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[Economy] SARFAESI Act, Asset
Reconstruction Company (ARC), Security
Receipts (SR), QIB, DRT, Central Registry
1. What is NPA?
2. Debt Recovery t ribunals (DRT)?
3. What is t he Sarf aesi Act ?
1. Appeal st ruct ure
2. Bank: Power t o Auct ion
4. What is ARC?
1. What are Securit y Receipt s (SR)?
2. What is Qualif ied Inst it ut ional Buyer (QIB)?
3. Foreign invest ment in ARC?
4. ARC New Power: convert Debt int o equit y
5. Ant i-argument s: Debt t o Equit y conversion
6. What is Cent ral Regist ry?
7. Misc.Amendment s
8. Summary
9. Mock Quest ions CSAT
10. Boring det ails
11. Commit t ees
What is NPA?
Bank gives loan t o a person.
Person f ails t o make regular payment s.
Bank gives him not ice t o correct his behavior. But he doesnt .
Bank declares t hat loan as Non-Perf orming Asset (NPA) (=Bad Loan)
Current ly Indian banks have NPAs wort h more t han Rs. 1 lakh crores.
Debt Recovery tribunals?
Prior t o 90s, banks had very hard t ime recovering bad loans.
Because of t en, borrowers (loan t akers) would f ile f rivolous cases in civil court s, t hen
taarikh pe taarikh, taarikh pe taarikh.. proceeding would go on f or years.
So 1993, Government est ablished Debt Recovery Tribunals t o deal wit h NPA mat t ers.
Now borrower cannot approach civil court , t heyve t o got o special Debt Recovery
Tribunal (DRT).
This led t o some relief , but t hen DRTs clogged down by t ruckload of cases. (Even now,
more t han 60,000 cases pending wit h DRTs)
In 2002, Government came up wit h new Act , named SARFAESI Act .
What is the Sarfaesi Act?
Securit isat ion
and Reconst ruct ion
of Financial Asset s
and Enf orcement of Securit y Int erest Act , 2002,
Suppose, Mr.Paraajay has opened f act ory wit h Rs.100 crores. He f inanced t his, via mixt ure of
Debt + equit y in f ollowing way. (make sure you underst and debt vs Equit y, if not click me)
Holder Rupees in Cr.
Equit y (IPO->Shares)
Paraajay and his f amily 20
Junt aa (public) 30
Debt (loans, Bonds) Business loan f rom SBI40
Bonds 10
Tot al 100
Init ially t he company runs well and good.
But t hen Mr.Paraajay doesnt revise his MBA books of t en, so he f orget s t he business
concept s. His company st art s making losses.
He f ails t o pay loan EMIs f or many mont hs.
SBI gives him not ice t o correct his behavior.
St ill, he doesnt st art paying money.
SBI declares t his Rs.40 crores loan NPA (Non-Perf orming Asset ).
Once a loan is declared as non-perf orming asset , SBI can t ake act ions under SARFAESI
act , t o recover t he loan money.
Bank have f ollowing powers under SARFAESI Act
1. Take possession of Mr.Paraajays asset s wit hout requiring court order. (Commericial or
resident ial, f ixed or moving asset s.)
2. Auct ion / Sale t hem.
3. Change t he administ rat ion/ Management of t hose asset s.
4. If Mr.Paraajay had sold away t he mort gaged asset t o t hird part y Mr.X, bank can order Mr.X
t o surrender t hat Asset .
5. If Mr.X owes money t o Mr.Paraajay, he can be ordered t o pay money.
*ARCs explained af t er a f ew paragraphs.
SARFAESI applies only t o loans above Rs.10 lakhs.
By t he way SARFAESI applies only t o t hose asset s mort gaged/secured t o get t he loan.
E.g. if Mr.Paraajay had t aken business-loan, SBI would have asked him t o sign away his
f act ory/machinary/vehicles/land et c. specif ic it ems as mort gage.
Hence SBI can at t ach only ^t hose asset s.
But SBI cannot t ake away Paraajays personal home-f urnit ure, expensive wrist -wat ch or
his sons bicycle in t he name of SARFAESI.
Similarly, Agricult ural land is exempt ed f rom SARFAESI at t achment .
Appeal structure
The borrower (loan t aker) has f ollowing opt ions:
Get a st ay order f rom Debt Recovert y t ribunal (DRT) against t he auct ion/sale of his
propert ies. (He cannot f ile case in Civil court s.)
Fight t he case in DRT.
If unhappy wit h DRT verdict , he can appeal t o Debt Recovery Appellat e Tribunal (DRAT).
But bef ore f iling appeal wit h DRAT, hell have t o deposit 50% of his pending loan money.
Bank: Power to Auction
First SBI cont act s t he expert s, get s valuat ion of Mr.Paraajays asset s.
Expert says theyre 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 xyz
land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes t o bid,
send us applicat ion along wit h Rs.50,000 as deposit , and t heir class 10, 12 marksheet s
and school leaving cert if icat es, duly at t est ed by a Gazet t ed of f icer.
Problem: somet imes, bidders donot t ake int erest in buying such propert ies, f act ories et c.
To f ix t his 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 at t ached t he a warehouse of Mr.Paraajay.
If t he land was in good urban area, SBI could open a new branch of f ice t here (or housing
f or it s employees).
But if plot /f act ory/house is in some remot e area= no useless f or SBIs personal business.
Under t he Banking regulat ion Act , a bank cannot keep such immovable propert y beyond 7
years, (max 12 years wit h RBIs permission).
So ult imat ely SBI will have t o auct ion it t o someone. What if t hey dont get bet t er price?
Crit iques of t he bill say, t his is not clarif ied in t he bill.
What is ARC?
Asset reconst ruct ion company (ARC).
They buy NPA (Bad loans) f rom Banks and t ry t o ext ract maximum money out of it =prof it .
Theyve t o regist er wit h Reserve Bank of India.
Examples:
1. ARCIL (Indias f irst and largest asset reconst ruct ion company (ARC))
2. Reliance Asset Reconst ruct ion Company Limit ed by Anil Ambani
In our example, SBI has NPA wort h Rs.40 crores.
ARC will buy t he NPA f ile f rom SBI at a lower rat e say 35 crores. (well, SBI is making loss,
yes, but somet hing is bet t er t han not hing.)
Besides, banks have hundreads of bad loan cases, t hey donot have t ime or manpower t o
pursue individual case, somet imes no bidders are int erest ed in auct ion. All t he f ilework and
donkey labour, In such cases, it s bet t er f or bank t o t ransf er NPA t o ARC.
But t hat doesnt mean ARC will give 35 crores t o t he SBI f rom it s own pocket !
Then how will t he Asset reconst ruct ion company (ARC) arrange f or t he money?= via
Securit y Reciept s.
What are Security Reciepts (SR)?
In above example, ARC needs Rs.35 crores t o buy a Non perf orming asset f rom SBI.
So ARC will issue securit y reciept s (SR) wort h Rs.35 crores.
Only Qualif ied Inst it ut ional buyers (QIB) can buy t hese securit y reciept s (SR).
SR are not bonds, t hey donot carry f ixed int erest rat e.
ARC will promise t o pay money on SR, when it get s money t he bad loan.
Alt hough, ARC usually promise 9% prof it on securit y reciept s (SR).
So, t hree possible sit uat ions:
1. Qualif ied inst it ut ional buyers (QIB) buy t hose securit y reciept s (SR). So Rs.35 cr cash goes
f rom QIB -> ARC -> SBI.
2. SBI it self recieves SR wort h Rs.35 crores f or f ree. (t hat means ARC will gradually pay t he
money t o SBI).
3. combinat ion of bot h: QIBs buy SR wort h 30 crores + SBI recieves f ree SR wort h 5 crores.
What is Qualified Institutional Buyer (QIB)?
These people have t he expert ise and t he f inancial muscle t o evaluat e and invest in t he capit al
market s.
Examples: (click on each t o read previous art icles on t hem)
1. Scheduled Commericial Banks
2. Foreign Inst it ut ional Invest or
3. Mut ual Funds
4. Vent ure Capit al Invest ors
5. Insurance Companies
6. Pension/ Providend Funds
Foreign investment in ARC
ARC =buy bad loans f rom banks.
ARC =arrange money f rom QIBs t o buy bad loans f rom banks.
Problem= Indian QIBs do not invest much in ARCs.
Theref ore ARCs capacit y t o buy NPA= very low.
And bank t hemselves dont have enough expert ize or manpower t o dispose t hose NPAs
quickly.
Previously Foreign invest ors could invest only upt o 49% in ARC=minorit y
shareholder=cannot inf luence company decisions.
Now, Government also increased f oreign invest ment limit in ARCs. This would at t ract
more invest ment in ARCs and help in quicker purchase and disposal of NPAs.
Foreign invest ment in ARC%
Earlier 49%
Now (December-24-2012) 74%
Anyways, back t o t he t opic, let s recap:
1. SBI had NPA. First solut ion: auct ion t he propert y. Did not work out .
2. Second solut ion: sell it t o ARC.
So, ARC purchased t he NPA wort h Rs.40 crores (at Rs.35 crores).
ARCs aim= ext ract maximum money out of t his invest ment . But how?
1. Auct ion t he asset s f ully or part ially. (sell t he machinary now, rent t he building and wait f or
land prices t o go up f or t wo years and t hen sell it .)
2. Sell t he propert y in combinat ion wit h ot her NPA propert ies of ot her def ault ers. (similar t o
buy one large pizza and get 20% discount on any medium sized pizzas).
3. Rest ruct ure t he EMIs of Mr.Paraajay. E.g. inst ead of 1 lakh per mont h, give us 75,000 per
mont h.
4. Change t he Management of t hat asset , appoint it s own direct ors/of f icers.
5. Order Mr.Paraajay t o out source or lease his business t o a anot her company.
^SARFAESI act empowers ARC t o do such t hings. The amendment Bill adds a new power t o
t he ARC.
ARC New Power: convert Debt into equity
Bef ore reading f urt her, Make sure you know t he pros and cons of Debt Vs. Equit y (already
discussed in an old art icle click me)
The new Amendment in SARFAESI, empowers ARC t o convert debt int o equit y.(f ully or
part ially).
Share holding Before:
Shares Rupees Cr.%
Paraajay and his f amily20 40%
Junt aa 30 60%
Tot al shares wort h 50 100%
Share holding After
Shares Rupees Cr.Approx. %
Paraajay and his f amily20 22%
Junt aa 30 33%
ARC 40* 44%
Tot al shares wort h 90 100%
*t hat is t he paper value of original debt (NPA loan of SBI t o Mr.Parajaay), Ot herwise ARC
purchased it @Rs.35 crores.
Anyways, This leads t o t wo sit uat ions:
1. If company st art s making more prof it in f ut ure, ARC will receive more share f rom t hat
prof it . (because more prof it =more dividend t o shareholders.)
2. If price of companys shares go up in t he sharemarket , ARC can sell t hose shares t o t hird
part y and make decent prof it .
Anti-arguments: Debt to Equity conversion
Crit iques says t his debt t o equit yprovision will be abused. This provision is made t o help bad
corporat es. How so? Well consider f ollowing:
Banks loss
SBI gave Rs.40 crores loan t o Mr.Parajaay
He ref uses t o pay loan=bad loan/NPA.
Then SBI sells t his bad loan f ile t o an ARC company @Rs.35 crores.
Hence, SBIs loss is 40-35=5 crores. (act ually more t han 5 crores, if we count t he possible
int erest rat e t hat he would have paid, if he had not def ault ed. And loss f igure will be
dif f erent if he had paid a f ew inst allment s earlier. Anyways, let s keep t he loss at 5 crore
f or t he moment .)
ARCs profit
Now ARC owns t he NPA asset s. (t heir invest ment Rs 35 crores)
Paraajay of f ers Rs.37 crores and ask ARC t o sell t he asset s t o his relat ive, f riend or proxy.
Hence, ARCs prof it is 37-35=Rs.2 crores.
And yet Mr.Parajaay successf ully saved Rs.3 crores (because originally he had t o pay
Rs.40 crores t o SBI, but he walked away by paying just Rs.37 crores!)
Few years back, CVC had held a meet ing wit h Bank chairmans and CBI of f icers. They
alleged ^t his t ype of mischief going on, in many loan def ault cases.
Now under t he new provision: if ARC convert s it s debt int o equit y (shares), t hen what will
happen?
1. It is very unlikely t hat Parajaays company will st art making huge prof it s (ot herwise it
wouldnt be in bad loan problem in t he f irst place!)
2. It is very unlikely t hat share-price of Parajaays company will go up in sharemarket .
(because it has negat ive publicit y due t o NPA).
Hence it is very unlikely t hat ARC will make huge prof it out of t his Equit y.
Then Mr.Parajaay can simply of f er t hem a way out : sell those shares to me, in my
friend,relative,driver or peons name @Rs.37 crores.
And ARC would agree, because 37-35=Rs.2 crores prof it !
Side question
How would Mr.Parajaay arrange t hose Rs.37 crores?
Ans. If Mr.Parajaay is t ot ally awesome t hen he wouldnt give 37 crores f rom his own pocket .
Hed just open anot her company, get new loan f rom second bank, issue IPOs t o get money
f rom junt aa. Then Iski topi uske sar pe.
^This is (one of t he many) reasons why Mr.Rat an Tat a said f ollowing t hing:
Overseas people go bankrupt or companies go bankrupt . Here t hey never dot hey
cont inue t o be sick and st ill operat e. Then t hey are operat ing t o kill you wit h dest ruct ive
compet it ion (using predat ory pricing et c.)
(Airline business) is prolif erat ed by many operat ors, some of t hem in f inancial t rouble.
I would hesit at e t o go int o t he (airline) sect or t oday in t he sense t hat t he chances are
t hat you would have a great deal of compet it ion which would be unhealt hy compet it ion.
Bank Employee unions are also against t he Debt t o Equit y clause of SARFAESI amendment .
(When t hey had gone on st rike t o oppose Banking Amendment bill, t hey also cit ed t his Debt -
equit y reason as well.)
Central Registry
Previously, borrowers used t o f orged propert y document s and get loans f rom mult iple
banks by giving t hem duplicat e propert y document s as securit y.
So when borrower ref uses t o pay up loan, many banks would make claim f or t he same
propert y!
To f ix t his problem, Reserve Bank of India (RBI) set up Cent ral Regist ry in 2011, under
SARFAESI.
This cent ral regist ry has det ails of all propert ies against which loans have been t aken.
Any person or bank can inspect records of t his regist ry t o make sure t he mort gaged
propert y is genuine.
Of f icial name: Central Registry of Securitisation Asset Reconstruction and Security Interest
of India (CERSAI)
Misc.Amendments
1. In public int erest , Union Government can issue not if icat ion t hat xyz provision of
SARFAESI act may not apply or may apply wit h modif icat ions t o a class or classes of
banks or f inancial inst it ut ions. Suppose many t ext ile export ers have t aken loans f rom
banks but due t o global recession t hey are not receiving payment s and hence unable t o
repay loans. In t hat case, Government can order not if icat ion t hat SARFAESI will apply to
all loans except those given for textile-export business.
2. Earlier a borrower could approach Debt Recovery t ribunal (DRT) t o get st ay order against
bank/ARC. New amendment says DRT cannot grant any st ay order unless bot h part ies
(Borrower vs. lender bank) are heard. This will ensure t he process of law is not misused by
unscrupulous borrowers t o get st ay orders just t o delay money-recovery.
3. Bill proposes t o enable banks and f inancial inst it ut ions t o ent er int o set t lement or
compromise wit h t he borrower. It also seeks t o empower t he Debt s Recovery Tribunal t o
pass an order acknowledging any such set t lement or compromise.
Summary
SARFAESI empowers banks and ot her f inancial inst it ut ions t o at t ach secured asset s of a
loan def ault er and sale, auct ion or manage t hem wit hout requiring court int ervent ion.
Parliament passed t he amendment t o SARFAESI Act and t he debt recovery t ribunal, in
Wint er session 2012.
Salient features of new amendment
1. Bank
can buy f or t he NPA propert y if t here are no ot her
bidders.
mult i-st at e co-operat ive banks can also t ake act ions
under SARFAESI.
2. Borrower
cant get st ay orders f rom DRT easily.
Can make set t lement / compromise wit h Bank/ARC.
3. Asset reconst ruct ion
companies (ARC) can convert t heir debt int o equit y (f ully or part ially)
4. Government can prohibit or modif y SARFAESIs applicabilit y in public
int erest .
Apart f rom t his amendment , Government has also increased f oreign invest ment limit in ARCs
f rom 49 t o 74%.
Mock Questions
Q1. Which of t he f ollowing are Qualif ied Inst it ut ional buyers (QIB)?
1. ICICI
2. LIC
3. EPFO
4. FII regist ered wit h SEBI
1. Only 2 and 3
2. Only 1 and 4
3. Only 2 and 4
4. All of t hem.
Q2. Which of t he f ollowing is not correct about SARFAESI act ?
1. It mandat es t he Rural regional banks t o lend at least 15% of t heir t ot al loans t o rural
cot t age indust ries.
2. It empowers banks t o reduce t heir NPAs.
3. It empowers RBI t o impose penalt ies on Bank responsible f or NPAs.
1. Only 1 and 2
2. Only 2 and 3
3. Only 2
4. Only 1 and 3
Q3 Find Correct St at ement
1. Foreign invest ment is prohibit ed in asset rest ruct ing companies.
2. To enjoy t he priviledges under SARFAESI act , t he Asset Reconst ruct ion Companies have
t o get t hemselves regist ered wit h SEBI.
1. Only 1
2. Only 2
3. Bot h
4. None
Boring details
1. Recovery of Debt s Due t o Banks and Financial
Inst it ut ions Act of 1993 (RDBF)
Est ablished Debt Recovert y t ribunal
(DRT) and
2. Securit isat ion and Reconst ruct ion of Financial
Asset s and Enf orcement of Securit y Int erest Act
of 2002 (SARFAESI)
Helps banks recover money f rom bad
loans.
3. Enf orcement of Securit y Int erest and Recovery of
Debt s Laws (Amendment ) Bill, 2011
Passed in Lok Sabha in Dec 2012, t o
amend above t wo laws (RDBF +
SARFAESI)
Committees
SARFAESI was based on recommendat ion of t hese t wo Commit t ees
1. Commit t ee on Banking Sect or Ref orms (Narasimham Commit t ee II), 1998
2. Rest ruct uring of weak Public Sect or Banks -Verma Commit t ee
The lat est amendment (Debt t o Equit y), is based on recommendat ions of Alok Nigam Panel on
ARCs, made by Finance Minist ry.
New Discussion Forum!
By t he way, Ive an announcement t o make. Many readers were suggest ing a discussion
plat f orm should be creat ed (e.g. Ant hropology opt ional, RBI aspirant s, RAS, CSIR, APFC
et c.) Because it is not very convenient t o carry on or f ollow discussions via t hese
comment s below every art icle. Plus, if youre browsing t his sit e via mobile phone,
t hen every t ime youve t o scroll-down a mile long page just t o read or reply comment s=
very inconvenient .
So, Ive set up a dedicat ed f orum: Mrunal.org/f orum
In t he same f orum, Ive set up a t hread on Current af f airs marat hon, wit h t he aim t hat ,
candidat es can discuss current af f airs wit h each-ot her, or at least ment ion t he t opics t hey
consider import ant , so everyone can do self -st udy. Here is t he
Link: mrunal.org/f orum/discussion/3/csat -current -af f airs-marat hon-2012-13.
Everyone invit ed t o part icipat e.
You may also st art your own t hreads t o discuss about RAS, CSIR, CDS, AFCAT et c. wit h
your peers.
No regist rat ion needed, just login wit h your f acebook/gmail account .
Previous Posts
1. [Economy] Banking Amendment Bill: Issues, Feat ures, Problems, Ref orms meaning
explained
2. [Economy] Capit al Goods and Capit al Gains: Meaning, Dif f erence Explained
3. [Economy] GMR-Maldives Airport Cont roversy, IFC, AAI: Meaning, Reason, Implicat ions,
Explained
4. [Economy] Inf rast ruct ure Debt Funds (IDF), Wit hholding Tax, EPFO Angle: Meaning,
Concept , Explained
5. [Economy] Fiscal Clif f : Meaning, Reasons, Implicat ions on US and Indian Economy
explained
6. [Economy] Nat ional Invest ment Board (NIB): Meaning, Funct ions, Ant i-Argument s
7. [Economy] 2G scam, Spect rum ref arming, Sist ema cont roversy, Allocat ion of Nat ural
Resources explained
8. [Economy] Collect ive Invest ment Scheme (CIS) and Mult i-Layer Market ing Frauds
9. [Economy] High GDP and High Corrupt ion: Cause or Consequence?
December 24t h, 2012 | Cat egory: Economy