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SARFAESI Act Management Of NPA (Non Performing Assets) – Part II

The banks and financial institutions have to approach Debts Recovery Tribunal to recover their dues from the defaulted borrowers either invoking The Recovery of Debts Due to Banks and financial Institutions Act, 1993 or SARFAESI Act of 2002. They also can invoke simultaneously both the Acts. In the case of SARFAESI ACT, it is compulsory that the account against which the recovery proceedings are to be initiated should be declared as NPA before invoking the said act. But the relevant question is whether the banks and financial institutions have to follow any guidelines of RBI before the declaration of account as NPA. It is worth noting here that immediately after the promulgation of SARFAESI Ordinance in the month of June 2002, RBI issued a circular DBS.CO.OSMOS/ B.C./ 4 /33.04.006/2002-2003 dated September 12, 2002 addressed to The Chairman/Managing Director /Chief Executive Officer of All Commercial Banks (Excluding RRBs) on Study on preventing slippage of NPA accounts wherein they have recommended certain steps to be taken to prevent slippage of accounts to NPA status and “expected that banks will work out their strategic response in keeping with the broad thrust of these guidelines.” But the big question is whether the banks and financial institutions have taken any “strategic response” as expected by RBI. That is a point to be pondered over.

Preventive steps as envisaged by RBI are as follows and the extracts of the relevant portion of the aforesaid circular of RBI are given here below.

(i) Early Recognition of the problem.

a. Recognise the problem early.

“Invariably, by the time banks start their efforts to get involved in a revival process, it’s too late to retrieve the situation – both in terms of rehabilitation of the project and recovery of bank’s dues. Identification of weakness in the very beginning (i.e., when the account starts showing first signs of weakness regardless of the fact that it may not have become NPA) is imperative. Assessment of the potential of revival may be done on the basis of a techno economic viability study. Restructuring should be attempted where, after an objective assessment of the viability and promoter’s intention (and his stake), banks are convinced of a turnaround within a scheduled timeframe.”

b. Recourse to the new ordinance. (SARFAESI ACT).

c. Early Alert System.

“The strategy for management of NPAs may be governed by the circumstances connected to each individual case. Generally, the NPA is more likely to be resolved in terms of recovery if the company is in operation. For this to be effective there must be a system of identifying the weakness in accounts at an early stage.”

d. “Under the “Early Alert” system, for internal monitoring purpose, banks may designate a time limit for overdue accounts to determine the threshold for a proactive intervention – well before the account becomes NPA.” Banks are expected to undertake an exercise to understand the impact of the early warning and alert system based on the symptoms of the impending problems so as to enable them to take preventive actions against the account becoming NPA.

e. Special Mention Accounts.

(i) “An asset may be transferred to this category once the earliest signs of sickness/ irregularities are identified. This will help banks to look at accounts with potential problems in a focused manner right from the onset of the problem, so that monitoring and remedial actions can be more effective. Once these accounts are categorized and reported as such, proper top management attention would also be ensured. Under off-site reporting, data on potential NPAs in terms of overdue position such as (i) Loans and Advances overdue for less than two quarters and (ii) Loans and Advances overdue for less than one quarter, are required to be submitted by banks on a quarterly basis.”


(ii) Identifying borrowers with genuine intent: Identifying borrowers with genuine intent from those who are non- serious with no commitment or stake in revival is a challenge confronting bankers.

“Borrowers having genuine problems due to temporary mismatch in funds flow or sudden requirements of additional funds may be entertained at the branch level, and for this purpose a special limit to tide over such contingencies may be built into the sanction process itself. This will obviate the need to route the additional funding request through the controlling offices in deserving cases, and help avert many accounts slipping into NPA category.”

(iii) Timeliness and adequacy of response:

“Longer the delay in response (in fact, sometimes branch officials may have to act suo-moto), greater the injury to the account and the asset. Time is a crucial element in any restructuring/rehabilitation strategy. Further, the response decided on the basis of techno-economic study and promoter’s commitment, has to be adequate in terms of extent of additional funding, relaxations etc. under the restructuring exercise. The package of assistance may be flexible, and where required, the bank may also look at the exit option.”

(iv) Focus on Cash Flows:

While financing, at the time of restructuring, banks may not be guided by the conventional Funds Flow Analysis only, which could yield a potentially misleading picture. Appraisal for fresh credit requirements may be done by analysing Funds Flow in conjunction with Cash Flows rather than only on the basis of Funds Flow”.

(v) Management effectiveness:

“The general perception among borrowers is that it is lack of finance that leads to sickness and NPAs. But this may not be the case all the time. Management effectiveness in tackling adverse business conditions is a very important aspect that affects a borrowing unit’s fortunes. Additional finance to an ailing unit may be committed by a bank only after basic viability of the enterprise also in the context of quality of management is examined and confirmed. Where the default is due to deeper malady, viability study or investigative audit should be done – it will be useful to have a consultant appointed as early as possible to examine this aspect. A proper techno-economic viability study must thus become the basis on which any future action can be considered.” Besides, “Here the role of frontline officials at the branch level is paramount as they are the ones who have intelligence inputs with regard to promoters’ sincerity, wherewithal, and capability to achieve a turnaround. Based on this objective assessment, banks should decide as quickly as possible whether it would be worthwhile to commit additional finance.

In this regard, banks may consider having ‘Special Investigative Audit’ of all financial transactions/business transactions, books of accounts in order to ascertain real factors that contributed to sickness of the borrower. Banks may have a panel of technical experts with proven expertise and track record for preparation of techno – economic viability study of the projects of the borrowers.

(vi) Consortium / multiple financing:

“During the exercise for assessment of viability and restructuring, a pragmatic and unified approach by all the lending banks/FIs as also sharing of all relevant information on the borrower would go a long way toward overall success of rehabilitation effort. However, there is an element of risk in any restructuring exercise, given the probability of success / failure. One may expect a success rate of 50% in restructuring efforts, for it is unrealistic to expect 100% success rate”. Further, “Corporate Debt restructuring (CDR) mechanism has been institutionalised in 2001 to provide a timely and transparent system for restructuring of the corporate debts of Rs.20 crore and above with banks and FIs on a voluntary basis and outside the legal framework. Under this system, banks may greatly benefit in terms of restructuring of large standard accounts (potential NPAs) and viable sub-standard accounts with consortium / multiple banking arrangements.”

(vii) Legal and related issues:

a. “Change in mindset regarding legal action: Legal action may be initiated once the Banks/FIs are convinced and have reached the conclusion that rehabilitation is not possible and there is no other way out. This will put pressure on the borrowers and will reduce the chances of depletion in the value of the security. In this context, the new securities ordinance, (SARFAESI ACT) as mentioned earlier, will go a long way in developing the culture of prompt repayment of banks’ / FIs’ dues.

Under this ordinance, substantial powers have been granted to the Banks / FIs for enforcement of securities without the intervention of the courts / tribunals. Similarly powers have been given to Banks / FIs to take over the management of business of the defaulting borrowers. With these special powers a strong message is being sent to the borrowers of Banks /FIs across the country. Banks would do well to capitalise on this message in dealing with recalcitrant borrowers and wilful defaulters.” It is thus very clear without any ambiguity that the banks and financial institutions can resort legal action only as a last resort and not otherwise.

b. Banks may take recourse to criminal proceedings along with civil suit where misleading information has been furnished influencing the bank’s credit decision. Also in case of value-less guarantees and diversion of funds, bank may not hesitate to initiate criminal proceedings. Also borrowers may be asked to declare on oath their borrowings, assets, and all other material facts, which can be the basis.

c. When considering a plan for the revival/rehabilitation, the lenders should retain the right to exercise control over the ownership/ management. This can be done by ensuring pledge of promoter’s shareholding to the lenders with a right to change ownership if certain covenants/stipulations are not met.”

(viii) Auditor’s Responsibility:

“In case any falsification of accounts on the part of the borrowers is observed by the banks / FIs, they should lodge a formal complaint against the auditors of the borrowers with the Institute of Chartered Accountants of India (ICAI) if it is observed that the auditors were negligent or deficient in conducting the audit to enable the ICAI to examine and fix accountability of the auditors.

With a view to monitoring end-use of funds, if the lenders desire a specific certification from the borrowers’ auditors regarding diversion / siphoning of funds by the borrower, the lender should award a separate mandate to the auditors for the purpose. To facilitate such certification by the auditors, the banks and FIs will also need to ensure that appropriate covenants in the loan agreements are incorporated to enable award of such a mandate by the lenders to the borrowers/auditors.”

(ix) Government relief:

“State Government relief (state tax waiver, subsidy etc.) in respect of accounts enjoying the same takes long time to come, thus worsening the overdue position. There is a need to work in the direction of cutting down/ reducing the time lag by closer monitoring. While it may so happen that circumstances warrant a different course of action, the above set of guidelines may be adhered to as a broader framework for preventing Study on preventing slippage of NPA accounts.”

Have the banks and financial institutions implemented the RBI recommendations in letter and spirit? Have they followed the recommendations diligently and sincerely? Do the employees and executives of the bank and financial institutions have the knowledge and expertise to faithfully carry out the recommendations of RBI particularly in handling the legal aspects? The answers to these questions are a BIG NO. The very fact that the level of NPA is ever increasing in spite of the enactment of Acts in favour of the banks and financial institutions, show that they have failed in their handling of NPA accounts and in their discharge of duty of care and concern for such accounts. Had they effectively executed the RBI recommendations, then even a 50% success rate would have made a drastic change in the entire NPA management scenario. Banks and financial institutions may not accept the realities and they may try to justify their actions presently being taken now by blaming the borrowers for creating impediments for the banks and FIs. But what are the realities?

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