SARFAESI Act enables banks to auction and sell the properties of the borrowers who failed to pay their debt, through reducing their non performing assets and asset reconstruction. This Act is function on the principle of assets securitisation, according to that, financial institutions rate their borrower according to the payment they made against their debt or loans and if any borrower fails to pay the same in time banks sell their assets in the market to investors. To put it simply assets securitisation is nothing but a process to change assets into securities and securities into liquidity if a borrower fails to pay his debt.
This act is only effective against only secured loans/debts. Apart from this the bank can recover its debt through securitisation which simply means to sale the securities in the market. Because of this act banks and other financial institutions has authority to get their debt without interference of courts, unless the security is invalid or fraudulent. When a borrower fails to pay his debt, he became defaulting borrower, the bank sends him notice to discharge his liabilities within 60 days and if he fails do so the bank can take possession of the security, or sale or lease the right over the security or manage the security or appoint someone else to do the same.
After nationalisation of banks although there is increase in the number of private investors but also there were increase in the incidents of default borrowers. Because of this even though the banks achieve a phenomenal growth they suffered a huge financial loss due to not repayment of their debts on the same time. There was no proper law which can entitle the banks to recover their debt from the borrowers without wasting time and money in law suits. This all leads to bad portfolio performance, low efficiency and productivity and eroded profitability. For instance banks had to maintain SLR (Special Liquidity Ratio) at the rate of 38.5% and CRR (Cash Reserve Ratio) at the rate of 3 to 15% according to Banking Regulation Act and RBI Act. Because of these high SLR and CRR the operational freedom of banks restricted. Apart from this the banks were unable to claim their debts from the default borrowers because of the inadequate legal system. For instance the adjudication for a civil suit for recovery of money takes time and the borrowers were taking advantage of the same. Because of this the foreign investors and other investors are afraid to invest in Indian market. So in 1990-91 when India announce Indian economy as LPG, government of India constituted Narasimhim committee headed by Sri M. Narasimhim former Governor of RBI, to review and suggest the aspects relating to structure and organisation procedure of the financial sector. This committee laid down foundation of reforms of Indian banking sector. Hence this committee is also known as Banking Sector Reforms (BSR). This committee recommended:
- Reduction in the rates of SLR and CRR
- Phasing out Directed Credit Programme
- Interest Rate Determination
- Structural Reorganizations of the Banking sector
- Establishment of the ARF Tribunal
- Removal of Dual control
- Banking Autonomy
These all recommendation is based on the following problems:
- Directed Investment Programme
- Directed Credit Programme
- Interest Rate Structure
- Various inconsistencies regarding the banking system
On the basis of these recommendation parliament introduced a new law i.e. Recovery of Debts due to Banks and Financial Institution (RDDB&FI). Under this Act there were established several tribunal across the country for recovery of debt under this Act. But the problem remains the same i.e. slow recovery process because of the hindrance in the process of adjudication of the tribunal. But due to no proper relief given to the banks, in early 1997, Mr.Narasimham was again asked to chair another committee to review the progress based on the 1st Committee’s report and to suggest a new vision for Indian banking industry. In April, 1998, Narasimham Committee submitted its report and recommended some major changes in the financial sector. Many of these recommendations have been accepted and are under process of implementation. These recommendations can be broadly classified into following categories:
- Strengthening Banking System
- Asset Quality
- Prudential Norms and Disclosure Requirements
- Systems and Methods in Banks
- Review and update bank laws
Later on in the year 2000 a new committee set up i.e. Andhyarjina Committee headed by Mr. T.R. Andhyarjina, former Solicitor General of India to suggest changes in the legal system in India that is required in that time regarding financial sector. This committee suggests that there is a need to enact a new law for speedy recovery of debts due to banks and financial institutions. It also recommended that banks should have power to take possession or sale the securities both movable and immovable for recovery of the debts, without the intervention of the courts and tribunals.
Finally Umerjee Committee framed the SARFAESI Act on the basis of recommendation made by these three committees and parliament passed the same.
The preamble of the Act suggests that this act came into existence “To regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto”. But in explanatory form we will found the following objective of the Act:
- Registration and regulation of securitisation companies or reconstruction companies by the Reserve Bank of India;
- Facilitating securitisation of financial assets of banks and financial institutions with or without the benefit of underlying securities;
- Facilitating easy transferability of financial assets by the securitisation company or reconstruction company to acquire financial assets of banks and financial institutions by issue of debentures or bonds or any other security in the nature of a debenture;
- Empowering securitisation companies’ or reconstruction companies to raise funds by issue of security receipts to qualified institutional buyers;
- Facilitating reconstruction of financial assets acquired by exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks and financial institutions;
- Declaration of any securitisation company or reconstruction company registered with the Reserve Bank of India as a public financial institution for the purpose of section 4A of the Companies Act, 1956;
- Defining ‘security interest’ as any type of security including mortgage and change on immovable properties given for due repayment of any financial assistance given by any bank or financial institution;
- Empowering banks and financial institutions to take possession of securities given for financial assistance and sell or lease the same or take over management in the event of default, i.e. classification of the borrower’s account as non-performing asset in accordance with the directions given or under guidelines issued by the Reserve Bank of India from time to time;
- The rights of a secured creditor to be exercised by one or more of its officers authorised in this behalf in accordance with the rules made by the Central Government;
- An appeal against the action of any bank or financial institution to the concerned Debts Recovery Tribunal and a second appeal to the Appellate Debts Recovery Tribunal.
Brief of the Act:
SARFAESI Act 2002 contains 41 sections in 6 chapters and 1 schedule. In those chapters, it deals with definitions, regulation of securitisation and reconstruction of assets, enforcement of security interest, establishment of a central registry, registrations of securitisation, reconstruction and security interest transaction, offences, penalties and punishments, and routine legal issues respectively.
This Act can only be enforced if the following conditions are fulfilled:
- The debt is secured.
- The debt has been classified as an NPA by the banks or financial institutions.
- The outstanding dues are one lakh or more than that or more than 20% of the principle loan amount and interest thereto.
- The security to be enforced is not an agriculture land.
This Act proposes securitisation and reconstruction of financial assets through securitisation companies and reconstruction companies for debt recovery. But for establishment of securitisation companies (SC) or reconstruction companies (RC), they must be registered under the companies act.
This Act provides three alternative methods for recovery of NPAs, these are
Securitisation: – Under this, issue of security for rising of receipt or funds by SCs or RCs from qualified institution buyer by forming schemes acquiring financial assets. To put it simply we can say that, under the Securitisation Act only banks and financial institutions can securitize their financial assets pertaining to NPAs with a securitisation company. Securitisation means, according to the Securitisation Act, acquisition of financial assets by any SC or RC from any financial institution or banks. The necessary funds for such acquisition may be raised from ‘qualified institutional buyers (QIB), by issuing security receipt representing undivided interest in such financial assets or otherwise. The SC or RC keeps and maintain separate and distinct accounts in respect of each such scheme for every financial asset required and ensure that realizations of such financial assets are held and applied towards redemption of investments.
Hence it is the process of polling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors.
Assets Reconstruction: – It means that SC/RC may according to the guidelines prescribed by RBI carry out asset reconstruction in any one of the following manners under sec. 9
- 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
Enforcement of security interest: – The Act empowers the lender, in the event of default by a borrower, to issue demand notice to the defaulting borrower and guarantor, calling upon them to discharge their dues in full within 60 days from the date of the notice. If the borrower fails to comply with the notice, the bank or the financial institution may take recourse to one or more of the following measures:
- Take possession of the security;
- Sale or lease or assign the right over the security;
- Appoint Manager to manage the security;
- Ask any debtors of the borrower to pay any sum due to the borrower.
If there are more than one secured creditors, the decision to make provisions of this Act will be made applicable only when 75% of them are agreeable.
It is clear from the explanation above that the secured creditors have upper hand in case of default borrower but it does not mean that the borrower has not been given any rights. The rights of borrowers are following: –
- The borrower can at any time before the sale is completed remit the dues and avoid losing his security.
- In case of an illegal act is done by authorised person, he will be liable for penal consequences.
- The borrowers entitle for compensation for any unhealthy or illegal acts.
- For redressing the grievances the borrowers can approach to DRT and DRAT in appeal.
 Preamble: SARFAESI Act 2002
 A financial institution, insurance company, bank, State Financial Corporation, State Industrial Development Corporation, Trustee or any AMC on behalf of any mutual fund, provident fund, gratuity fund or pension fund, FIIs registered with SEBI or any other body corporate specified by SEBI.
 Security receipt means a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation.