The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 is a legislation that helps financial institutions to ensure asset quality in multiple ways. This means that the Act was framed to address the problem of NPAs (Non-Performing Assets) or bad assets through different processes and mechanisms.
The SARFAESI Act gives detailed provisions for the formation and activities of Asset Securitization Companies (SCs)and Reconstruction Companies (RCs). Scope of their activities, capital requirements, funding etc. are given by the Act. RBI is the regulator for these institutions.
As a legal mechanism to insulate assets, the Act addresses the interests of secured creditors (like banks). Several provisions of the Act give directives and powers to various institutions to manage the bad asset problem. Following are the main objectives of the SARFAESI Act.
- The Act provides the legal framework for securitization activities in India
- It gives the procedures for the transfer of NPAs to asset reconstruction companies for the reconstruction of the assets.
- The Act enforces the security interest without Court’s intervention
- The Act give powers to banks and financial institutions to take over the immovable property that is hypothecated or charged to enforce the recovery of debt.
Major feature of SARFAESI is that it promotes the setting up of asset reconstruction (RCs) and asset securitization companies (SCs) to deal with NPAs accumulated with the banks and financial institutions. The Act provides three methods for recovery of NPAs, viz:
(ii) Asset Reconstruction; and
(iii) Enforcement of Security without the intervention of the Court.
The Act, thus brings three important tools/powers into asset management of financial banks and institutions – securitization of assets, reconstruction of assets and powers for enforcement of security interests (means asset security interests). To understand the SARFAESI Act, we should know the meaning of these terms as well.
What is Securitization?
Securitization is the process of pooling and repackaging of financial assets (like loans given) into marketable securities that can be sold to investors.
In the context of bad asset management, securitization is the process of conversion of existing less liquid assets (loans) into marketable securities. The securitization company takes custody of the underlying mortgaged assets of the loan taker. It can initiate the following steps:
i. Acquisition of financial assets from any originator (bank), and
ii. Raising of funds from qualified institutional buyers by issue of security receipts (for raising money) for acquiring the financial assets or
iii. Raising of funds in any prescribed manner, and
iv. acquisition of financial asset may be coupled with taking custody of the mortgaged land, building etc.
What is asset reconstruction?
Asset reconstruction is the activity of converting a bad or non-performing asset into performing asset. The process of asset reconstruction involves several steps including purchasing of bad asset by a dedicated asset reconstruction company (ARC) including the underlying hypothecated asset, financing of the bad asset conversion into good asset using bonds, debentures, securities and cash, realization of returns from the hypothecated assets etc.
Reconstruction, is to be done with the RBI regulations and the SARFAESI Act gives the following components for reconstruction of assets: –
a) taking over or changing the management of the business of the borrower,
b) the sale or lease of a part or whole of the business of the borrower;
c) rescheduling of payment of debts payable by the borrower;
d) enforcement of security interest in accordance with the provisions of this Act;
e) settlement of dues payable by the borrower;
f) taking possession of secured assets in accordance with the provisions of this Act.
What is mean by ‘enforcement of security interests’?
The Act empowers the lender (banker), when the borrower defaults, to issue notice to the defaulting borrower and guarantor, calling to repay the debt 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 enforce security interests (means interest of the bank/creditor) by following the provisions of the Act:
a) Take possession of the security;
b) Sale or lease or assign the right over the security;
c) Appoint Manager to manage the security;
d) Ask any debtors of the borrower to pay any sum due to the borrower.
If there are more than one secured creditors, the decision about the enforcement of SARFEASI provisions will be applicable only if 75% of them are agreeing.
Features of the amendment to the SARFAESI Act in 2016
Government has amended the SARFAESI Act in August 2016 to empower the ARCs (Asset Reconstruction Companies), to rejuvenate Debt Recovery Tribunals (DRTs) and to enhance the effectiveness of asset reconstruction under the new bankruptcy law.
The amendment has given more regulatory powers to the RBI on the working of ARCs. It was also aimed to empower asset reconstruction and the functioning of DRTs in the context of the newly enacted bankruptcy law.
As per the amendment, the scope of the registry that contains the central database of all loans against properties given by all lenders has been widened to include more information.
RBI will get more powers to audit and inspect ARCs and will get the freedom to remove the chairman or any director. It can also appoint central bank officials into the boards of ARCs.
RBI will get the power to impose penalties on ARCs when the latter doesn’t follow the central bank’s directives. Similarly, it can regulate the fees charged by ARCs from banks while dealing with NPAs. The penalty amount has been increased from Rs 5 lakh to Rs 1 crore.
The amendment has brought hire purchase and financial lease under the coverage of the SARFAESI Act.
Regarding DRTs, the amendment aims to speed up the DRT procedures. Online procedures including electronic filing of recovery applications, documents and written statements will be initiated.
The amendments are important for DRTs as they can play an important role under the new Bankruptcy law. DRTs will be the backbone of the bankruptcy code and deal with all insolvency proceedings involving individuals. The defaulter has to deposit 50 per cent of the debt due before filing an appeal at a DRT.