A study on debt recovery systems in the Indian Banking sector

1. `
Group 8
SARFAESI ACT
A study on debt recovery systems in the Indian Banking sector
Pritam Saha (1311034)
Yashad Vasant Kashar (1311167)
Atirek Kumar (1311291)
8-12-2014

2. 1
Contents
Acknowledgement......................................................................................................................2
Background................................................................................................................................3
SARFAESI ACT 2002 – A Brief Study.......................................................................................6
Operational Reality..................................................................................................................10
Latest Developments in Debt Recovery Space......................................................................... 14
International Perspectives – China and USA.......................................................................... 15
Non-Performing Loan Securitization Laws in People’s Republic of China..........................................15
Consumer Protection in Asset Securities Market, USA ........................................................................18
Recommendations ...................................................................................................................20
References................................................................................................................................ 21

3. 2
Acknowledgement
We would like to take this opportunity to express our heartfelt gratitude to Professor P C
Narayan who has been inspiring and highly informative as a teacher of ethical and cutting-
edge financial practices. His insights into the evolution of financial institutions across the
world through real life cases and examples from his own experiences have shaped our
understanding not only in a theoretical way but more importantly in a practical sense.
To conclude, we also wish to laud all of our classmates for making the classroom discussions
extremely lively with their enlightening examples and the high level of preparation as is
expected from the students of IIM Bangalore.
Pritam
Yashad
Atirek

4. 3
“If we are to achieve results never accomplished before, we must expect to employ methods
never before attempted” - Sir Francis Bacon
Background
The banking sector forms the backbone of every monetized economy in the world and is
the primary route for debt creation in the Indian economy. The banking industry in India is
governed by the Banking Regulation Act of India, 1949. The weak financial system inherited
by independent India consisted of commercial banks in the organized sector intermediating
savings – in the form of deposits (demand and term), and investments – in the form of lending,
to primarily large corporations. This led to a lop-sided pattern of credit creation in the system,
which along with inherent inefficiencies and a series of bank failures that reduced the number
of banks from 566 in 1951 to 90 in 1968, induced the government to undertake a bank
nationalization drive in 1969. The main thrust of nationalization agenda was social banking,
with the stated objectives of:
 Increasing the geographical coverage of the banking system (between 1969 and 1990,
the nationalized banks added over 55,000 branches to their network)
 Extension of credit to the priority sector (comprising largely of agriculture, agro-
processing, and small-scale industries)
This phase was characterized by administered interest rates, mandatory syndicated
lending and significant investment of deposits in bonds issued by the government and
‘‘approved’’ (quasi-government) institutions through the route of Statutory Liquidity Ratio
(SLR) requirements of as high as 38.5%. The Cash Reserve Ratio (CRR), which was 3.5% in
1962-63, was increased to 15% in 1989-90 and in 1990-91.
While the social agenda of the banking sector was arguably a success, the Indian banking
sector, about 88% of whose assets were managed by state-owned banks, was in distress.
 The need to meet such high statutory requirements made them dependent on brokers
in the share market for arranging call money deposits to meet the same. The result was
brokers availing favours from banks which ultimately resulted in securities scams
which surfaced in 1990-91
 While the ratio of gross operating profit of the scheduled commercial banks rose from
0.8% (of assets) in the seventies to 1.5% in the early nineties, the net profit of the banks
declined
 The problem was further compounded by a high proportion of borrower defaults
encouraged by inadequate debt recovery mechanisms in the existing legal system with

5. 4
debt recovery cases under the jurisdiction of civil courts and taking on average 5 years
for resolution. Non-Performing Assets (NPA) piled up and remained unrecovered on
the balance sheets of banks leading to a situation of “credit crunch”
In 1990-91 with the securities scam coming to the fore, the Government of India
constituted the Narasimham Committee (headed by Sri. M. Narasimham – former Governor
of RBI) to review the aspects relating to structure and organisational procedures of the
financial system and make recommendations for improvement. Narasimham Committee laid
down a foundation for the reform of the Indian banking sector and hence is also known as
Banking Sector Reforms (BSR) Committee.
Based on the Committee’s recommendations, RBI abolished the existing system of “Health
Codes” for advances and introduced prudential norms relating to income recognition, asset
classification and provisioning in advances portfolio with effect from 31st May 1993. In 1993,
Parliament also passed the “Recovery of Debts due to Banks and Financial Institutions Act”.
The claims of banks and financial institutions involving INR 10,00,000 (ten lakhs) and above
came to be separated and brought within the fold of the said Act for adjudication by the Debt
Recovery Tribunals established across the country. But the effectiveness of the Act was
reduced due to the impediments in the performance of the Debt Recovery Tribunals (DRT),
one such impediment being automatic operation of stay under Sec 22 of Sick Industrial
Companies (Special Provisions) Act (SICA) on making reference to ‘Board for Industrial and
Financial Reconstruction’ (BIFR) created under article 4 of SICA by the borrower’s industrial
entity.
Other measures that came into effect during this first phase of banking sector reforms
included:
 Between 1992 and 1997, CRR was reduced from 15% to about 10% and the SLR was
reduced from 38.5% to 25% over the same period
 Prior to 1992, the lending rates structure consisted of six categories based on the size
of advances. During the 1992–94 period, the lending rates structure was rationalised
to three categories, and in 1994 banks were given the freedom to determine interest
rates on all loans exceeding INR 200,000 (i.e., USD 4,500). By 1998, banks were free
to determine the interest rates for all loans, with the understanding that the lending
rates on loans up to INR 200,000 would not exceed the declared prime lending rates
(PLR) of the banks
 As early as 1993, the threshold for the mandatory formation of consortiums was raised
from INR 50 million to INR 500 million. Further, banks within consortiums were

6. 5
permitted to frame the rules or contractual agreements governing the consortium
lending
 In 1996, selective credit controls on all sensitive commodities except sugar were
removed. Banks were also allowed much greater flexibility about the proportion of the
cash credit component of the loans, the new floor being 25%
 1997 witnessed further elimination of credit controls with banks no longer subjected
to the instructions pertaining to Maximum Permissible Bank Finance (MPBF) and
were allowed to evolve their own methods for assessing the credit needs of the potential
borrowers. Further, banks were no longer required to form consortiums to lend in
excess of INR 500 million, and restrictions on their ability to provide term loans for
projects were withdrawn
In 1998, the RBI initiated the second generation of banking reforms based on the
recommendations of the Narasimham Committee II. The major recommendations of the
committee were:
 A minimum target of 9% Capital Risk-Adequacy Ratio (CRAR) to be achieved by the
year 2000 which should be further raised to 10% for the year 2002
 A risk weight of 5% for market risk of government-approved securities should be
attached
 An asset to be classified as doubtful if it is in the category of 18 months in the first
instance and eventually for 12 months and loss if it has been so identified but not
written off
 Income recognition and asset classification should apply to government advances
 The minimum shareholding by government/RBI in the equity of nationalised banks
and SBI should be brought down from 51% to 33%
 The urgent need to bring reforms in the existing legal system for speedy recovery of the
debts of the banks and financial institutions
 Creation of asset reconstruction companies (ARCs) to simultaneously improve the
quality of the balance sheets of the banks and to facilitate recovery of loans
 Rehabilitation of weak Public Sector Banks (PSBs) with high percentage of NPAs (20%
NPAs of total loan assets)
On the debt recovery front, in order to have a coordinated approach to the recovery of large
NPA accounts, as also for institutionalising an arrangement for a systematic exchange of
information with respect to large borrowers (including defaulters and NPAs) common to
banks and financial institutions, a Standing Committee was constituted in August 1999 under
the aegis of Industrial Development Bank of India (IDBI). Also, in 2000 Andhyarjuna

7. 6
Committee (headed by Mr. T.R. Andhyarjuna – Former Solicitor General of India) was
constituted by the Government of India to suggest changes in the existing legal system. It
recommended the enactment of laws conferring powers to banks and financial institutions as
have been conferred upon ‘land development banks’ and ‘state financial corporations’ for
taking possession and sale of securities (both movable and immovable) without the
intervention of court for speedy recovery with proper safeguards. It also mentioned that the
law should also provide for the creation of a new registry jointly by the banks and financial
institutions for registration of mortgages and hypothecation charges in place of the existing
obsolete office of sub-registrar of assurance which maintained records of transfers.
Finally, Umarji Committee (headed by the former retired Executive Director of RBI)
framed the Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (SARFAESI) and it came into effect as an ordinance on 21st June 2002 and
was accordingly enacted by Parliament on 17th December 2002.
SARFAESI ACT 2002 – A Brief Study
The Securitisation Act consists of 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.
The Act deals with three aspects:
 Enforcement of Security Interest by secured creditor (banks/financial institutions)
 Transfer of non-performing assets to Asset Reconstruction Company, which
subsequently handles disposing of those assets and realisation of the proceeds
 Providing a legal framework for securitisation of assets
The Act stipulates four conditions to be met prior to enforcement of rights by a creditor:
 The debt is secured
 The debt has been classified as an NPA by the banks

8. 7
 The outstanding dues are INR 1,00,000 (one lakh) and above and more than 20% of
the principal loan amount and interest there on
 The security to be enforced is not an agricultural land
The Securitisation Act proposes securitisation and reconstruction of financial assets
through Securitisation Companies (SCO) and Reconstruction Companies (RCO) which ought
to be 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 (Owned Fund
is aggregate of paid up capital, paid up preference capital, reserves and surplus excluding
revaluation reserve, as reduced by debit balance on P&L account, miscellaneous expenditure
(to the extent not written off), intangible assets, diminution in value of investments/short
provisions against NPA and further reduced by shares acquired in SCO/RCO and deductions
due to auditor qualifications) of INR 20 million 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 with the provision of different rates for different classes of SCO and RCO.
The Act provides three alternative methods for recovery of NPAs:
 Securitization: Issue of security for raising of receipts or funds by SCOs/RCOs from
the Qualified Institutional Buyers (QIB) by forming schemes for acquiring financial
assets. The SCO/RCO shall keep and maintain separate and distinct accounts in
respect of each such scheme for
every financial asset acquired and
ensure that realizations of such
financial assets are held and applied
towards redemption of investments
and payment of returns assured on
such investments under the relevant
scheme
 Asset Reconstruction: It implies
acquisition by any SCO/RCO of any
right or interest of any bank or
financial institution in any financial
assistance for the purpose of
realization of such financial

9. 8
assistance. The SCO/RCO, for the purpose of asset reconstruction, should provide for
any one or more of the following measures:
1. Proper management of the business of the borrower, by change in, or takeover
of the management of the business of the borrower
2. Sale or lease of a part or whole of the business of the borrower
3. Rescheduling of payment of debts payable by the borrower
4. Enforcement of security interest by taking possession of secured assets in
accordance with the provisions of this Act
 Enforcement of Security: The banks/financial institutions can 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 may take recourse to one or more of the following measures
without intervention of the court
1. Take possession of the security
2. Sale or lease or assign the right over the security
3. Manage the same or appoint any person to manage the same
The Act also empowers the bank/financial institutions to:
1. To give notice to any person who has acquired any of the secured assets from
the borrower to surrender the same to the Bank
2. To ask any debtor of the borrower to pay any sum due or becoming due to the
borrower
3. Any Security Interest created over agricultural land cannot be proceeded upon
and only those properties given as security can be proceeded upon but not the
guarantors' personal property
4. If on receipt of demand notice, the borrower makes any representation or raises
any objection, Authorised Officer shall consider such representation or
objection carefully and if he comes to the conclusion that such representation
or objection is not acceptable or tenable, he shall communicate the reasons for
non-acceptance within 15 days of receipt of such representation or objection
Setting up of Central Registry (CR): The Government of India, Ministry of Finance
notified to set up the CR, to prevent frauds in loan cases involving multiple lending from
different banks on the same immovable property. This Registry has become operational on
March 31, 2011. CR is a Government Company licensed under Section 25 of the Companies
Act 1956 and has been incorporated with the name of "Central Registry of Securitization Asset
Reconstruction and Security Interest of India" (CIN No: U67100DL2011NPL215270) having
its registered office at New Delhi for the purpose of operating and maintaining the Central
Registry under the provisions of the SARFAESI.

10. 9
A register called the Central Register maintained both in electronic and non-electronic
form will be kept at the head office of the Central Registry for entering the particulars of the
transactions including creation of security/satisfaction or payment on any security interest
relating to securitization and reconstruction of financial assets and shall be open for inspection
by any person during the business hours on payment of prescribed fee.
Amendments:
 A formal procedure has been prescribed for taking into record the substitution of banks
by SCO/RCOs in any proceedings pending before any tribunal/court/other authority
with respect to the financial assets which the SCO/RCOs have acquired from such bank
 SCO/RCOs have been permitted to convert any portion of the debt due to them by the
borrower into equity shares of the borrower company
 The banks have been permitted to purchase the immovable property which has been
furnished to them as security and which is being sold under an auction process
provided the purchase price offered by other auctioneers in respect thereto, is below
the reserve price set by the bank. The bank can hold such property for a maximum
period of 12 years after which the bank is mandatorily required to dispose of such
property in compliance with the Banking Regulation Act, 1949
 In public interest, Union Government can issue notification that a certain provision of
the Act may not apply or may apply with modifications to a class or classes of banks or
financial institutions
 Earlier a borrower could approach the Debt Recovery Tribunal (DRT) to get stay order
against bank/RCO. New amendment says DRT cannot grant any stay order unless both
parties (borrower and lending bank) are heard ensuring the process of law is not
misused by unscrupulous borrowers to get stay orders just to delay money-recovery
 Bill proposes to enable banks and financial institutions to enter into settlement or
compromise with the borrower. It also seeks to empower the Debt Recovery Tribunals
to pass an order acknowledging any such settlement or compromise
Some salient features of amendments in the Act are summarized below:
Bank
 Can buy the NPA property if there are no other bidders
 Multi-state co-operative banks can also take action under SARFAESI
Borrower
 Can’t get stay orders from DRT easily
 Can reach settlement/compromise with Bank/RCO

11. 10
RCO  Can convert their debt into equity (fully or partially)
Government  Can prohibit or modify the Act’s applicability in public interest
Operational Reality
The SARFAESI Act has proven to be one of the most efficient remedies to the problems
in the debt recovery process in India. The figures speak in favour of the act. Cases referred
under SARFAESI have been rising constantly.
(Amount in Rs Crores) One time settlement Scheme Lok Adalats DRTs SARFAESI Act
2003-04
No of Cases Referred 139,562 186,100 7,544 2,661
Amount Involved 1,510 1,063 12,305 7,847
Amount Recovered 617 149 2,117 1,156
2004-05
No of Cases Referred 132,781 185,395 4,744 39,288
Amount Involved 1,332 801 14,317 13,224
Amount Recovered 880 113 2,688 2,391
2005-06
No of Cases Referred 10,262 268,090 3,534 41,180
Amount Involved 772 2,144 6,273 8,517
Amount Recovered 608 265 4,735 3,363
2006-07
No of Cases Referred 160,368 4,028 60,178
Amount Involved 758 9,156 9,058
Amount Recovered 106 3,463 3,749
2007-08
No of Cases Referred 186,535 3,728 83,942
Amount Involved 2,142 5,819 7,263
Amount Recovered 176 3,020 4,429
2008-09
No of Cases Referred 548,308 2,004 61,760
Amount Involved 4,023 4,130 12,067
Amount Recovered 96 3,348 3,982
2009-10
No of Cases Referred 778,833 6,019 78,366
Amount Involved 7,235 9,797 14,249
Amount Recovered 112 3,133 4,269
2010-11
No of Cases Referred 616,018 12,872 118,642

12. 11
Amount Involved 5,254 14,092 30,604
Amount Recovered 151 3,930 11,561
Source - Banking Sector Reforms and NPA: A study of Indian Commercial Banks, Meenakshi Rajeev, H P Mahesh & RBI
Reports
According to the report “Trend and Progress of Banking in India, 2012-13” released by
RBI, banks have been able to recover approximately INR 18,500 crore through the SARFAESI
Act.
Recovery Channel
2011-12 2012-13
No. of cases
referred
Amount
involved
Amount
recovered*
Col. (4)
as % of
Col. (3)
No. of
cases
referred
Amount
involved
Amount
recovered*
Col. (8)
as % of
Col. (7)
1 2 3 4 5 6 7 8 9
Lok Adalats 4,76,073 17 2 11.8% 840691 66 4 6.1%
DRTs 13,365 241 41 17.0% 13408 310 44 14.2%
SARFAESI Act 1,40,991 353 101 28.6% 190537 681 185 27.2%
Total 6,30,429 611 144 23.6% 1044636 1057 232 21.9%
Notes:
1. *: Refers to amount recovered during the given year, which could be with reference to cases referred during the given year as well as
during earlier years.
2. DRTs – Debt Recovery Tribunals
NPAs of SCBs recovered through SARFAESI over last few years
As is clear from the figure, a large amount of debt recovery is being done through the
Act and it has proven to be an important tool for banking companies. In 2012-13, 80% of the
NPAs recovered by the banks were through the SARFAESI route. Further, banks remained the
most important subscribers of securitised assets of SCOs/RCOs. Another way of measuring
effectiveness of SARFAESI is to check whether the NPAs of banks as a percentage of loans and
advances have gone down or not.
46.05%
38.18%
51.22%
58.00%
53.60%
56.81%
73.90%
70.13%
79.70%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13
Percentage of NPAs recovered through SARFAESI

13. 12
The below figure displays the trend in NPAs of Scheduled Commercial Banks (SCB)
before and after the SARFAESI Act coming into being. While the net NPA ratio has more or
less come down over the years, the percentage fall in NPA ratio picked up suddenly after 2002
(SARFAESI Act implementation). But the fall in NPA ratio slowed as well as reversed for some
time, due to recession around 2008 resulting in bad debts. The initial major fall in NPA ratio
after 2002 signals the effectiveness of the SARFAESI act.
NPA movements of SCBs
But there have been many implementation as well as legal issues with SARFAESI that
have come to the fore:
1. Collusion of asset reconstruction companies and the borrower: The
underlying motive behind bringing in RCO (Asset Reconstruction Companies) as a tool
in the recovery process is to clean up the balance sheet of the banks so that they can
concentrate on their core activities. Moreover, A SCB getting into the task of loan
recovery process takes a hit on its brand image and hence RCOs are preferable for loan
recovery process.
In a meeting called by CVC in May 2010, attended by major bank CMDs, it was
opinionated that some RCOs are found to be directly in collusion with defaulters, in
what is called as a “sweetheart deal”. RCOs were found to be undervaluing the assets
and then selling it back to the borrowers or their relatives. This has become a primary
method for many real estate developers to steal investor wealth by allowing the
primary property to default and then buying the same property through a legally
-40.00%
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
NPA movements of SCBs
Net NPA as %age of Net Advances %age fall in net NPA ratio from last year
SARFAESI Act
introduced
Fall in NPA ratio
slowing down due
to recession

14. 13
separate entity held by associates of the promoter at a deep discount. This is further
assisted by the existence of a gentleman’s agreement between developers not to bid for
each other’s defaulted properties.
2. SARFAESI being classified as draconian by borrowers: It is alleged that
SARFAESI act has been used to pressurize borrowers to surrender their properties
without even considering the fact that in some cases the borrower is not a wilful
defaulter and is willing to settle the dues in the near term
3. Seller in the auction: As there are no specific guidelines on whether a QIB
(Qualified Institutional Buyer), who has acquired the right to sell the property can
actually buy it through participating in the auction, hence QIBs at times with the
permission of the court acquire the property to clear the liability from their books even
if the value of the acquired asset is lower as compared to the price paid in the auction
4. Right to appeal at Debt Recovery Tribunal: In a number of cases the
implementation has been marred by the borrower challenging the act of the bank in
DRTs (Debt Recovery Tribunal) and getting a stay order from it. In a number of cases,
DRTs have given stay orders without any major basis due to the claim of irreparable
loss to the borrower in case of the bank taking over the security. Eventually the stay
order is removed but by that time the damage is done. On the other hand, despite the
orders of Supreme Court stating that the appellant can only approach courts after the
exhaustion of existing alternatives, high courts have been entertaining the appeal of
borrowers which is causing delay in settlements
5. Government dues being the first priority: Under the stipulations of the Act,
government dues, e.g. Sales Tax, are to be paid first by the lender on a property
acquired through SARFAESI. This also includes any taxes pending from the date
before the acquisition of the property as a mortgage. This is valid even if the debtor has
measures to pay for taxes after the acquisition of the said property
6. NBFCs and cooperative banks getting excluded from SARFAESI: Debt
Recovery Amendment Act, 2002 allowed co-operative banks to be a part of SARFAESI
Act, but Gujarat HC in April 2013, ruled out that co-operative banks cannot use
SARFAESI for debt recovery procedures because Co-operative Societies Act has an in-
built debt recovery mechanism and the application of SARFAESI to co-operative banks
clashed with Banking Regulation Act, 1949. Along with this NBFCs are also not allowed
to be a part of SARFAESI since the act limits itself to the institutions listed in schedule
5(c) of the constitution in which NBFCs do not fall. Given the fact that consumer base
of NBFCs is more subprime in nature than regular banking institutions, the application
of SARFAESI to NBFCs is a long standing demand of the banking industry

15. 14
7. Auction value and selection of properties: Under the stipulation of SARFAESI
Act, once the time limit has passed, the bank can go ahead with the selling of the
property unilaterally and banks generally do not consider the view of the borrower.
Moreover, there is no stipulation on the auction value of the asset. Banks have more
than enough discretion to decide on the sale value in the auction and even if a particular
asset has a greater value than the debt, banks can sell it at the debt price and the
borrower need not get any residuals. Again, given a host of properties/assets with the
borrower, banks have the right to select which property to enforce without the advice
of the borrower
Latest Developments in Debt Recovery Space
 Demand to remove the clause of old management restoration after debt
recovery: RCOs have asked RBI to relook at the norm that forces them to restore the
old management once the recovery of dues is done. They have also asked RBI to
provide legal immunity to the new management. This is primarily because RCOs have
the power of restructuring the management in case of default and to bring in new
management, for which incentives are needed. It becomes difficult to bring in new
management when by norms the RCOs would need to replace them with old
management after debt recovery. This also poses the problem of moral hazard as the
new management knows that as soon as the debt recovery is done they will have to
leave their positions.
However, the architect of SARFAESI, M R Umarji contends that the idea behind
restoration of old management is that since the debt has been paid, the borrower has
all the right to decide on how to run his business. Just because he took a loan does not
mean that he has surrendered his sovereignty on business decisions to the bank
permanently.
 Introduction of a new category (non-co-operative) borrowers: RBI is
mulling over introducing a new category of borrowers called as non-co-operative who
use legal means to stall any move of debt recovery. These kind of borrowers will contest
every kind of case in the court or use any suitable measure to postpone the recovery.
However there is nothing illegal about it, but the financial system bears the cost for
this. RBI is trying to classify this set of people to increase their borrowing costs in the
financial system.

16. 15
International Perspectives – China and USA
Non-Performing Loan Securitization Laws in People’s Republic of China:
Background: The evolution of policy reforms in the economy of the People’s Republic of
China (PRC) has led to it becoming more liberal and hence creating a conducive environment
for securitization as a favourable means for disposal of non-performing assets. Most of the
NPAs are from the 4 largest state owned banks:
1. Bank of China (BoC)
2. Agriculture Bank of China (ABC)
3. China Construction Bank (CCB)
4. Industrial and Commercial Bank of China (ICBC)
This development is further supported by the evolving legal framework in the country and
necessitated by the inadequacy of existing recovery methods of non-performing loans.
Mortgage Backed Securities are not that common in PRC. With the latest MBS issue
being in July 2014 for the first time in 7 years. PRC has tried to shed this policy framework by
allowing for private residential ownership in 1992 and many moves to promote private
housing ownership throughout the 90’s. Moves like establishing a housing fund and providing
housing benefits as a part of working compensation ultimately led to creating a conducive
environment for mortgage securitization.
History of Securitization and Restructuring in PRC: The lenders in PRC economy
include banks (Commercial, policy, foreign, state-owned) and cooperatives providing credit
(Rural and Urban). State owned banks are major lenders for state owned enterprises.
In 1996, Guangdong Zhuhai Highway Ltd. issued for the first time, securities of value
USD 200 million in the US market. In 2000, two of the major state owned banks i.e. China
Development Bank (CDB) and Industrial and Commercial Bank of China (ICBC), were chosen
to start the issuance of securitized loans with. In the same year 4 Asset Management
Companies (AMC) were established corresponding to 4 major state owned banks in China.
Subsequently in year 2003, China Security Regulatory Commission (CSRC), the Chinese
counterpart of SEC in USA, issued guidelines for asset management business for securities
company clients. It also released similar guidelines for credit asset securitization later in 2005.
In the same year, major banks: China Development Bank and China Construction Bank issued
short and long term securitizations. The People’s Bank of China, the central bank, takes
measures so as to affect reconstruction of financial assets.

17. 16
Legal framework for Asset Securitization: Although China did not have any legislation
for backing/regulating “asset securitization” to solve the issue of non-performing loans,
reforms for the same were taking place slowly. The Securities Law of 1995 can be considered
as a building block for asset securitization legal framework.
The regulatory framework exists for:
1. Primary Market for Non-Performing Assets: Where banks transfer their
NPA to Asset Management Companies (AMC)
2. Secondary Market for NPAs: Where AMCs transfer/sell the NPAs to investors
For the primary market, the regulation focusses on the Banks themselves, which
basically generate NPAs in the first place. Thus, these concern the regulation of commercial
banks in the terms of their loan issuance. The first of the regulations was in 1997 – The General
Provisions on Issuing Loans issued by Peoples Bank of China. The “PRC Commercial Bank
Law 2003” is another reform which enforces due diligence of borrowers before issuing loans.
For the secondary market, the regulation puts focus on AMCs. In this market, there are far
too many entities which issue different guidelines with respect to different aspects of AMC
transactions. For example,
 CBRC (China Banking Regulatory Commission) is responsible for regular banking
business
 CSRC (China Securities Regulatory Commission) is responsible for business related to
securities
 Ministry of Finance is responsible for supervising general financial management
 State Administration of Foreign Exchange (SAFE) for transactions involving foreign
exchange
Thus, there is a lack of a single clear set of guidelines for AMCs. Moreover, sometimes these
guidelines even conflict with each other creating uncertainty in the minds of investors.
The CBRC’s “Administrative Rules for Pilot Securitization of Credit Assets” released in
2005 was the first law supporting asset backed securitization. Thus, it was after the SARFAESI
Act in India. But, the law does not carry the legal weight as other national laws. These rules
draw heavily from western economies, especially USA. Certain key features of these rules are
as follows:
 Comprehensive description of requirements for parties to issue and trade asset backed
securities in inter-bank bond markets

18. 17
 The rules do not define what exactly the “credit assets” are. This means banks are
uncertain of what receivables are included in this
 Only state owned banks can be the originators for such securitized assets
 In case of bankruptcy of the bank, the rules do not protect the transferred assets
 The bank creating asset backed securities has to publicly announce the creation
 Only Special Purpose Vehicles (SPV) can be entrusted with the securities. The company
law in China creates restrictions on which companies can act as SPVs. These act as
trusts with only trustees allowed to make decisions in sale of these assets. The asset
backed securities can only be traded in Chinese National Interbank Bond Market.
Peoples Bank of China has the authority to allow these SPVs to issue securities in the
market
 Rules also require that credit rating agencies rate these asset backed securities before
their sale in the interbank market
Key issues with Chinese laws dealing with NPA resolution of AMCs:
 The influence of government on judicial system.
 The redressal mechanism (courts) not following proper laws, mostly against the
AMCs
 Difficulties and delays in enforcing the judgment of the courts
Recent Developments: After the subprime crisis in 2008-09, the asset securitization
reforms were suspended for many years. Recently in 2012, CBRC, PBoC and Ministry of
Finance issued “Circular on relevant matters concerning further expansion of pilot
securitization of credit assets”. This has led to revival of credit asset securitization.
NPL/NPA situation in China Banking Institutes, Source: CBRC annual reports, www.cbrc.gov.cn
2009.5 2010 2010.5 2011 2011.5 2012 2012.5
0
0.5
1
1.5
2
2.5
3
1000
1050
1100
1150
1200
1250
1300
2010 2011 2012
NPLinbillionRMB
Year
China Banking Institutes
NPL Outstanding NPL Ratio (%)

19. 18
NPL/NPA situation in Chinese Commercial Banks, Source: CBRC annual reports, www.cbrc.gov.cn
Consumer Protection in Asset Securities Market, USA:
Unlike India, the US has a trend of Third Party Collectors which collect debt on behalf
of banks. In general creditors go for these collectors only when their in house efforts have
failed. The industry of debt collection in US has been growing with time. During 1900’s The
Federal Deposit Insurance Corporation (FDIC) and Resolution Trust Corporation (RTC)
started selling non-performing loan portfolios to private buyers. Federal Trade Commission
(FTC) first laid out guidelines on ideal collection practices for creditors in 1968.
The Fair Debt Collection Practices Act came into effect in 1977. It was originally
established in order to put an end to unfair and deceptive debt collection practices in the USA.
The debt covered under this act has to be consumed for personal/household/family purposes
only and the law does not cover corporate debt. The Federal Trade Commission (FTC), a
consumer protection agency enforces the act. Thus, consumers can use this law to raise their
voice against unlawful debt recovery practices by banks. Still there have been claims of FDCPA
not being adequate for protecting consumer rights and need for more stringent laws. In
comparison, the SARFAESI Act was introduced in order to facilitate the debt recovery for
banks and to eliminate the legal impediments in the process.
The debt collection in the US has more legal remedies than those in India. For example,
creditors can get their recovery through a direct deduction from debtor’s pay-check. At the
same time consumers have other legal remedies in their hands such as filing for bankruptcy.
The Uniform Commercial Code (UCC) Article 9, part 6 provides many such legal remedies.
The following are some of those remedies:
2006 2007 2008 2009 2010 2011 2012 2013
0
1
2
3
4
5
6
7
0
200
400
600
800
1000
1200
1400
2007 2007.5 2008 2008.5 2009 2009.5 2010 2010.5 2011 2011.5 2012
NPLOutstanding,billionRMB
Year
Commercial Banks in China
NPL Outstanding NPL Ratio (%)

20. 19
 Collection of liquid assets: Collecting collateral of accounts, deposit accounts and
other rights to payment in a commercially reasonable manner
 Assembly of collateral: Collecting tangible collateral which is not in secured party’s
possession. The debtor has to collect such assets and make them available to creditors
at a location reasonably convenient to both parties. This can be done pre or post default
 Repossession of collateral: It authorizes secured party to take possession of
collateral by removing from the debtor’s site and take its possession or even make it
unusable or dispose it off after default. This should be done without breaching peace
or else judicial process has to be followed
 Disposition of collateral: It authorizes secured party to sell lease license or sell or
dispose all or part of the collateral in a commercial reasonable manner. The UCC does
not define “commercially reasonable” though, leaving it to judgment on a case by case
basis. The secured party has to give notice of proposed disposition
 Strict Foreclosure: The secured party acquires collateral in full or partial
satisfaction of the secured obligation without the need for a disposition. The consent
of the debtor and extent of the same plays an important role here
 Execution Sale: Here the secured party or the creditor can sue the debtor to collect
the secured asset and it further seeks to liquidate the same. Here there is no risk of
doing disposition or repossession improperly
 Redemption: It gives the debtor a right to redeem the collateral until the creditor has
not collected or disposed of it. Of course the debtor has to fulfil the debt to be able to
do so
Thus, creditors should make use of all the available remedies along with negotiation fully.
Source: Economic Research, Federal Reserve Bank of St Louis
0.00
1.00
2.00
3.00
4.00
5.00
6.00
1984-11-14 1990-05-07 1995-10-28 2001-04-19 2006-10-10 2012-04-01 2017-09-22
US Commercial Banks NPA/Total Loans %

21. 20
Recommendations
 Further regulatory support and incentives to facilitate the transfer of NPAs by
banks/financial institutions to RCOs
 Establishment of clear valuation guidelines and acceptance of NPA valuation
methodology would eliminate contentions over NPAs being undersold at auctions
 Providing Flexibility to RCOs in determination of resolution strategies
 Bringing in legislative solutions and otherwise to resolve the issue of collusion between
RCOs and borrowers or their relatives as well as between real estate
developers/borrowers
 Bringing in greater borrower protection mechanisms without allowing debt settlement
periods to increase by penalizing frivolous litigation severely
 Altering the clause relating to Government dues having first priority such that the debt
recovery amount is calculated after the deduction of pending taxes on the acquired
property and hence allows the debtor to recover more in case the taxes result in lower
than mandated recovery amount.
 Bring in NBFCs and co-operative banks with greater proportion of sub-prime
borrowers under the purview of the Act to improve viability of these institutions
 Create a strong and competitive secondary market for NPAs enabling efficient transfer
of the same from RCOs to investors
 Incentivise the growth of third party debt collection agencies while regulating the same
to protect borrower rights
 Clarify and resolve conflicts and interferences between clauses of various acts
prevailing in allied and overlapping sectors to improve consistency and
implementation

22. 21
References:
1. The Securitization and Reconstruction of Financial Assets and Enforcement of
SecurityInterest Act, 2002
2. Economic Systems 32 (2008) 177–196 - "Does lending behaviour of banks in emerging
economies vary by ownership? Evidence from the Indian banking sector" by Sumon
Kumar Bhaumik and Jenifer Piesse
3. Legal history before passing SARFAESI Act by : C. P. S. Ramachary
(http://www.lawyersclubindia.com/articles/Legal-history-before-passing-
SARFAESI-Act-4688.asp#.U-fPn_mSwVt)
4. IJMSSR Volume 2, No. 1, January 2013, "Implementation of SARFAESI Act - some
issues" by V. Sekar and Dr. V. Balachandran
5. Seminar on Corporate Rescue and Insolvency, “SARFAESI Act, 2002 & Role of Asset
Reconstruction”, 10th September 2010
6. Indian Company Law: Critical issues under SARFAESI Act, 2002?
7. Live Samachar – “Bring non-banking finance companies under SARFAESI Act: study”
8. Indian Corporate Law: Supreme Court exempts Co-Operative Banks from claiming
under Recovery of Debts Due to Banks and Financial Institutions Act
9. ASSOCHAM suggests NBFCs under SARFAESI Act, Sunday, February 23, 2014
10. RBI’s own guidelines may hamper Raghuram Rajan’s NPA drive, By Sangita Mehta,
ET Bureau | 21 Jan, 2014
11. CBI probes IDBI Bank loan to Kingfisher Airlines, livemint, Sat, Aug 09 2014
12. “Non-performing loans securitization in the PRC”, Johnny P Chen, Dept. of
Economics, Stanford University
13. “Research in Securitization of Non-performing loans of China’s state owned Banks”,
Yifei Yin, Xian Jiaotong University
14. “Significance of restart of asset securitization in China”, Takeshi Jingu, A note by
Nomura Research Institute Ltd., September 2013
15. “Using Asset Management Companies to resolve non-performing loans in China”,
Guonan Ma, Ben Fung
16. “Enforcing security interests under Article 9 of the UCC”, Alan M Christenfeld, Barbara
M Goodstein
17. “Collecting Consumer debt in America”, Robert M Hunt