The Hindu Business Line : SC verdict on Securitisation Act

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 procedures.

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 date.

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@yahoo.com)

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