not if icat ion that “SARFAESI will apply toall loans except those given for textile-export business.”

2. Earlier a borrower could approach Debt Recovery t ribunal (DRT) to get stay order againstbank/ARC. New amendment says DRT cannot grant any stay order unless both part ies(Borrower vs. lender bank) are heard. This will ensure the process of law is not misused byunscrupulous borrowers to get stay orders just to delay money-recovery.

3. Bill proposes to enable banks and f inancial inst itut ions to enter into set t lement orcompromise with the borrower. It also seeks to empower the Debts Recovery Tribunal topass an order acknowledging any such sett lement or compromise.

SummarySARFAESI empowers banks and other f inancial inst itut ions to at tach secured assets of aloan defaulter and sale, auct ion or manage them without requiring court intervent ion.Parliament passed the amendment to SARFAESI Act and the debt recovery t ribunal, inWinter session 2012.

Salient features of new amendment

1. Bankcan buy for the NPA property if there are no otherbidders.mult i-state co-operat ive banks can also take act ionsunder SARFAESI.

2. Borrower can’t get stay orders f rom DRT easily.Can make sett lement / compromise with Bank/ARC.

3. Asset reconstruct ioncompanies (ARC) can convert their debt into equity (fully or part ially)

4. Government can prohibit or modify SARFAESI’s applicability in publicinterest .

Apart f rom this amendment, Government has also increased foreign investment limit in ARCsfrom 49 to 74%.

Mock Questions

Q1. Which of the following are Qualif ied Inst itut ional buyers (QIB)?

1. ICICI2. LIC3. EPFO4. FII registered with SEBI

1. Only 2 and 32. Only 1 and 43. Only 2 and 44. All of them.

Q2. Which of the following is not correct about SARFAESI act?

1. It mandates the Rural regional banks to lend at least 15% of their total loans to ruralcot tage industries.

2. It empowers banks to reduce their NPAs.3. It empowers RBI to impose penalt ies on Bank responsible for NPAs.

1. Only 1 and 22. Only 2 and 33. Only 24. Only 1 and 3

Q3 Find Correct Statement

1. Foreign investment is prohibited in asset restruct ing companies.2. To enjoy the priviledges under SARFAESI act , the Asset Reconstruct ion Companies have

to get themselves registered with SEBI.

1. Only 12. Only 23. Both4. None

Boring details1. Recovery of Debts Due to Banks and Financial

Inst itut ions Act of 1993 (RDBF) Established Debt Recoverty t ribunal(DRT) and

2. Securit isat ion and Reconstruct ion of FinancialAssets and Enforcement of Security Interest Actof 2002 (SARFAESI)

Helps banks recover money from badloans.

3. Enforcement of Security Interest and Recovery ofDebts Laws (Amendment) Bill, 2011

Passed in Lok Sabha in Dec 2012, toamend above two laws (RDBF +SARFAESI)

CommitteesSARFAESI was based on recommendat ion of these two Commit tees

1. Committee on Banking Sector Reforms (Narasimham Committee II), 1998

2. Restructuring of weak Public Sector Banks -Verma Commit tee

The latest amendment (Debt to Equity), is based on recommendat ions of Alok Nigam Panel onARCs, made by Finance Ministry.

New Discussion Forum!By the way, I’ve an announcement to make. Many readers were suggest ing a discussionplat form should be created (e.g. Anthropology opt ional, RBI aspirants, RAS, CSIR, APFCetc.) Because it is not very convenient to carry on or follow discussions via thesecomments below every art icle. Plus, if you’re browsing this site via mobile phone,then every t ime you’ve to scroll-down a mile long page just to read or reply comments=very inconvenient.So, I’ve setup a dedicated forum: Mrunal.org/forumIn the same forum, I’ve setup a thread on “Current affairs marathon“, with the aim that,candidates can discuss current af fairs with each-other, or at least ment ion the topics theyconsider important, so everyone can do self -study. Here is theLink: mrunal.org/forum/discussion/3/csat-current-af fairs-marathon-2012-13.Everyone invited to part icipate.You may also start your own threads to discuss about RAS, CSIR, CDS, AFCAT etc. withyour peers.No registrat ion needed, just login with your facebook/gmail account.

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December 24th, 2012 | Category: Economy