CHAPTER:1

NPA:ASSET RECONSTRUCTION COMPANIES

1) NPA
A Non-performing asset (NPA) is defined as a credit facility in respect of which
the interest and/or installment of principalhas remained ‘past due’ for a specified period of
time.NPA is a classification used by financial institutions that refer to loans that are in
jeopardy of default. Once the borrower has failed to make interest or principle payments for
90 days the loan is considered to be a non-performing asset. Non-performing assets are
problematic for financial institutions since they depend on interest payments for income.
Troublesome pressure from the economy can lead to a sharp increase in non-performing
loans and often results in massive write-downs.With a view to moving towards international
best practices and to ensure greater transparency, it had been decided to adopt the ‘90 days’
overdue’ norm for identification of NPA, from the year ending March 31, 2004. Accordingly,
with effect from March 31, 2004, a non-performing asset (NPA) is a loan or an advance
where;

 Interest and/or installment of principal remain overdue for a period of more than 90 days
in respect of a term loan,
 The account remains ‘out of order’ for a period of more than 90 days, in respect of
an Overdraft/Cash Credit (OD/CC),
 The bill remains overdue for a period of more than 90 days in the case of bills purchased
and discounted,
 Interest and/or installment of principal remains overdue for two harvest seasons but for a
period not exceeding two half years in the case of an advance granted for agricultural
purposes.

1
 Any amount to be received remains overdue for a period of more than 90 days in respect
of other accounts.
 Non submission of Stock Statements for 3 Continuous Quarters in case of Cash Credit
Facility.
 No active transactions in the account (Cash Credit/Over Draft/EPC/PCFC) for more than
90 days.
 Classification of N.P.A:-

Banks are required to classify non-performing assets further into the following three
categories based on the period for which the asset has remained non-performing and the
reliability of the dues:

1. Sub-standard assets: a sub standard asset is one which has been classified as NPA for a
period not exceeding 12 months.
2. Doubtful Assets: a doubtful asset is one which has remained NPA for a period
exceeding 12 months.
3. Loss assets: where loss has been identified by the bank, internal or external auditor or
central bank inspectors. But the amount has not been written off, wholly or partly.

Sub-standard asset is the asset in which bank have to maintain 15% of its reserves. All
those assets which are considered as non-performing for period of more than 12 months are
called as Doubtful Assets. All those assets which cannot be recovered are called as Loss
Assets.

2
 CHAPTER:2
NPA IN BANKING

1) BANK
A bank is a financial intermediary that accepts deposits and channels those deposits
into lending activities, either directly by loaning or indirectly through capital markets. A bank
links together customers that have capital deficits and customers with capital surpluses. Due
to their importance in the financial system and influence on national economies, banks
are highly regulated in most countries. Most nations have institutionalized a system known
as fractional reserve banking. They are generally subject to minimum capital
requirementsbased on an international set of capital standards, known as the Basel Accords.

Banking in its modern sense evolved in the 14th century in the rich cities of Renaissance
Italy but in many ways was a continuation of ideas and concepts of credit and lending that
had its roots in the ancient world.

Non-performing assets, also called non-performing loans, are loans,made by a bank or

finance company, on which repayments or interest payments are not being made on time. A
loan is an asset for a bank as the interest payments and the repayment of theprincipal create a
stream of cash flows. It is from the interest payments that a bank makes its profits. Banks
usually treat assets as non-performing if they are not serviced for some time. If payments are
late for a short time a loan is classified as past due. Once a payment becomes really late
(usually 90 days) the loan classified as non-performing.

A high level of non-performing assets compared to similar lenders may be a sign of

problems, as may a sudden increase. However this needs to be looked at in the context of the
type of lending being done. Some banks lend to higher risk customers than others and
therefore tend to have a higher proportion of non-performing debt, but will make up for this
by charging borrowers higher interest rates, increasing spreads. A mortgage lender will
3
almost certainly have lower non-performing assets than a credit card specialist, but the latter
will have higher spreads and may well make a bigger profit on the same assets, even if it
eventually has to write off the non-performing loans.

 Bank crisis

Banks are susceptible to many forms of risk which have triggered occasional systemic
crises. These include liquidity risk (where many depositors may request withdrawals in
excess of available funds), credit risk (the chance that those who owe money to the bank will
not repay it), and interest rate risk (the possibility that the bank will become unprofitable, if
rising interest rates force it to pay relatively more on its deposits than it receives on its loans).
Banking crises have developed many times throughout history, when one or more risks have
emerged for a banking sector as a whole. Prominent examples include the bank runthat
occurred during the Great Depression, the U.S. Savings and Loan crisis in the 1980s and
early 1990s, the Japanese banking crisis during the 1990s, and the sub-prime mortgage
crisis in the 2000s.

 Economic functions
The economic functions of banks include:

1. Issue of money, in the form of banknotes and current accounts subject to check or
payment at the customer's order. These claims on banks can act as money because they
are negotiable or repayable on demand, and hence valued at par. They are effectively
transferable by mere delivery, in the case of banknotes, or by drawing a check that the
payee may bank or cash.
2. Netting and settlement of payments – banks act as both collection and paying agents
for customers, participating in interbank clearing and settlement systems to collect,
present, be presented with, and pay payment instruments. This enables banks to
economize on reserves held for settlement of payments, since inward and outward

4
 payments offset each other. It also enables the offsetting of payment flows between
geographical areas, reducing the cost of settlement between them.
3. Credit intermediation – banks borrow and lend back-to-back on their own account as
middle men.
4. Credit quality improvement – banks lend money to ordinary commercial and personal
borrowers (ordinary credit quality), but are high quality borrowers. The improvement
comes from diversification of the bank's assets and capital which provides a buffer to
absorb losses without defaulting on its obligations. However, banknotes and deposits
are generally unsecured; if the bank gets into difficulty and pledges assets as security,
to raise the funding it needs to continue to operate, this puts the note holders and
depositors in an economically subordinated position.
5. Asset liability mismatch/Maturity transformation – banks borrow more on demand debt
and short term debt, but provide more long term loans. In other words, they borrow
short and lend long. With a stronger credit quality than most other borrowers, banks
can do this by aggregating issues (e.g. accepting deposits and issuing banknotes) and
redemptions (e.g. withdrawals and redemption of banknotes), maintaining reserves of
cash, investing in marketable securities that can be readily converted to cash if needed,
and raising replacement funding as needed from various sources (e.g. wholesale cash
markets and securities markets).
6. Money creation – whenever a bank gives out a loan in a fractional-reserve
banking system, a new sum of virtual money is created.

 NPA INSURANCE BROKER GROUP:-

Established in 1997, UNA is a unique force in the Insurance Broking market place.
Owned solely by its 12 Members, it offers customers a quality independent service, with the
expertise and shared resources of over 35 locations nationwide. With a combined staff of over
1,000 placing in excess of £350M of premium into the UK market, through our values of
“strength in unity”, UNA is one of the key buying groups within the Insurance Industry

5
giving its membership increased negotiating power with insurers and access to exclusive
covers and policy wordings. The NPA Insurance Broking Group has been carefully selected
to join UNA, sharing common goals, retaining independence and offering best of breed
customer service, expertise and insurance solutions for their clients.

6
 CHAPTER:3

Causes for Non Performing Assets

A strong banking sector is important for a flourishing economy. The failure of the
banking sector may have an adverse impact on other sectors. The Indian banking system,
which was operating in a closed economy, now faces the challenges of an open economy.On
one hand a protected environment ensured that banks never needed to develop sophisticated
treasury operations and Asset Liability Management skills.On the other hand a combination
of directed lending and social banking relegated profitability and competitiveness to the
background. The net result was unsustainable NPAs and consequently a higher effective cost
of banking services. One of the main causes of NPAs into banking sector is the directed loans
system under which commercial banks are required a prescribed percentage of their credit
(40%) to priority sectors. As of today nearly 7 percent of Gross NPAs are locked up in 'hard-
core' doubtful and loss assets, accumulated over the years.

The problem India Faces is not lack of strict prudential norms but

I. The legal impediments and time consuming nature of asset disposal proposal.
II. Postponement of problem in order to show higher earnings.
III. Manipulation of debtors using political influence.
 Macro Perspective Behind NPAs

A lot of practical problems have been found in Indian banks, especially in public sector
banks. For Example, the government of India had given a massive wavier of Rs. 15,000 Crs.
under the Prime Minister ship of Mr. V.P. Singh, for rural debt during 1989-90. This was not
a unique incident in India and left a negative impression on the payer of the loan.Poverty
elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on various
grounds in meeting their objectives. The huge amounts of loan granted under these schemes

7
were totally unrecoverable by banks due to political manipulation, misuse of funds and non-
reliability of target audience of these sections. Loans given by banks are their assets and as
the repayments of several of the loans were poor, the quality of these assets was steadily
deteriorating. Credit allocation became 'Lon Melas', loan proposal evaluations were slack and
as a result repayments were very poor.

There are several reasons for an account becoming NPA.

 Internal factors
 External factors
 Internal factors:
1. Funds borrowed for a particular purpose but not use for the said purpose.
2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
5. In-ability of the corporate to raise capital through the issue of equity or other debt
instrument from capital markets.
6. Business failures.
7. Diversion of funds for expansion\modernization\setting up new projects\ helping or
promoting sister concerns.
8. Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-
appropriation etc
9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-
ups, delay in settlement of payments\ subsidiaries by government bodies etc.
10.Improper appraisal of the credit proposal / credit requirements.
11.Lack of Supervision and follow up.
12.Vested interest
13.Improper treatment to borrowers (attitude as well as system constraints)

8
 The internal factors leading to NPAs may work at either institutional level or
Borrower’s level or both.

A. Institutional level:
The Institution’s philosophy, its policy, procedure and people should be well
coordinated.Very often aggressive lending policy and absence of well designed
Procedures for sanctioning advances result in high NPA levels. Before sanctioning loans
gathering, processing and analyzing information are at the heart of decision making, failing
which the bank’s loan portfolio gets ruined. Appraisal deficiencies have put many banks in
difficult conditions. In addition, delays in sanctioning loans and inappropriate repayment
schedules worsen the situation. At post sanction stage inappropriate disbursement and Lack
of adequate supervision / monitoring develop problems and losses. For example, sound loans
at the initial stage are not good for any bank.

 Other Causes:
Credit concentration deficiency causes NPAs as lack of information regarding
repaid or growing areas for financing hinder accuracy. Secondly, credit process issues like
sanctioning advances under unsatisfactory terms, violating credit principles lead to
destruction of the bank. Over extension of credit to directors, large share holders and lending
under pressure from interested parties also cause trouble.Technical in competence and lack of
complacency also cause NPAs. Inadequate supervision unfamiliar borrowers and dependence
on oral information instead of reliable complete financial data, optimistic interpretation of
credit weakness are dangerous.Poor selection of risks involving highly leveraged loans to
establish business situation were bank financed share of required capitals is large related to
the equity investment of owners, may also cause unpleasant situation. Lack of assessment of
the credit worthiness of borrowers is get another reason for high NPAs. Loans based on
expectations of successful completions of business rather than borrowers‟ creditworthiness

9
are always at risk. Loans made because of benefits such as large balance in deposits in a bank
rather than on sound security or collateral are also not advisable. Loans against problematic
collaterals might also cause NPAs. Liquidation of such collaterals and loans against
collaterals without adequate margin create hurdles for a bank.

B. Borrowers’ Level;
Project related problems, managerial aspects like failure in marketing,
inefficient management, labour problems and product obsolesces cause NPAs. Also,financial
indiscipline like diversion of funs for different purposes is another cause of this situation.

 External factors:
1. Sluggish legal system -

o Long legal tangles

o Changes that had taken place in labour laws
o Lack of sincere effort.

2. Scarcity of raw material, power and other resources.

3. Industrial recession.
4. Shortage of raw material, raw material\input price escalation, power shortage,
industrial recession, excess capacity, natural calamities like floods, accidents.
5. Failures, non-payment\over dues in other countries, recession in other countries,
externalization problems, adverse exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.
7. Recession in economy / industry not visualized earlier.
8. Failure of the product or service to take off.
9. Internal conflict among the promoters.
10.Mismanagement of the unit.
10
 11.Willful default.

The external factors are those factors that lead advances into NPA beyond the
control of borrowers or institution i.e. banks. Such factors are natural calamities, state of
economy, recession or competition, trade policy, technological , advances, regulatory
advances , environmental pollution control requirements, lack of adequate support from the
legal system , loan waivers etc. These factors are not exhaustive but inclusive. The factors
that affect the NPAs would reflect in the policies of the bank especially for lending, recovery
management, monitoring and effective supervision. If proper attention is not given to
recovery Management of NPAs, banks will lose their profitability and will not be able to
satisfy its creditors and share holders.

 Steps taken &affect on bank of NPA:-

A) Various Steps for Reducing NPAs

1. Prepare a loan recovery policy and strategies for reducing NPAs.

2. Create special recovery cells as head office/Zonal office/ regional office levels identify
critical branches for recovery
3. Fix targets of recovery and draw time bound action programmer
4. Select proper techniques for solving the problem of each NPA
5. Monitor implementing of the time bound action plan
6. Take corrective steps when ever found necessary while monitoring the action planand
make changes in the original plan if necessary

B) The impact of NPAs on the profitability of the banks is summarized in the following
points

1. Reduces earning capacity of the assets: NPA‟s reduced the earning capacity of the
assets and as a result of this return on assets get affected.

11
2. Blocks capital: NPA‟s carry risk weight of 100% (to the extent it is uncovered).
Therefore they block capital for maintaining Capital adequacy. As NPA‟s do not earn
any income, they are adversely affecting “Capital Adequacy Ratio” of the bank.
3. Incurrence of additional cost: Carrying of NPA’s require incurrence of “Cost of Capital
Adequacy” Cost of funds in NPA’s and Operating cost for monitoring and recovering
NPA’s.
4. Reduces EVA: While calculating Economic Value Added (EVA =Net operating profit
after tax minus cost of capital) for measuring performance towards shareholders value
creation, cumulative loan loss provisions on NPAs s considered as capital. Hence, it
increases cost of capital and reduces EVA.
5. Low yield on advances: Due to NPAs, yield on advances shows a lower figure than
actual yield on “standard Advances”. The reasons that yield are calculated on weekly
average total advances including NPAs.
6. Affect on Return on Assets: NPAs reduce earning capacity of the assets and as a result
of this, ROA gets affected.

12
 CHAPTER:4

Measures taken for reducing N.P.A

1. Debt Recovery Tribunals (DRTs)

Narasimham Committee Report I (1991) recommended the setting up of Special

Tribunals to reduce the time required for settling cases. Accepting the recommendations,
Debt Recovery Tribunals (DRTs) were established. There are 22 DRTs and 5 Debt Recovery
Appellate Tribunals. This is insufficient to solve the problem all over the country (India).
Banking NPA News

Revitalise debt tribunals: Supreme Court tells Government At least Rs. 1.57 lakh crore
that is locked in dispute between borrower private institutions and lender government
financial institutions could be open for public investments if the government expeditiously
sets up debt recovery tribunals, arms them with efficient officers and strengthens them with
modern technology tools. There are 33 debt recovery tribunals (DRT) in India, with three
each in Chennai, Delhi, Kolkata and Mumbai. Delhi, Kolkata and Mumbai have the
maximum number of pending cases. Taking note of the government’s neglect in setting up
the tribunals, which is the sole forum for debt recovery, the Supreme Court has passed a slew
of directions with a view to decrease the mounting recovery dispute suits and to ensure
efficiency of administration. It is reported that by March last year, a whopping 67,524 cases
were pending for resolution in 33 DRTs and five debt recovery appellate tribunals (DRAT).
This figure demonstrates a steep 80% jump in a span of 15 months from 37,616 cases
pending at the end of 2010. In a recent study, the industry body Assocham said, the net non-
performing assets (NPAs) of Indian banks may surge by 27% to Rs2,00,000crore by March
2013. While disposing of a lawsuit filed by the Union government challenging a judgment by
the Punjab and Haryana High Court that asked it to complete the building for DRTs and
DRATs within three years, the top court has, for the time being, allowed the government to

13
house them in leased premises. In due course, however, the court said every debt recover
authority must function from functional premises, equipped with computers and efficient and
legally qualified personnel to speedily dispose of the pending disputes. Realising the
importance of such semi-judicial tribunals, the judges also asked all the high courts to ensure
that the tribunals don’t suffer from any more government apathy. Before the Recovery of
Debts Due to Banking and Financial Institutions Act, 1993came into being, all banks and
financial institutions were required to move the already pendency-bogged down civil courts.
That delayed disposal of such suits on account of heavy dockets resulting in undue delay in
recovery of loans and enforcement of securities.

2. Securitization Act 2002

Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interest Act 2002 is popularly known as Securitization Act. This act enables the banks to
issue notices to defaulters who have to pay the debts within 60 days. Once the notice is issued
the borrower cannot sell or dispose the assets without the consent of the lender. The
Securitization Act further empowers the banks to take over the possession of the assets and
management of the company. The lenders can recover the dues by selling the assets or
changing the management of the firm. The Act also enables the establishment of Asset
Reconstruction Companies for acquiring NPA. According to the provisions of the Act, Asset
Reconstruction Company of India Ltd. with eight shareholders and an initial capital of Rs. 10
crores has been set up. The eight shareholders are HDFC, HDFC Bank, IDBI, IDBI Bank,
SBI, ICICI, Federal Bank and South Indian Bank.

3. LokAdalats

LokAdalats have been found suitable for the recovery of small loans. According to RBI
guidelines issued in 2001. They cover NPA up to Rs. 5 lakhs, both suit filed and non-suit
filed are covered. LokAdalats avoid the legal process. The Public Sector Banks had recovered
Rs. 40 Crores by September 2001.

14
4. Compromise Settlement

Compromise Settlement Scheme provides a simple mechanism for recovery of NPA.

Compromise Settlement Scheme is applied to advances below Rs. 10 Crores. It covers suit
filed cases and cases pending with courts and DRTs (Debt Recovery Tribunals). Cases of
Willful default and fraud were excluded.

5. Credit Information Bureau

A good information system is required to prevent loans from turning into a NPA. If a
borrower is a defaulter to one bank, this information should be available to all banks so that
they may avoid lending to him. A Credit Information Bureau can help by maintaining a data
bank which can be assessed by all lending institutions.

6. The Securitization Companies and Reconstruction Companies (Reserve

Bank) Guidelines and Directions, 2003

The Reserve Bank of India, having considered it necessary in the public interest, and
being satisfied that, for the purpose of enabling the Reserve Bank to regulate the financial
system to the advantage of the country and to prevent the affairs of any Securitisation
Company or Reconstruction Company from being conducted in a manner detrimental to the
interest of investors or in any manner prejudicial to the interest of such Securitisation
Company or Reconstruction Company, it is necessary to issue the guidelines and directions
relating to registration, measures of asset reconstruction, functions of the company, prudential
norms, acquisition of financial assets and matters related thereto, as set out below, hereby, in
exercise of the powers conferred by Sections 3, 9, 10 and 12 of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, issues to
every Securitization Company or Reconstruction Company, the guidelines and directions
hereinafter specified.
15
  Scheme of the Act

The Securitisation Act contains 41 sections in 6 Chapters and a Schedule. Chapter 1

contains 2 sections dealing with the applicability of the Securitisation Act and definitions of
various terms. Chapter 2 contains 10 sections providing for regulation of Securitisation and
reconstruction of financial assets of banks and financial institutions, setting up of
Securitisation and reconstruction companies and matters related thereto. Chapter 3 contains 9
sections providing for the enforcement of security interest and allied and incidental matters.
Chapter 4 contains 7 sections providing for the establishment of a Central Registry,
registration of Securitisation, reconstruction and security interest transactions and matters
related thereto. Chapter 5 contains 4 sections providing for offences, penalties and
punishments. Chapter 6 contains 10 sections providing for routine legal issues.

 Salient features.

The salient features of the Securitisation Act are as under:

 Incorporation of Special Purpose Vehicles viz. Securitisation Company and

Reconstruction company.
 Securitisation of Financial Assets.
 Funding of securitisation.
 Asset Reconstruction.
 Enforcing security interest i.e. taking over the assets given as security for the loan.
 Establishment of Central Registry for regulating and registering securitization
transactions.
 Offences & Penalties.
 Boiler - plate provisions.
 Dilution of provisions of SICA.

16
  Exempted transactions

 Incorporation & Registration of Special Purpose Companies

The Securitisation Act proposes to securitise and reconstruct the financial assets
through two special purpose vehicles viz. 'Securitisation Company ('SCO')' and
'Reconstruction Company (RCO)'. SCO and RCO ought to be a company incorporated under
the Companies Act,1956 having securitisation and asset reconstruction respectively as main
object.The Securitisation Act requires compulsory registration of SCO and RCO under the
Securitisation Act before commencing its business. Further a minimum financial stability
requirement is also provided by requiring SCO and RCO to possess owned fund of Rs.2 crore
or up to 15% of the total financial assets acquired or to be acquired. The RBI has the power to
specify the rate of owned fund from time to time. Different rates can be prescribed for
different classes of SCO and RCO. Existing SCO and RCO are also required to get registered
under the Securitisation Act. The application for registration will have to be made to RBI.The
SCO or RCO which has obtained the registration certificate under the Securitisation Act shall
be a Public Financial Institution within the meaning of Section 4A of the Companies Act,
1956.Besides it's core business of securitisation and asset reconstruction a SCO/RCO may
perform the following functions:

 Acting as recovery agent on behalf of any bank or financial institution.

 Acting as manager1 to manage the secured assets the possession of which has been
taken over by the secured creditor.
 Acting as receiver if appointed by any Court or Debt Recovery Tribunal.

A SCOO or RCOO, which is carrying on any other business other than that of
securitisation or asset reconstruction before commencement of the Securitisation Act, has to
discontinue such other business within one year from the commencement of the
Securitisation Act.

17
  Securitisation of financial Assets

Under the Securitisation Act only banks and financial institutions can securitise their
financial assets pertaining to NPAs with a securitisation company. Securitisation means,
according to the Securitisation Act, acquisition of financial assets by any securitisation
company or reconstruction company from any financial institution or banks. The necessary
funds for such acquisition may be raised from 'qualified institutional buyers ('QIB')' 2, by
issuing security receipts3 representing undivided interest in such financial assets or other
wise.

Financial assets are as under:

 A claim to any debt or receivables or part thereof, whether secured or unsecured.

 Any debt or receivables secured by, mortgage of, or charge on, immovable property.
 A mortgage, charge, hypothecation or pledge of movable property.
 Any right or interest in the security whether full or part underlying such debt or
receivables.
 Any beneficial interest in property, whether movable or immovable, or in such debts,
receivables, whether such interest is existing, future, accruing, conditional or
contingent.
 Any financial assistance.

The much-needed legal framework for the securitisation of financial assets has been
made by the enactment of the Securitisation Act. Securitisation of financial assets is a
financial tool for the lenders to securitise their future cash flows from the secured assets and
thus to release their funds blocked in them. In the hands of the SCO and RCO the secured
assets become "merchandise", realisation of which gives them their return. This aspect brings
in the much-needed expertise in adept handling in realisation of the secured assets. The legal
impediments of normal civil law procedure to foreclose the mortgaged assets have thus been
effectively removed by empowering the enforcement of the secured assets. Securitisation of
18
financial assets may take some time to fructify as it requires sound accounting principles also
for which standards to be prescribed. In other words there should be accounting framework,
as well, besides legal framework.

 Acquisition of Rights and interests in financial assets.

This is the main part of securitisation. Section 5 provides for the acquisition of rights or
interests in financial assets of any bank or financial institution by SCO / RCO,
notwithstanding any thing contrary contained in any agreement or any other law for the time
being in force, in either of the following manner:

 Issuing a debenture or bond or any other security in the nature of debenture, as

consideration agreed upon by a SCO /RCO and bank/financial institution,
incorporating therein the terms and conditions of issue.
 Entering into an agreement with bank/financial institution for the transfer of such
financial assets on such terms and conditions as may be agreed upon.

Upon acquiring the financial assets from the bank/financial institution, the SCO/RCO
steps into the shoes of the lender qua the borrower. The Securitisation Act has provided for
all necessary rights and powers for SCO/RCO to realize the financial assets from the
borrower.

 Funding of Securitisation.

The SCO/RCO may raise the necessary funds, for the acquisition of financial assets,
from the QIB by issuing a security receipt. Security receipt is exempted from compulsory
registration under the Registration Act. Security receipts issued by any SCO or RCO shall be
"securities" within the meaning of Section 2(h)(ic) of the Securities Contracts (Regulation)
Act, 1956.A Scheme of acquisition has to be formulated for every acquisition detailing
therein the description of financial assets under acquisition, the quantum of investment, rate

19
of return assured etc. Further separate and distinct accounts have to be maintained in respect
of each scheme of acquisition. Realizations made from the financial assets have to be held
and applied towards the redemption of investments and payment of assured returns.In the
event of non-realization of financial assets, the QIB holding not less than 75% of the total
value of the security receipts issued, are entitled to call a meeting of all QIB and pass
resolution and every such resolution is binding on the SCO/RCO.

 Assets Reconstruction

A SCO or RCO may, according to the guidelines prescribed by RBI, carry out asset
reconstruction in any one of the following manners:

 Taking over the management of the business of the borrower.

 Changing the management of the business of the borrower.
 Selling or leasing of a part or whole of the business of the borrower.
 Rescheduling of the payment schedule of the debt.
 Enforcing the security interest.
 Entering into settlement with the borrower for the payment of debt.

However, the above measures are subject to the provisions contained in any other law
for the time being in force.

 Enforcing Security Interest

The second objective of the Securitisation Act is to provide for the enforcement of
security interest i.e. taking possession of the assets given as security for the loan. Section 13
of the Securitisation Act contains elaborate provisions for a lender (referred to as 'secured
creditor') to take possession of the security given by the borrower. The sum and substance of
the provisions are as under:

20
 The Lender has to send a notice of demand, giving details of the amount payable and
the secured assets5 intended to be enforced in the event of non payment, to the
defaulting borrower to discharge his liabilities.
 No borrower, after the receipt of the demand notice, shall transfer the secured assets in
whatsoever manner without prior written consent from the lender.
 The Borrower has to discharge the liabilities within 60 days from the date of receipt of
notice of demand.
 In the event of non payment of demand by the borrower, the lender may take any one
or more of the following measures:

o Taking possession and / or management of the secured assets of the borrower

with a right to transfer the same by way of lease, assignment or sale for realising
the secured asset.
o Appointing any person as manager to manage the secured assets the possession
of which has been taken over.
o Asking any person, who has acquired any of the secured assets from the
borrower and owes money to the borrower, to pay so much of the money which
is sufficient to pay the secured debt.
 Any transfer of secured assets made by the lender shall be deemed to be made by the
owner of such secured asset.
 If the borrower pays all the dues together with all costs, charges and expenses incurred
by the lender before the date fixed for the sale of the secured assets, the lender shall not
transfer or sell the secured assets.
 When the are more than one lender or joint financing, the approval of lender(s)
representing not less than 75% of the amount due is required to take any steps to
enforce the security interest and such approval is binding on all the lenders.
 In the case of a corporate borrower under liquidation the sale proceeds from the
secured assets shall be distributed as per Section 529A of the companies Act, 1956.

21
 In the event of lender opts to realise his security instead of relinquishing his security
and proving his debt, may retain the sale proceeds of his secured assets after depositing
the workmen's dues with the Liquidator.
 If the sale proceeds of the secured assets are not fully satisfying the debt due, the
lender may file a claim before the DRT or before a competent court for the recovery of
the shortfall.
 The lender also has an option to proceed against any of the guarantors or sell the
pledged assets without taking any measures against the borrower.
 The lender can take the assistance of the Chief Metropoliton Magistrate or District
Magistrate, as the case may be, in taking possession of the secured assets from the
borrower.
 If any person, including the borrower, is aggrieved by any of the measures adopted by
the lender, he may prefer an appeal to the DRT within 45 days by depositing atleast
75% of the claim of the lender. The decision of the DRT is further appealable to an
Appellate Tribunal.
 The lender can initiate any proceedings to enforce the security interest unless his claim
of the financial asset is made within the period prescribed under the Limitation Act,
1963.

22
 CHAPTER:5

Instrument issued by A.R.C’S

The Reserve Bank of India (RBI) prescribed uniform accounting standards for asset
reconstruction companies(ARCs) for acquiring non-performing loans, recognising revenue
and management fees to ensure common treatment for firms.The new norms will be effective
from accounting year 2014-15. These recommendations are based on the views of the Key
Advisory Group (KAG) constituted by the Centre on ARCs, the RBI said on Wednesday.The
expenses for diligence before acquiring financial assets should be charged immediately by
recognising these in the profit and loss statement for the period in which such costs are
incurred, the RBI said.Referring to booking income, the RBI said yields should be recognised
only after fully redeeming the entire principal amount of security receipts and instruments
issued to investors. Management fees may be recognised on an accrual basis.Valuation of
security receiptsWhere underlying cash flows are dependent on realisation from non-
performing assets, security receipts (SRs) can be classified as available for sale. Hence,
investments in SRs may be aggregated for arriving at net depreciation or appreciation of
investments under the category.ARCs should provide for net depreciation. Net appreciation
should be ignored. The provisions for net depreciation should not be reduced on account of
net appreciation.All the liabilities due within one year should be classified as "current
liabilities". Also, assets maturing within one year, along with cash and bank balances, should
be treated as "current assets".The capital and reserves will be treated as liabilities on the
liability side while investment in SRs and long-term deposits with banks will be treated as
fixed assets on the assets side, the RBI added.

23
  “Asset” to “Security” via Securitization - a legal insight

Introduction:
Terms like structured finance and securitization have been the buzz words in the
financial world for long. They are considered to be one of the foremost means of capital
creation, and are an important tool of risk management as they allow elimination of
substantial risk associated with bad or non-performing assets and allows diversification of
asset portfolio. Hence, banks, financial institutions and several other entities are better able to
manage their risk exposures by passing them on to investors or third parties. The present
bulletin attempts to briefly discuss the concept of securitization and elaborate upon the legal
provisions governing securitization in India.

1. Securitization - Concept and mechanism

Securitization involves conversion of assets or future cash flows into marketable
securities. The conversion of existing assets into marketable securities is referred to as
assetbacked securitization whereas conversion of future cash flows into marketable securities
is known as future-flow securitization. An asset is converted into a capital market security to
raise money from the capital markets

24
2. Legal provisions

A) Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interests Act, 2002 (SARFAESI) In India.
SARFAESI was introduced in 2002. It has been recognized as facilitating asset
recovery and reconstruction. SARFAESI deals with three aspects:
(i) Providing a legal framework for securitization of assets.
(ii) Enforcement of security interest by secured creditor (banks/financial institutions).
(iii) Transfer of non-performing assets to asset reconstruction companies, which then dispose
off those assets and realize proceeds.
It has made provisions: (a) for registration and regulation of securitization companies or
reconstruction companies by India’s federal bank, the Reserve Bank of India (“RBI”); (b) to
facilitate securitization of financial assets of banks; (iii) to empower securitization companies
and asset reconstruction companies to raise funds by issuing security receipts to qualified
institutional buyers; (iv) for empowering banks and financial institutions to take possession of
securities given for financial assistance and sell or lease them to take over management in the
event of default.

B) Stamp duty and registration law

Stamp duty is attracted on account of transfer of receivables (which constitute
actionable claims) through a written instrument. The written instrument is considered a
“conveyance”1 in law, which is an instrument liable to stamp duty. Several states in India do
not draw a distinction between conveyances of real estate and conveyance of receivables and,
thus, levy the same rate of stamp duty on both types of conveyances. The rates vary from
state to state. However, some states have introduced concessional rates of stamp duty on
actionable claims amounting to 0.1% or more on the value of the transferred receivables.

25
Further, under section 8 of SARFAESI, security receipt issued by securitization company or
asset reconstruction company which does not create, declare, assign, limit or extinguish any
right, title or interest to or in immovable property except where it entitles the holder of
security receipt to an undivided interest afforded by a registered instrument, is not required to
be compulsorily registered. Also, any transfer of security receipt is optionally registrable.
This section is an exception to the registration rules stipulated in section 17 (1) of the
Registration Act, which lists the documents that are compulsorily registrable. Section 8 of
SARFAESI is a non-obstante clause i.e. it overrides the Registration Act. Registered
documents/instruments have a legal standing and are admissible as evidence in a court of law
in the event of a dispute. On the contrary, non-registration renders the document redundant
for all practical purposes.

C) RBI Guidelines
The RBI issued securitization guidelines in February 2006. These cover the regulatory
framework for securitization of standard assets by banks, all-India term lending and
refinancing institutions and Non Banking Financial Companies. The guidelines address
several aspects. For example, they describe what constitutes a true sale, criteria to be met by
SPV, other aspects like representation and warranties by originator and re-purchase of assets
from SPVs, policy on provision of credit enhancement/ liquidity/ and underwriting facilities,
prudential norms for investment in securities issued by SPV, accounting treatment of the
securitization transactions and disclosures. The present bulletin does not address the
regulatory scope of each of these issues which, by themselves, are quite exhaustive. The
regulations are not free from shortcomings. For instance, structures where in SPVs buy assets
from many sellers and then issue securities are not covered in the guidelines. The guidelines
in their current form are applicable to securities based on the asset portfolio of banks. They
do not include a secured loan form of securitization in which assets are not transferred to the
SPV but the SPV provides loan to the originator who, in turn, creates a security interest on
the assets.

26
D) Other laws
In addition to the above, tax is another important consideration in a securitization
transaction. Tax is leviable at various stages on the participating entities depending on the
transaction. Based upon the securitization structure, the originator, SPV and the investors are
all liable to pay tax at different rates, as applicable to them.The SEBI (Public Offer and
Listing of Securitised Debt Instruments), Regulations 2008 provides for public issue and
listing of instruments that are issued by a SPV that purchases securities through
securitization. Until the word “security” was amended under section 2 (h) of the Securities
Contracts (Regulation) Act, 1956, securitized instruments were prohibited from being listed
on the stock exchange. In fact, the 2008 Regulations specify the details of the SPV, the
manner in which it can acquire receivables as well as the form of instruments it can issue –
overall, they have been drafted quite elaborately.

27
 CHAPTER:6

Effects of Securitization and ARC’s

Mumbai: Asset reconstruction companies (ARCs), which are in the business of buying bad
loans from banks, are facing funding challenges as the proportion of such loans on the books
of banks has reached record levels this financial year, even as resources available to them to
buy these loans is limited.These companies are expecting that the Reserve Bank of India
(RBI) will make it easier for them to raise capital when it releases final guidelines on asset
reconstruction companies that relax restrictions on the equity that a single entity can hold in
them and allow banks to loan money to them against future receivables.Accordingly to Asset
Reconstruction Co. (India) Ltd (Arcil), the largest company of its kind in India, close
to Rs.20,000 crore of bad loans have already come into the market this fiscal, the most in any
year since the asset restructuring business started in India in the early 2000s.Such sales are
expected to only increase in the next fiscal as banks try to offload bad loans and clean up
their balance sheets.Bad loans on the books of listed banks have risen consistently over the
past two years, largely on account of a slowing economy. From Rs.1.32 trillion at the end of
the March 2012, such loans swelled to Rs.1.79 trillion by December 2012, and to Rs.2.43
trillion at the end of December 2013.Capital is now a big challenge for asset reconstruction
companies in the context of large scale sale of bad loans, said Siby Antony, managing
director and chief executive officer at Edelweiss Asset Reconstruction Co. Ltd.Antony added
that there is a need for long-term funds to be made available to such companies.“I would
think that RBI should advise banks to extend long term funds to asset reconstruction
companies, without any collateral, except security receipts. There is a limit to which equity
capital can be raised because asset reconstruction companies are constrained by the
regulatory prescription of a maximum 49% investment by one company.”Security receipts
(SRs) are issued to banks pending recovery from an bad account. These SRs are then
encashed after the loan is recovered.Last year, the government allowed foreign investors to

28
buy upto 100% equity in asset reconstruction companies; but RBI rules stipulate that a single
entity cannot hold more than 49% stake. RBI may consider removing that restriction, said
Antony.RBI’s equity restriction may have been made with an eye on asset reconstruction
companies with a smaller equity base. Its rules state that such companies must have minimum
owned funds (equity plus free reserves) of only Rs.2 crore, but many ARCs have at
least Rs.100 crore of such funds.P. Rudran, managing director and chief executive of Arcil,
said that capital is an issue particularly for smaller asset reconstruction companies.“Suppose
there is a Rs.1,000crore asset up for grabs. In the current scenario, asset reconstruction
companies have to invest at least 5% or Rs.50 crore up front if they want to take this over.
For a smaller company, this is difficult because there are no sources of funding, except maybe
qualified institutional buyers (QIBs).”RBI is currently working on new norms for ARCs
which will be issued “shortly”, the central bank said in response to a query.Currently, small
assets in the Rs.300 crore to Rs.500 crorerange are being offloaded by banks. Next year
larger assets, particularly from the infrastructure sector, are expected to come up for sale, said
officials at asset reconstruction companies, making funding a bigger challenge than it already
is.“Like banks have deposits as a means to raise money, there is a need for asset
reconstruction companies to have a source of funding which they can tap,” said G.K. Sharma,
chief executive officer at Invent Assets Securitisation and Reconstruction Pvt. Ltd, which
expects at least Rs.50,000 crore of bad loans to come up for sale in the next financial
year.Sharma suggested that high networth individuals be allowed to invest in securities issued
by asset reconstruction companies because they are more aware of the risks and are always
looking for better returns.RBI in its final guidelines may also try and make it easier for asset
reconstruction companies to borrow from banks by reduce the risk weightage for these loans
to 100% compared to the 150% currently, said Antony of Edelweiss. In simple words, it
means that banks have to set aside more money if they lend to asset reconstruction companies
because they are perceived to be riskier than other borrowers. Sharma from Invent Assets
Securitisation and Reconstruction said that may not be enough.“Debt has to be serviced and
asset reconstruction companies deal with bad loans in which returns are speculative. If a

29
company takes a bank loan to buy a bad loans and cannot pay it back because of whatever
reasons, it risks itself being called a defaulter,” Sharma said.“The need of the moment is a
hybrid instrument which provides enough upside for investors such as high net worth
investors to invest in it,” he said.Historically, asset reconstruction companies in India were
promoted by banks.Arcil for example has 15 shareholders, led by State Bank of India.
Besides local banks, Barclays Bank Plc, FirstRand Bank Ltd from South Africa andLathe
Investment Pte. Ltd, a subsidiary of Government of Singapore Investment Corp (Ventures)
Pte. Ltd, are the foreign shareholders in the company.In recent years, private sector firms
such as Edelweiss, Reliance Group, JM Financial Ltd, among others have entered the
segment.

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 CHAPTER:7

Asset Reconstruction Companies

A) Reliance Asset Reconstruction Company Limited

Reliance Asset Reconstruction Company Limited (Reliance ARC) is a premier asset

reconstruction company, the principal sponsor / shareholder of which is the Reliance Group
(through Reliance Capital Limited). The other sponsors / shareholders are Corporation Bank,
Indian Bank, GIC of India, Dacecroft and Blue Ridge.Reliance ARC has adopted a buyer
driven model for acquisition of NPAs (individual as well as portfolio cases) in cash (of
course, if selling banks choose to remain invested, they will have the option to subscribe to
the Security Receipts).Reliance ARC would prioritize larger cases requiring restructuring /
strategic sale envisaging funds (including equity) infusion for revival at the borrower level.
Reliance ARC will also acquire cases for which the resolution strategy envisaged is
settlement with the promoters / strip sale of assets through the legal route.

 Their Vision:

To be the leading player in a healthy and robust financial market place targeted at
economically beneficial resolution of NPAs and thereby contribute to the growth and
development of the economy

 Role of Reliance ARC in Financial Sector

Asset Reconstruction Companies (ARCs) have been created internationally to bring
about system-wide clean up of Non Performing Assets (NPAs) in the financial sector. The
Government of India and Reserve Bank of India (RBI) have taken measures to regulate and
control NPAs in the financial system to facilitate faster debt recovery. Strengthening of credit
appraisal and monitoring system, risk based supervision, institution of Debt Recovery

31
Tribunals and Corporate Debt Restructuring (CDR) are some of the key initiatives taken in
this regard. Enactment of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act, 2002) has boosted these initiatives. This
Act has paved the way for formation of Asset Reconstruction Companies.

 ARC models (International experience)

Broadly 3 different models have been adopted internationally:

Model I: Government owned ARCs came into existence to deal with banking crisis to find a
system-wide solution and act as nodal entities to address NPA “stock”. The success of this
model is predicated on fiscal support (by way of recapitalisation of banks) and forbearance
from the Government and the regulator. This model results in a clean exit from NPAs to the
banks. Resolution and consequent risks-rewards remains with investors.

Model II: Non-governmental ARCs model has been adopted in situations of high level of
NPAs but without crisis dimensions. This model adopts a market based approach to address
NPA “stock” & “flow”. There is no direct participation by Government. Only a conducive
framework is provided by Government and Regulator for resolution and exit. This model
requires presence of willing sellers and investors. Attendant risk and reward remain with
investors. A strong regulatory inducement is essential for the success of this model.

Model III: A “Bad Bank” is carved out within a bank by isolation of stressed assets as the
bank’s work - out group / affiliate. This is a “self help” mechanism without any special
powers from Government and Regulator. In this model, the focus is on NPA workout. This
model leaves the NPAs with banks and consequently, the attendant risk and reward remains
with them. This model has achieved limited success due to the absence of debt aggregation.

 Indian model

ARCs in India have been set up as non-government vehicles, not government

owned/supported, with elements of Models II & III detailed above. Government is facilitator,

32
not participant in ARCs. ARCs act as resolution agencies, not rapid disposition agencies as in
the South East Asian region. There is provision for multiple ARCs in the Indian model for
value maximization. Opportunities for investment in distressed assets have increased for
investors since the demand-supply dynamics have become favorable. Further, a robust view
is being taken on the operational nature of underlying assets and accordingly the demand for
underlying assets is increasing. With the Indian economy in a capacity-additive mode and
legal and regulatory framework becoming increasingly hospitable to resolution of NPAs,
combined with the increasing interest evinced by new investors, ARCs have become the ideal
vehicles to channel investment in distressed debt.

 Factors impeding resolution of NPAs

Public Sector Banks (PSBs), which account for a major share of the NPAs, primarily
focus on net NPA percentage and draw comfort from its improvement, which can happen,
more often than not, by growth in their loan book. The focus on the reduction of the gross
NPA block has emerged only recently.Inter-creditor issues come into play between the term
lenders and working capital bankers because of the borrowers’ propensity to service the
working capital bankers for a longer period of time, while letting the term loans go
unserviced. Different security profiles of the term lenders and working capital bankers
(because of the depletion in value of current assets), pose difficulties in achieving
convergence of approach amongst the lenders required for the achievement of 75% debt
acquisition (for invocation of the powers under SARFAESI Act provisions).Due to logistical
reasons, it is not cost effective for the PSBs to have a focussed expert attention at a
centralised point, leading to wastage of resources and delay in NPA resolution.Transparent
practices are important to encourage bidders’ participation in the NPA auction undertaken by
the banks/FIs. It has been observed that, at times, the price expectation of the selling banks is
higher than the best bid price discovered through the auction process. It is the desire of the
bid participants that more transparent practices be followed by the selling banks for evolving
a mature market. In several cases, reserve price is not being disclosed. Bidders often spend

33
substantial resources and monies to participate in the bidding process, however, sometimes
deals are being called off by the sellers without citing convincing reasons. The end effect is
that few deals of sale of NPAs on cash basis can be concluded, resulting in large quantum of
NPAs (on gross basis) remaining in banks books.Additionally, the factors which may still
impede the working of ARCs and need immediate attention are inadequate transparency in
accounting causing distortions in valuation and delay in recognising the impending loss in
value (due to non classification of assets so as to reflect their true value). Further, lack of up-
to-date data on statutory and other liabilities, and high stamp duty and registration charges in
certain states adversely impacts the value that can be offered to the selling banks/FIs.

 ARCs in unique position to resolve NPAs

ARCs are required to take up the aforesaid challenges for effective and speedy action
by invoking SARFAESI Act and other measures by bringing into play their expertise in asset
resolution.RBI guidelines for ARCs provide a strict time frame of 5 years (including 1 year
planning period) for resolution, thus bringing in a sense of urgency for the ARCs, right at the
acquisition stage itself. Debt aggregation in the hands of ARCs not only releases the
bandwidth of the banks/FIs for their core activities and recycling of the capital available to
the banking system, but also makes it worthwhile for the lenders to cooperate with the ARCs,
given the position of strength and expertise with which the ARCs tackle the errant
borrowers.Given the industrial nature of most of the large NPAs and lack of significant
exposure to the real estate sector, restructuring either with the existing promoters or business
sale to strategic investors is the key for value maximisation for which the ARCs are uniquely
placed, given their expertise and tight time frame prescribed by RBI.Accordingly, ARCs are
in a strategic position to bring stability to the financial system and facilitate revival of
economic growth. The conducive factors in favour of ARCs are legal empowerment and
booming economic conditions potent with possibilities of unlocking the value of collateral
based loans. ARCs with pragmatic approach towards debt restructuring and flexibility to

34
explore multiple resolution strategies in a dynamic framework, can achieve successful
resolution.

 Market Environment

NPAs in banking system and the role of ARCs:

NPAs in the Indian Financial system, though substantial, are still lower as a proportion
of the GDP at current factor cost, as compared to other countries in the region. However,
standard assets restructured by banks (including cases restructured through the CDR process)
do not figure as NPAs. Assets that have been restructured continue to require significant
amount of lender supervision. There is always a likelihood that some of these assets may turn
into NPAs again. Net NPAs of Scheduled Commercial Banks as a percentage of Net
Advances have steadily reduced from 8.1% in 1996-97 to 4.4% in 2002-03 and further to
1.1% in 2006-07 (Source: RBI Deputy Governor’s speech at FICCI-IBA Conference on
“Global Banking: Paradigm Shift” on September 14, 2007). However, the increase in Gross
NPAs is continuing. Thus, there is ample scope in the current context for ARCs to add value
to the financial system. With the present upturn in the economy, ARCs would be able to
deliver value by resolution through a concerted approach, particularly in light of the
fragmented debt structure in most large NPAs, where invocation of SARFAESI powers
would be crucial for resolution.Boost in Credit GDP Ratio will increase fresh flow of NPAs.
India has a very low, though improving, Credit-GDP ratio (51% as on March 31, 2007 as
compared to 30% as on March 31, 2000, as per RBI’s annual report for FY07). With the
increase in this ratio, the flow of NPAs would also increase. NPAs are mostly industrial
assets – exposure to ‘bubble sectors’ being minimal. Further, the resolution of larger cases
(80% by value) requires intense workout by way of corporate restructuring, business sale or
combination of both.Accelerated provisioning norms (Basel II) for banks to result in
increased flow to the NPA market. Indian Banking Industry has low provisioning coverage
on account of time based provisioning as against cash flow based provisioning in developed
countries. From FY 07 banks have to provide 100% provision in respect of doubtful assets
35
over 3 years old, which will increase fresh flow of NPAs into the system. Tough provisioning
requirement will enable banks to sell their NPAs without taking any hit in their P&L A/c.
Stricter provisioning norms / write offs after 3 years will compel banks to shift towards
“Write-Off and Sell” approach from the present “Provide and Hold” approach.With the
implementation of BASEL II norms, the capital adequacy ratio of banks needs to be
improved. As per the BASEL II accord, the minimum capital to be maintained by a bank for
operational risk is 15% of the average gross total assets of previous 3 years. Additional
capital will also be required to cover for credit risk and market risk. In order to raise this
additional capital, a number of banks approached the capital markets in FY 2006 and FY
2007. Unlocking the capital locked in NPAs will help the banks to mobilise the required
additional resources and also reduce capital requirements. Banking statistics all over the
world indicate that NPAs are a natural bi-product in any economy. In the developed economy
of USA around 1% of the loan book is written off every year. Therefore, in the Indian
context, given the growth rate of the economy, it is unlikely that the accretion rate will go
down significantly in the near future.Recent dispensations expected to facilitate induction of
new investors. Inter-bank purchase/sale of NPAs has been allowed in July 2005, leading to
significant portfolio buy-outs through competitive bidding process. Further, Foreign Direct
Investment in equity of ARCs and participation of Foreign Institutional Investors (FIIs) in
Security Receipts (SRs) of ARCs has been allowed by RBI in November 2005. The said
dispensations are expected to facilitate cash buy out of NPAs through induction of third party
investor money. The above measures are a welcome development for creation of a vibrant
market for investment in NPAs, in the country

 Reliance Business with

Lenders:

Given Reliance ARC’s objective of resolving impaired assets, banks and financial
institutions are the clients for them. Reliance ARC acquired non-performing assets so that
lenders' books are clean of NPAs and lenders can concentrate in their core business.If you are
36
a lender, providing secured financial assistance to companies, which have become stressed
assets over time, you may transfer your exposure to Reliance ARC for effective resolution.

Investors:

Reliance ARC offers multiple opportunities to investors to invest in the Indian

distressed assets during pre-resolution, resolution and post resolution stages. Reliance ARC
seeks investor participation both in single asset and in portfolio of assets. In addition to
investment in Reliance ARC's paper i.e. security receipts, investors can invest by way of
take-out financing, mezzanine financing, equity investment and senior debt funding directly
at the borrower level.

Asset Buyers:

Reliance ARC acquires non-performing assets from banks and financial institutions,
secured by underlying assets mortgaged and /or hypothecated by the borrowers to the lenders.
The assets secured by the borrowers include facilities like land, building, plant &
machineries, current assets and collaterals.One of the resolution approaches of Reliance
ARC towards maximizing realisation is by selling the secured assets to a buyer / actual user
who finds it most valuable.

Service Providers:

Reliance ARC proposes to deploy comprehensive and best possible capabilities

required for resolving the NPAs acquired from banks and financial institutions. As against
building all the capabilities in-house, Reliance ARC acknowledges that the most effective
way of building the required capabilities is to work with the leaders in various fields on a
collaborative basis. Accordingly the organisational structure adopted by Reliance ARC is
lean and flat, which aims at faster response time and focuses on the core areas. Service
providers (including valuers, advocates, legal firms and resolution agencies) with required

37
capabilities are invited to forward their details to us. Reliance ARC would take note of your
services and capabilities and would revert as and when the services are required.

B) ARCIL:- (Asset Reconstruction Companies India Limited)

About them:

Asset Reconstruction Company (India) Limited (Arcil) is India's first and largest asset
reconstruction company, to commence business of resolution of Non-Performing Assets
(NPAs) upon acquisition from Indian banks and financial institutions. It is sponsored by
prominent banks and financial institutions namely State Bank of India (SBI), IDBI Bank
Limited (IDBI), ICICI Bank Limited (ICICI) and Punjab National Bank (PNB). Arcil has its
registered office at Mumbai, Maharashtra. Arcil has acquired portfolio from more than 65
banks and financial institutions since inception. Arcil also forayed into reconstruction of retail
assets through its division 'Arms' which is currently spread across 18 locations in India.Arcil
was incorporated as a public limited company in 2002 and in pursuance of Section 3 under
the Securitisation Act, 2002, it holds a certificate of registration issued by the Reserve Bank
of India (RBI) and operates with powers conferred under the Securitisation Act, 2002. As the
premier ARC, Arcil played a pioneering role in setting standards for the industry in India. It
commenced business by acquiring its first tranche of financial assets on 31stDecember, 2003.
In the first decade, Arcil has acquired more than 48,000 worth of NPAs from the Indian
banking system. In the process, it has also empowered the Indian banking system to grow
faster and remain stronger in a challenging economic environment.

Role:

Unlocking and recycling capital for the banking system and the economy.The primary
objective of Arcil is to expedite recovery of the amounts locked in NPLs of lenders
andthereby recycling capital. Arcil thus, provides relief to the banking system by managing
NPLs and help them concentrate on core banking activities shareholder's value.Creating a
vibrant market for distressed debt assets / securities in India offering a trading platform for
38
LendersArcil has made successful efforts in funneling investment from both domestic and
international players for funding these acquisitions of distressed assets, followed by
showcasing them to prospective buyers. This has initiated creation of a secondary market of
distressed assets/securities in the country besides hastening their resolution. These efforts
have the potential of leading the country's distressed debt market to international standards.

Background:

The genesis of asset reconstruction business in India owes its origin to enactment of the
Securitisation Act, 2002. Prior to promulgation of the Securitisation Act, 2002, banks and
financial institutions had no option but to enforce their security interests through the court
process, which was extremely time consuming. There was also no provision in any other law
in respect of enforcement of hypothecation, though hypothecation was one of the major
security interests by the banks and financial Institutions in India. It was in this backdrop that
the Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Ordinance, 2002 was passed on June 21, 2002 which was enacted by the parliament
in December 2002 and became the Securitisation Act, 2002.

Achievements:

As the pioneer in the asset reconstruction space, Arcil not only participated in the
process of framing the guidelines but also helped define the contours of the industry, claiming
many of the firsts. Arcil has meaningfully engaged the stakeholders in the asset
reconstruction domain and established a business model conducive to Indian ecology.

The leader:

As the leader in this genre of business, Arcil undertook significant efforts in market
seeding, creating awareness and acquainting banks and financial institutions with the concept
and business model, attracting capital to this new class of asset, et all. Arcil has facilitated
development of a business environment, which today has attracted many players to set up

39
business in this domain. It has meaningfully engaged the investors through dialogue and
dissemination of information. This is expected to lead the flow of new capital for the asset
class in the near future. Some of the significant initiatives of Arcil in this context are:

o Participation in the process of framing regulatory guidelines for the acquisition,

resolution and valuation of NPL and operating guidelines for conducting asset
reconstruction business in India.
o Rationalization of stamp duty payable on acquisition of NPL from sellers in several
States in the country thereby reducing the transaction costs, which is a sine-qua-non for
business viability (all major States have provided for remission in stamp duty to
notional levels)
o Setting up a valuation framework in line with international best practice.
o Creation of a unique transaction model taking into account conflicting interests of
sellers doubling as investors(in the absence of new money) in the Special Purpose
Vehicles (SPV) with Arcil as trustee for the investors in the trusts, by sharing upside
from the resolution
o Setting up a fund involving third party investors (not being sellers doubling as
investors)
o Establishment of a framework for rating of security receipts(SRs) with underlying
NPLs and the security interest - a first of its kind in India

Holistic Solutions Provider:

Arcil commenced its operations with acquisitions of medium and large NPLs
pertaining to corporate borrowers. These borrower accounts, typically offer opportunities for
innovative financial and business restructuring, capturing the concern value or even growth
opportunities in core business by hiving off or capturing value pockets in a diversified
business. The treatment for resolution in this segment resembles the approach akin to private
equity business model.Soon after commencement of business, Arcil realized that a large
number of NPLs relating to small and medium enterprises, including self-employed business
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ventures too existed in the financial system. Arcil then broadened its operations by including
these NPLs under its focus. The resolution of such NPLs typically involves settlement or sale
of collaterals, often through the process as prescribed under the Securitisation Act, 2002 or
otherwise.Leveraging its rights and the powers conferred under the Securitisation Act, 2002
and other enabling provisions, Arcil usually deploys several strategies, often simultaneously,
for resolution of the NPLs. Arcil has innovatively developed a approach for resolution of this
class of assets by engaging and repackaging interests of all stakeholders, including the
borrower. In this area, Arcil demonstrates complex transaction structuring and value
enhancement capabilities.Arcil provides customized risk-mitigated transaction structures for
acquisition of NPLs from banks and financial institutions to facilitate sell-down. Increasingly,
banks are looking for a cash exit from NPLs as against staying invested by doubling as
investors in SRs.To enable transaction closure with the sellers which prefer clean exit for
cash, Arcil has augmented its capital base substantially. Also, Arcil has demonstrated fund
raising capabilities by having a successful fund raising program for investment in SRs, with
several large domestic and global investors participating in them; a "first-of-its-kind"
achievement in India. These funds are raised on need basis whenever there is a requirement
for additional funds to be invested in SRs to give cash exit to the selling banks and financial
institutions.Besides occupying leadership position in asset reconstruction business, these
initiatives have enabled Arcil posting a robust growth in operating and financial performance,
from its very onset.In the last few years, the lending profile of the Indian banking system has
shown shift towards retail finance. The retail financial assets comprising housing loans, loans
against property, car loans, two & three wheeler loans, and commercial vehicle loans that
account for about 20-25% of the incremental asset growth in the banking sector. As a fallout
of the growth in this segment of financial assets, the NPLs in this segment have witnessed
growth, requiring focused attention for recovery by third-party agencies. Recognizing that
this NPL segment as an emerging area for Arcil's future business growth, Arcil entered the
retail NPA recovery in 2007 and has consistently been building capabilities to capitalize on
its first mover advantage in this business segment.Thus, Arcil with its all-encompassing

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business approach, is uniquely positioned itself as a holistic solutions provider, responding to
the needs of the banking system in dealing with NPLs.

Milestones:

Asset Reconstruction Company (India) Limited (Arcil) is India's first and largest asset
reconstruction company in the country to commence business of resolution of Non-
Performing Assets (NPAs) upon acquisition from Indian banks and financial institutions. It is
sponsored by prominent banks and financial institutions namely State Bank of India (SBI),
IDBI Bank Limited (IDBI), ICICI Bank Limited (ICICI) and Punjab National Bank (PNB).
Arcil is having its Registered Office at Mumbai, Maharashtra. Arcil has acquired portfolio
from more than 65 banks and financial institutions since inception. Arcil also forayed into
reconstruction of retail assets through its division 'Arms' which is currently spread across 18
locations in India. Arcil was incorporated as a public limited company in 2002 and in
pursuance of Section 3 of the Securitisation Act, 2002, it holds a certificate of registration
issued by the Reserve Bank of India (RBI) and operates under powers conferred under the
Securitisation Act, 2002. As the premier ARC, Arcil played a pioneering role in setting
standards for the industry in India. It commenced business by acquiring its first tranche of
financial assets on 31stDecember, 2003. In the first decade, Arcil has acquired more than `
48,000 worth of NPAs from the Indian banking system. In the process, it has also empowered
the Indian banking system to grow faster and remain stronger in a challenging economic
environment.

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CONCLUSION
So herby I conclude that, NPA is drawback of the economy of the country& increasing
day-by-day which is causing a lot of problems for the banking system. Though it is a Boon
for the country, it can still be reduced or controlled by using correct norms & strict
regulations. RBI has introduced various methods to reduce the NPA & different departments
to control it.

By giving the NPA accounts to the ARC companies they can cover the NPA amount
by securitization of assets. These companies follow strict rules for recovering the amount
from the defaulters. The ARC company make agreement with the company who is giving the
A/C’s to them, in which they clearly mention about all the terms & conditions on which they
are going to make the payment back to the bank’s or any Financial institution. It might be that
they may deal by having some proportion of money before the recovery of NPA & remaining
amount after the recovery. They charge commission for the service that ARC are giving to
the banks or Financial Institution. ARC’S may apply compensation technique or directly by
selling of Assets which have being kept with them which is given by the banks or Financial
Institution as a security of the Account.

By using these techniques the ratio of the NPA’S will be reduced to certain extent and
amount will be recovered quickly. So ARC’S are the best way for recovering the money from
the defaulters of the loans or the borrowers.

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Webliography
https://www.sesameindia.com/npa-recovery-delinkure

https://www.bankingschool.co.in/loans-and-advances/strategies-for-reducing-npa

https://www.scribd.com/mobile/doc/30350791/Management-of-NPA-in-Banking

http://www.indianeconomy.net/splclassroom/405/what-are-asset-reconstruction-companies-
arcs/

http://www.en.m.wikipedia.org/wiki/Non-performing_asset

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