[sbinews] SC verdict on Securitisation Act ? More bark than bite? (Businessline)

  • From: "Rajendra S. Pai" <rspai9@xxxxxxxxx>
  • To: sbinews@xxxxxxxxxxxxx
  • Date: Wed, 14 Apr 2004 20:28:55 -0700 (PDT)

SC verdict on Securitisation Act ? More bark than
Padmalatha Suresh 

(The Securitisation Act aims to achieve two
objectives: make adequate provisions for the recovery
of loans and also to foreclose the security. But the
crux of the issue is: would the Act be an effective
tool to make a drastic difference to the NPA menace in
the short run?)

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 allow 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

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 against 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. 

But the crux of the issue is: Would the Act be an
effective tool to make a drastic difference to the NPA
menace in the short run? 

As of March 2003, the total NPAs of the private and
public sector banks put together stood at a whopping
Rs 65,000 crore (Source: Trend and Progress of Banking
in India, RBI). NPAs, simply defined, are those loans
and advances in respect of which interest and/or
principal have not been paid for 180 days from the due
From April 1, 2004, however, any loan on which
interest or principal is not paid for more than 90
days would be reckoned as NPA. The banking system is,
therefore, sure to see a swelling NPA portfolio in the
current year. 

The public sector banks, major contributors to the NPA
kitty (Rs 53,000 crore as on March 2003), have the
priority sectors (47 per cent) and the non-priority
sectors (51 per cent) contributing in equal measure to
their present plight. Agriculture, small-scale
industries and `other' priority sectors, enjoy not
only a degree of security-free borrowing status but
also some immunity from action by lenders. How much of
these advances could be recovered through the
provisions of the Securitisation Act is a moot point. 

An interesting shift is noticed in the case of private
sector banks. While their legacy of NPAs is lower at
Rs 12,000 crore due to their limited presence and
limited government interference, their composition of
NPAs provides a study in contrast. The nine new
private sector banks, tech-savvy and aggressive, carry
a combined NPA level of more than Rs 7,000 crore, much
more than the 21 old private sector banks. 
It is common knowledge that these banks have been
notably driving the retail banking revolution in the
country in the last few years. The Supreme Court
verdict would help these banks in a limited manner in
respect of their corporate NPAs. 

However, in case of defaults by retail borrowers, the
banks would have to weigh the costs and benefits of
tracing each delinquent retail borrower, seizing his
assets and trying to sell them off to realise the
dues. The lenders may prefer to create homogeneous
pools of these assets and securitize them with an
asset reconstruction company (ARC) instead. 

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. 

The assets which form security for bank loans and
advances have to be valued/revalued on a periodical
basis to determine the security shortfall. The
provisions made by banks depend on this valuation. In
a period when interest rates are headed southwards,
and asset values are on a steady ascent due to
increased consumer spending, there is a possibility
that the `security' could be overvalued on paper. But
when the asset has to be liquidated or sold, reality
may fracture paper valuations. 
Then is the Act futile for the time being? On the one
hand, borrowers whose assets have been seized could be
spurred to legal recourse by the striking down of the
75 per cent down payment provision. On the other,
existing assets may not yield the desired salvage
values to the lenders. The third dimension would be
the burgeoning NPA levels due to the implementation of
the 90-day norm. This is the short-term picture. In
the medium and long term, the Securitisation Act would
ensure that both lenders and borrowers learn their
lessons. Lenders would fine-tune their appraisal and
monitoring mechanisms to prevent future NPAs, and feel
comfortable in the knowledge that securities can be
liquidated without much ado. 

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 assets. 

(The author is a financial consultant and visiting
faculty at IIMs. The views are personal. Send feedback
to padmalathasuresh@xxxxxxxxx) 

R.S.Pai, Web Address: http://rspai.tripod.com

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