Background of the sector. The following measures have

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Background
Of The Act

The
pre-eminent problem faced by banks and financial institutions is that of bad
debts euphemized as non-performing assets in banking terminology. This phrase
has its specific significance in the Act and has been designedly defined in the
Act1 to
mean an asset or account of a borrower, which has been classified by a bank or
financial institution as sub-standard, doubtful or loss asset, in accordance
with the directions or under guidelines relating to asset classifications
issued by the Reserve Bank of India.

   The Non-performing Assets (NPAs) or bad
debts of banks and financial institutions, which crossed the figure of Rs.
1,10,000 crores as on March 31, 2002, are understandably a cause of great
concern not only to the lender banks and financial institutions but also to the
Government. To deal with this grave problem, the Central Government promulgated
the Securitisation and Reconstruction of Financial Assets and Enforcement of
Securities Ordinance, 2002 on June 21, 20022.

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   The Act in hand has substituted that
Ordinance.

   The Non-Performing Assets (NPAs) or bad
debts of banks and financial institutions exceeded Rs. 1,10,000 crores as on
March 31, 2002. The Government has established 33 Debt Recovery Tribunals
(DRTs) to collect the NPAs. According to the available statistics, 33,049 cases
involving Rs. 42,989 crores are pending before the DRTs as on March 31, 2002.
With a view to recovering NPAs, the Government promulgated the Securitisation
and Reconstruction of Financial Assets and Enforcement of Securities Ordinance,
2002 on June 21, 2002.

     While presenting the Union Budget on
February 28, 2002, the Finance Minister stated, in his speech in paragraph 9 as
follows:

       “Reforms in the Banking Sector will be
continued to enhance the efficiency and competitiveness of the sector. The
following measures have either been taken or are being taken:

?  Public Sector Banks recovered Rs. 12,860 crore in
2000-01 as compared with Rs. 9,883 crore in the previous year and net NPAs as
percentage of net advances came down to 6.7% as on March 31, 2001 as compared
to 7.4% in the previous year.

 

?  29 Debt Recovery Tribunals and 5 Appellate Tribunals
have been set up as on September 30, 2001. The DRTs had disposed of 18,703
cases involving Rs. 14,026 crores. Recovery made was Rs. 3,527 crore.

 

?  To help banks and financial institutions to provision
for NPAs as required by the RBI, additional fiscal relief is being offered,
details of which will be given in part B of my speech. This will enable banks
to review their lending rates.

 

?  A new Bill on Banking Sector Reforms is proposed to be
introduced in Parliament to strengthen creditor rights through foreclosure and
enforcement of securities by banks and financial institutions. This Bill will
also enable securitisation for money locked up in long-term loans.

 

?  A pilot asset reconstruction company will be set up by
June 30, 2002 with the participation of public and private sector banks,
financial institutions and multilateral agencies. This company will initiate
measures for taking over non-performing assets in the banking sector and also
develop a market for securitised loans.”

 

The
relevant para of Part B of the speech, as referred as above, is para 167 as
reproduced below:

    “167. Presently, banks are allowed to
deduct up to 5% of their    total income
against provisions made by them for bad and 
doubtful debts. In order to strengthen the financial position of banks,
I propose to increase this allowance to 7.5% of the total    income. Further, in my budget for the year
1999-2000, I had granted an option to banks to deduct up to 5% of their
NPAs  falling in the category of loss or
doubtful assets as on the last day   of
the accounting year. I propose to enhance this optional deduction to 10%, and
also allow a similar option of deduction up  
to 10% of loss or doubtful assets to public financial institutions.”

 In para 9 of his speech, the Minister had to
say that banking sector reforms have proceeded in a phrased manner over the
past decade, yet the problem of non-performing assets with banks has continued,
and, therefore, special attention had to be and was being paid to the recovery
of NPAs. The Minister admitted that because of special attention being paid in
that direction, the Public Sector Banks had been able to recover Rs. 800 crores
of the NPAs from 2 lakh accounts in 2000-01, with the result that net NPAs as
percentage of net advances were almost half at 7.4% in 1999-2000 compared to
14.5% in 1993-94.

    The Minister assured that seven more Debt
Recovery Tribunals would be set-up during 2001-02.

    Obviously enough, the Government was alive
to the seriousness of the problem and has been taking various steps, and the
enactment of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 is a major step towards solving the
problem of bad debts and facilitating recovery.

   The enactment of the Act had been preceded
by a study conducted by various Committees set-up to gauge the problem of
banking industry and bring out suggestions; and reference deserves to be made
to the three Committees set-up for the purpose, namely, the Narasimham
Committee I; the Narasimham Committee II, and the Andhyarujina Committee on
Legal Reforms.

Narasimham Committee I

The
Narasimham Committee was constituted in 1991 relating to the financial system
prevailing in the country. It considered wide-ranging issues relevant to the
economy, banking and financing, etc. Under Chapter V of the Report under the
heading “Capital Adequacy, Accounting Policies and other Related Matters”, it
was opined that a proper system of income recognition and provisioning is
fundamental to the preservation of the strength and stability of the banking
system. It was also observed that the assets are required to be classified, it
also takes note of the fact that Reserve Bank of India had classified the
advances of a bank, one category of which was bad debts/doubtful debts. It then
mentions that according to the international practice, an asset is treated as
non-performing when the interest is overdue for at least two quarters. Income
of interest is considered as such, only when it is received and not on the
accrual basis3.

   The Committee suggested that the same should
be followed by the banks and financial institutions in India and an advance is
to be shown as non-performing asset where the interest remains due for more
than 180 days. It was further suggested that Reserve Bank of India should
prescribe clear and objective definitions in respect of advances which may have
to be treated as doubtful, standard or substandard, depending upon different
situations. Apart from recommending the setting up of Special Tribunals to deal
with the recovery of dues of the advances made by the banks, the Committee
observed that impact of such steps would be felt by the banks only over a
period of time, in the meanwhile, the Committee, also suggested for
reconstruction of assets saying:

    “The Committee has looked at the mechanism
employed under similar circumstances in certain other countries and recommends
the setting up of, if necessary by special legislation, a separate institution
by the Government of India to be known as ‘Assets Reconstruction Fund’ (ARF)
with the express purpose of taking over such assets from banks and financial
institutions and subsequently following up on the recovery of dues owed to them
from the primary borrowers.”

While
recommending for setting up of Special Tribunals, the Committee observed:

“Banks
and financial institutions at present face considerable difficulties in
recovery of dues from the clients and enforcement of security charged to them
due to the delay in the legal processes. A significant portion of the funds of
banks and financial institutions is thus blocked in unproductive assets, the
values of which keep deteriorating with the passage of time. Banks also incur
substantial amounts of expenditure by way of legal charges which add to their
overheads. The question of speeding up the process of recovery was examined in
great detail by a Committee set up by the Government under the Chairmanship of
the late Shri Tiwari. The Tiwari Committee recommended, inter alia, the setting
up of Special Tribunals which could expedite the recovery process.”

Narasimham Committee II

Report
of the Second Narasimham Committee II, as submitted in April 1998, had the
following recommendations to make, namely-

   
i)       
An Asset can be
classified as bad or doubtful in case same has continued to remain as
substandard asset for last twelve months with the resultant loss so identified
though not written off;

 
ii)       
The advances
guaranteed by the Government, liable otherwise to be classified as NPA, should
either be treated as NPA or shown separately in the balance sheet for the
purpose not other than mere transparency;

iii)       
Banks are advised
to reduce their NPAs to below 5% by year 2000 and thereafter below 3% by the
year 2002;

iv)       
All loan assets
constituting a higher proposition of NPAs and considered in the bad or loss and
doubtful category should be transferred to an Asset Reconstruction Company
(ARC) which shall issue to the concerned bank or financial institution SWAP
BONDS representing the realisable value of the bulk or assets so transferred;

 
v)       
The banking
industry should switch over to international practices with regard to
recognized income by introducing a 90 days norm;

vi)       
Provision generally
of 1% should be made on Assets of the standard category;

vii)       
Greater attention
by the banks has to be given to Asset Liability Management so as to avoid
mismatches and thereby mitigate liquidity and interest rate risks;

viii)       
There should be an
independent mechanism for reviewing and identifying potential NPAs;

ix)       
Laws should be
amended to keep pace with changing commercial practices as also to conform to
reforms made, or to be, made, in the financial sector.

In its Second Report, the Narasimham Committee observed
that NPAs in 1992 were uncomfortably high for most of the public sector banks.
In Chapter VIII of the Second Report, the Narasimham Committee deals about
legal and legislative framework and observed:

         “8.1. A
legal framework that clearly defines the rights                                      and
liabilities of parties to contracts and provides for speedy   resolution of disputes is a sina qua non for
efficient trade and commerce, especially for financial intermediation. In our
system, the evolution of the legal framework has not kept pace with changing
commercial practice and with the financial sector reforms. As a result, the
economy has not been able to reap the full benefits of the reforms process. As
an illustration, we could look at the scheme of mortgage in the Transfer of
Property Act, which is critical to the work of financial intermediaries…”

 

One of the measures recommended in the circumstances
was to vest the financial institutions through special statutes, the power of
sale of the assets without intervention of the court and for reconstruction of
assets. It is thus to be seen that the question of non-recoverable or delayed
recovery of debts advanced by the banks or financial institutions has been
attracting attention and the matter was, considered in depth by the Committees
specially constituted consisting of the experts in the field. In the prevalent
situation where the amounts of dues are huge and hope of early recovery is
less, it cannot be said that a more effective legislation for the purpose was
uncalled for or that it could not be resorted to. It is again to be noted that
after the Report of the Narasimham Committee, yet another Committee was
constituted headed by Mr. Andhyarujina for bringing about the needed steps
within the legal framework.

 

 

ANDHYARUJINA COMMITTEE

This
was a committee on Legal Reforms. This Committee, being a ten-member Committee
under the Chairmanship of Shri. T.R. Andhyarujina, former Solicitor General of
India, had been set-up in February, 1999 to formulate specific proposals for
giving effect to the suggestions as made by the Narasimham Committee. The
report of this Committee was submitted in May, 2000 and as regards legal
reforms in banking sector, had highlighted the following points as regards
bringing about the present Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act:

                   
i)       
Banks must be
vested with power of taking possession and sale of securities without
intervention of court as regards mortgaged properties;

                 
ii)       
The existing
Recovery of Debts Due to Banks and Financial Institutions Act, 1993 should be
amended to make its provisions more effective; and

               
iii)       
Amendment should
also be made in the Contract Act, 1872, by making provision of giving more time
to Banks and Financial Institutions to enforce their claims under Guarantee.

In
view of what has been stated above, there is not much substance in the
submission made on behalf of the petitioners that while the Recovery of Debts
Due to Banks and Financial Institutions Act was in operation, it was uncalled
for to have yet another legislation for the recovery of the mounting dues.
Considering the totality of circumstances and the financial climate world over,
if it was thought as a matter of policy to have yet speedier legal method to
recover the dues, such a policy decision cannot be faulted with nor is it a
matter to be gone into by the courts to test the legitimacy of such a measure
relating to financial policy4.

In
1999, the Reserve Bank of India had also set-up a Working Group on Development
of the Market for Asset Securitisation which had submitted its report in
December, 1999, identifying several impediments in the matter of securitization
and making certain suggestions. This Working Group was followed by its
successor which virtually prepared a draft Bill on Securitisation, and the same
was submitted to the Government for its consideration.

Other
policy decisions taken conterminously by the Reserve Bank of India include-

     
i)       
One Time Settlement Scheme- This Scheme was introduced in 1999; and in pursuance
of this Scheme, mainly covering small borrowers, the Public Sector Banks had
recovered a total sum of Rs. 2,192 crores pertaining to 5.23 lakh accounts as
on 30.06.2001. Although the Scheme was not extended yet  banks had the liberty to frame their own
policies both for recovery and for writing off, including compromise and
negotiated settlements conforming to Reserve Bank Guidelines issued in 1995,
and a Scheme in the name of Mid-term Monetary and Credit Policy had been
further announced on 22.10.2001, by Dr. Bimal Jalan, Governor of the Reserve
Bank of India.

 

   
ii)       
Corporate Debt Reconstruction Scheme- This Scheme was announced in the year 2001 and had its
application only to multi-banking accounts having an outstanding exposure of
Rs. 20 crore and above with banks and financial institutions.

 

  iii)       
Policy Norms for Non-Performing Assets- Stricter norms had been adopted in this policy and the
Reserve Bank of India, through its matter circular of 4.7.2000, revised its
prudential norms on Asset classification.

 

  iv)       
Monetary and Credit Policy for 2002-03- This Policy was announced by Dr. Bimal Jalan, Governor
of the Reserve Bank of India on 29.4.2002, stating that-

    “Consistent with the recommendations of
Narasimham Committee II, and with a view to moving closer to international best
practices, it is proposed that with effect from March 31, 2005, an asset would
be classified as doubtful if it remained in the sub-standard category for 12
months. Banks are permitted to phase the consequent additional provisioning
over a four-year period with a minimum of 20% each year.”

 

Subsequently a mid-term
review of this policy was announced on 29.10.2002, stating that-

     “There has been some improvement with
regard to NPAs, operating expenses and cost of funds of commercial banks. Gross
NPAs of public sector banks as a percentage of gross advances declined from
12.4% in March 2001 to 11.1% in March 2002. The net NPAs as a percentage of
advances also declined from 6.7% to 5.8% during the same period. With a view to
moving towards international best practices and to ensure greater transparency,
commercial banks were advised to adopt 90 days norm for recognition of loan
impairment from the year ending March 31, 2004. The 90 days norm has also been
made applicable to Urban Co-operative Banks and regional rural banks, w.e.f.
March 31, 2004. In order to facilitate adoption of 90 days norm for negotiation
of loan impairment from the year ending March 31, 2004, banks were advised to
switch to charging interest on advances at monthly rests with effect from April
1, 2002.”

 

Hithertofore, Section 69
of the Transfer of Property Act permitted a mortgagee to take possession of
mortgaged property and sell the same without intervention of court only in case
of English Mortgage, which is a transaction where the mortgagor binds himself
to repay the mortgage money on a certain day and transfers the mortgaged
property, absolutely to the mortgagee but subject to proviso that he will
retransfer it to the mortgagor upon payment of the mortgage money as agreed5.

 

   That apart, the mortgagee could take
possession of mortgaged property where there existed specific provision in the
mortgage deed and the mortgaged property were situated in specified towns like
Kolkata, Chennai or Mumbai, but in other cases possession of property could be
taken only by intervention of court.

 

    Taking possession of the mortgaged property
through intervention of courts for enforcement of the security interest of the
mortgagee was, of course, a slow process with the result that by the time the
secured creditor could in any case get possession of the asset, the asset had
either withered away or become of no value. There was, however, no provision
either in the Contract Act or in the law relating to hypothecation, with regard
to hypothecated asset which is equally a major security interest created in
favour of the secured creditor.

 

    The predominant suggestions made,
therefore, in the Reports of the Narasimham Committee was to empower the banks
and financial institutions to take possession of the securities and to sell
them or their part without the intervention of courts; and this recommendation
was given effect to in the text of section 13 of the Draft Bill which opened
with a non-obstante clause, thereby giving this section an overriding effect
over anything contained in section 69 or 69A of the Transfer of Property Act,
1882.

 

     The
Government on its part, consolidated, the reports of the aforesaid Narasimham
Committee as also the draft bill prepared and proposed by the Andhyarujina
Committee; and without losing time, an Ordinance with the title as that of the
Act, was promulgated by the President, in exercise of his powers under Article
123(1) of the Constitution of India, since the Parliament was not then in
session and the President was satisfied that circumstances did exist rendering
it necessary for him to take immediate action.

 

    The Ordinance being Ordinance 2 of 2002,
was thus, promulgated on June 21, 2002 and had come into force at once.

 

    With a view to replacing the Ordinance by
an Act of the same name, a Bill was introduced, on July 9, 2002, but the same
could not be passed in the Monsoon Session of the Parliament in August 2002.
Normally, therefore, the life of the Ordinance had to be extended by a fresh
Ordinance, issued again, in August, 2002, so as to replace the former
Ordinance. Finally, the Ordinance came to culminate into an Act in the winter
session of the Parliament in December, 2002 which was deemed to have come into
force on the 21st of June, 2002 i.e., the date of promulgation of
the first Ordinance.

 

    The Bill as such having been passed by both
Houses of Parliament received the assent of the President on 17th
December, 2002 and came on the statute Book with its name as the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (54 of
2002).

 

   Taking cue from certain implications of the
Supreme Court judgement in Mardia
Chemicals Ltd. v Union of India6,
the Act came to be amended through the Enforcement of Security Interest and
Recovery of Debts Laws (Amendment) Ordinance, 2004 (5 of 2004), which was
enacted by the Parliament as Enforcement of Security Interest and Recovery of
Debts Laws (Amendment) Act, 2004 (30 of 2004).

1
Section 2(1)(o) of the Act.

2
S.Venugopalan: Securitisation Ordinance- An Overview, (2002) 40 SCL (Magazine),
p.76

3
Mardia Chemicals Ltd. v Union of India, AIR 2004 SC 2371

4
Mardia Chemicals Ltd. v Union of India, AIR 2004 SC 2371

5
Section 58(c) of the Transfer of Property Act, 1882

6
Mardia Chemicals Ltd. v UOI, AIR 2004 SC 2371

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