Final dissertation llm-rubina muazzam final

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“INDIAN BANKS BIG NPA PROBLEM AND DEBT RECOVERY SOLUTIONS”
A dissertation submitted in partial fulfillment of the requirement for award of the
degree of
Master of Laws
Submitted by: - Under the supervision of: -
Name of student: Rubina Muazzam Faculty name: Ms. Vibha Srivastava
Roll no. : LS/LM/15/001 Designation: Professor
Enrolment no:15SLLALLM4003
School of Law and Legal Affairs
Noida International University
Gautam Budh Nagar,
Uttar Pradesh-India
(2015-2016)

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DECLARATION
I, Rubina Muazzam, daughter of Prof. Dr. Mohd. Muazzam hereby declare that the dissertation
on “Indian Banks Big NPA Problem and Debt Recovery Solutions” is original work, and it has
not been submitted, either in part or full, anywhere else for the purpose of, academic or
otherwise.
Date: Name of student: Rubina Muazzam
Roll no.: LS/LM/15/001
Enrolment no.: 15SLLALLM4003

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CERTIFICATE
This is to certify that Ms. Rubina Muazzam who is a bonafide student having enrolment No.
15SLLALLM4003. She is submitting this Dissertation entitled "Indian Banks Big NPA Problem
and Debt Recovery Solutions" for awarding the degree of Master in Laws. She has worked on
the above mentioned topic under my constant supervision and guidance to my entire satisfaction
and her/his dissertation is worthy of consideration for the award of the Degree of Master of
Laws. As this dissertation meets the requirements laid down by School of Law and Legal
Affairs, Noida International University, hence, I recommend this dissertation to be accepted for
evaluation.
Name of Supervisor: Ms. Vibha Srivastava Dr. Pankaj Dwivedi
Designation: Professor Head of Department
School of Law and Legal Affairs School of Law and Legal Affairs

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ACKNOWLEDGEMENT
On the occasion of the submission of this LL.M Dissertation synopsis on topic “Indian Banks Big
NPA Problem and Debt Recovery Solutions”, first of all I humbly pray to almighty God and then
my respected Father and Mother by whose grace this work has been completed. I express my
deep sense of gratitude to Dr. Pankaj Dwivedi, HOD, School of Law, Noida International
University, Noida, whose ideas have always been a source of inspiration for me. His disciplined
approach towards the life has always motivated me to do a work in a very systematic &
organized way within the proper time.
I express my sincere gratitude to the Professor (Dr.) Vikram Singh, the Honorable Pro-
Chancellor, (former DGP Uttar Pradesh), Vice-Chancellor Professor (Dr.) Kumkum Diwan,
Registrar, and Directors of all the schools of the University. They have been a source of
inspiration for me to complete this synopsis. They have been conscious guardian for me. I am
really grateful to them and remain thank full for their guidance.
I express my deep sense gratitude to my supervisor Prof. Ms. Vibha Srivastava School of Law &
Legal Affairs, Noida International University, Noida. She guided me in proper manner by which
it become possible to work on this issue. I am highly thankful to her.
I take this opportunity to express my profound gratitude to all the respected teachers of School
of Law and Legal Affairs. I have no words for the contribution of all my respected teachers and
staff of my University for their consistent suggestions regarding my Dissertation work, which
helped me immensely to undertake a long academic journey. Library staff also deserves my
special gratitude for their kind cooperation.
Last but not least, I am grateful to all my friends, to have been there with me to encourage, to
guide and help me out in the difficult moments of my life both in University and outside, during
the entire course of LLM.
Rubina Muazzam
LS/LM/15/001
15SLLALLM4003

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LIST OF ABBREVIATIONS
ABC: Adjusted Bank Credit
ABS: Asset Backed Securities
AFCs: Assets Financing Companies
ALM: Asset Liability Management
AMC: Asset Management Company
ANBC: Adjusted Net Bank Credit
ARC: Asset Reconstruction Company
BCBS: Basel Committee on Banking Supervision
BFS: Board for Financial Supervision
BIS: Beaureu of international Settlement
CADP: Common area development programme
CAPM: Capital Assets Pricing Model
CAR: Credit Adequate Ratio
CARE: Credit Analysis and Research Ltd
CCF: Credit Conversion Factor
CFSA: Committee on financial sector assessment
CIBIL: Credit Information Bureau Ltd
CLO: Collateralized Loan Obligation
CPs: Commercial Papers
CPC: Civil Procedure Code
CRR: Cash Reserve Ratio
CRAR: Capital Risk Weighted Asset Ratio
CRISIL: Credit Rating Information Service of India Ltd
DDP: Dessert development programme
DEA: Data Envelopment Analysis
DFI: Development Financial Institution
DICGC: Deposit Insurance and credit Guarantee Corporation
DPAP: Draught prone area programme
DRDA: District rural development agency
DRT: Debt Recovery Tribunal

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DRAT: Debt Recovery Applet Tribunal
DGA: Duration Gap Analysis
ECAIs: External Credit Assessment Institutions
ECGC: Export Credit Guarantee Corporation
FDI: Foreign Direct Investment
FI: Financial Institution
GOI: Government of India
GTB: Global Trust Bank
HFC: Housing Finance Company
IRDP: integrated rural development programme
IRAC: Income Recognition and Asset Classification
IRS: Interest rate swaps
KCCS: Kissan Credit Card Scheme
KYC: Know your Customer
LGD: Laws given default
MBS: Mortgaged Backed Securities
MFAL: Marginal farmer’s agricultural labourers
MOU: Memorandum of Understanding
MPBF: Maximum Permissible Bank Finance
MSME: Micro Small and medium enterprise
NABARD: National Bank for Agricultural and Rural Development Bank
NBC: Net Bank Credit
NBFC: Non Banking Financial Companies
NBFI: Non Banking Financial Institution
NC: Narasimham Committee
NGO: Non Governmental Organisation
NHB: National Housing Banks
NPA: Non Performing Asset
OBC: Oriental Bank of Commerce
OPS: Other Priority Sector
OSS: Off-Site Surveillance Software

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OTS: One Time Settlement
PACS: Primary Agricultural Credit Societies
PEO: Programme evaluation Organization
PLR: Prime Lending Rate
PSA: Priority Sector Advances
PSB: Public Sector Bank
PTC: Private Trust Company
PCBs: Primary Cooperative Banks
RFIs: Rural Financial Institutions
RIDF: Rural Infrastructure Development Fund
ROA: Return on Asset
RRB: Regional Rural Bank
SACP: Special Agricultural Credit Plan
SARFAESI: Securitization and reconstruction of financial asset and
Enforcement of Security Interest
SCB: Scheduled Commercial Bank
SEB: Salary Earners’ Bank
SFDA: Small farmer’s development agency
SGSY: Swarna Jayanti Gram Swarozgar Yojna
SHGs: Self Help Groups
SIDBI: Small Industry Development Bank of India
SLR: Statutory liquid Ratio
SME: Small and medium enterprise
SPV: Special Purpose Vehicle
SSI: Small Scale Industry
STCBs: State Cooperative Banks
TAFCUB: Task Force for Cooperative Urban Bank
TGA: Traditional Gap Analysis
UCB: Urban Cooperative Bank
VC: Venture Capital
WPI: Whole Sale Price Index

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TABLE OF CASES: NPA ACCOUNTS

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INDEX
CHAPTER NO. SUBJECT PAGE NO.
Declaration 2
Certificate 3
Acknowledgement 4
List of Abbreviations 5
Table of Cases 8
Chapter 1 Introduction 13
1.2 Abstract 14
1.3 present scenario 14
1.4 classification of NPA’s 15
1.5 Development and Comparisons of
Banks and Non-Banking Financial
Institution
17
1.6 Non-Banking Financial Company 18
1.7 Cooperative Banking Sector 19
Chapter- 2 Difficulties With The Non-Performing
Assets And Review Of Literature And
Genisis Of Committees.
37
2. Difficulties With The Non-
Performing Assets
38
2.2 Review Of Literature And Genisis
Of Committees
39
2.3 Various Committee Reports – On
Credit
39

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2.4 Various Committee Reports On
NPA
42
2.5. Conclusions 43
Chapter- 3 Comparative Study With Other
Countries And Scope Of The Study
45
3.1 Comparative Study With Other
Countries
46
3.2 The Need for the Study 48
3.3 Statement of the Problem 48
3.4 Objectives of Study 49
3.5 Limitation of the Study 49
3.6 Methodology of the study 49
3.7 Conclusion 50
Chapter- 4 LEGAL FRAME WORK AND
NOTIFICATION
51
4.1 Introduction 52
4.2 Purpose of the Act 52
4.3 The Securitisation and
Reconstruction of Financial Assets and
Enforcement of Security Interest Act,
2002
53
4.4 Debt Recovery 62
4.5 SEBI 71

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Chapter- 5 Solutions to NPA 82
5.1 Steps which cure the disease of
NPAs
83
5.2 Bad loans 84
5.3 present scenario 84
5.4 Comparison/ Charts 87
Chapter- 6 FINDINGS AND CONCLUSIONS 91
6.1 Introductions 92
6.5 Major findings 93
Chapter-7 Suggestion and Recommendations 99
BIBLIOGRAPHY 102
Books
Reports
Articles/ journal
Websites
Case Laws
105

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INTRODUCTION
1. Brief Introduction:
Banking sector reforms in India has progressed promptly on aspects like interest rate
deregulation, reduction in statutory reserve requirements, prudential norms for interest rates,
asset classification, income recognition and provisioning. But it could not match the pace with
which it was expected to do. The accomplishment of these norms at the execution stages without
restructuring the banking sector as such is creating havoc. This research paper deals with the
problem of having non-performing assets, the reasons for mounting of non-performing assets and
the practices present in other countries for dealing with non-performing assets.
During pre-nationalization period and after independence, the banking sector remained in private
hands Large industries who had their control in the management of the banks were utilizing
major portion of financial resources of the banking system and as a result low priority was
accorded to priority sectors. Government of India nationalized the banks to make them as an
instrument of economic and social change and the mandate given to the banks was to expand
their networks in rural areas and to give loans to priority sectors such as small scale industries,
self-employed groups, agriculture and schemes involving women.
To a certain extent the banking sector has achieved this mandate. Lead Bank Scheme enabled the
banking system to expand its network in a planned way and make available banking series to the
large number of population and touch every strata of society by extending credit to their
productive endeavours. This is evident from the fact that population per office of commercial
bank has come down from 66,000 in the year 1969 to 11,000 in 2004. Similarly, share of
advances of public sector banks to priority sector increased form 14.6% in 1969 to 44% of the
net bank credit. The number of deposit accounts of the banking system increased from over 3
crores in 1969 to over 30 crores. Borrowed accounts increased from 2.50 lakhs to over 2.68
crores.

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1.2 Abstract
The Indian banking system has undergone significant transformation following financial sector
reforms. It is adopting international best practices with a vision to strengthen the banking sector.
Several prudential and provisioning norms have been introduced, and these are pressurizing
banks to improve efficiency and trim down NPAs to improve the financial health in the banking
system. In the background of these developments, this study strives to examine the state of affair
of the Non performing Assets (NPAs) of the public sector banks and private sector banks in India
with special reference to weaker sections. The study is based on the secondary data retrieved
from Report on Trend and Progress of Banking in India. The scope of the study is limited to the
analysis of NPAs of the public sector banks and private sector banks NPAs pertaining to only
weaker sections for the period seven (7) years i.e. from 2004-2010. It examines trend of NPAs
in weaker sections in both public sector and private sector banks .The data has been analyzed by
statistical tools suchas percentages and Compound Annual Growth Rate (CAGR). The study
observed that the public sector banks have achieveda greater penetration compared to the private
sector banks vis-à-vis the weaker sections.
1.3
In present times, banking in India is fairly mature in terms of supply, product range and reach.
But reach in rural India still remains a challenge for the public sector and private sector banks.
The Reserve Bank of India is mainly concerned with providing finance to weaker section of
society, development of priority sectors and providing credit under differential rate of interest
scheme. After reforms in 1991, the entry of many private players has been permitted. Post
liberalization demand PSB’s to compete with well diversified and resource rich private banks
and to provide fine funded services and unique products to suit customers need. PSB’s have
already sacrificed alot of their profits for achievement of social objectives. Due to cut throat
competition and technology, the PSB’s are thinking to improve productivity and profitability
which is essential to survive in a globalised economy. The future of PSB’s would be based on
their capability to continuously build good quality assets in an increasingly competitive
environment and maintaining capital adequacy and stringent prudential norms.

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1.4 CLASSIFICATION OF NPA’s:
As per the RBI guidelines any loan repayment which is delayed beyond 180 days has to be
identified as NPAs. NPAs are further classified into
i. Substandard Assets I.e. those which are NPA for a period not exceeding two years
(Up to 2 years).
ii. Doubtful Assets I.e. Loans which have remained NPA for a period exceeding two
years and which are not considered as loss assets. NPA accounts belonging to this
category are further classified as D1 – When the account remains NPA for 3rd year.
D2 – When the account remains NPA for 4th and 5th year. D3 – When the account
remains NPA for 6th year onwards.
iii. Loss Assets A loss asset is one where loss has been identified but the amount has not
been written off wholly or partly. In other words, such assets are considered as
uncollectible. As per RBI guidelines provisions for NPA are to be made as under:-
a) 10% of sub-standard assets
b) 20% for doubtful assets
c) 100% for loss assets.
As per recent guidelines even on standard assets a provision @ 0.25% is required to be made. In
this connection following quotation from Narasimham Committee Report 1998 is worth quoting
“NPAs in 1992 were uncomfortably high for most of our PSBs and for some, high enough to
warrant concern, especially where the ratio of NPAs to Capital funds was disturbing high and in
some cases exceed net worth and undermined solvency. If the depositor’s money in such cases
was not at risk, as it strictly would otherwise have been, it is because of the implicitly guarantee
provided by the state ownership of the banks. Since 1992, there has been some improvement
even with a progressive tightening of the definition in the level of NPAs of the public sector
banks as a group. In spite of some write-off of loss accounts in this period, gross NPAs, which
perhaps reflects the true extent of contamination of the portfolios, were as high as 23.2% of the
total advances in March 1993 but have since come down from 14.5% in March 1994 to around
Rs.20, 000 Crores or 9.2% in March, 1997” To find out the causes of NPAs in Indian banking
sector, the total NPAs are to be classified into two broad categories viz:
i. Legacy NPAs

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ii. New NPAs
i. Legacy NPAs These are the NPAs acquired even before the prudential accounting norms were
introduced. Government has given the task of social banking to the PSBs and issued guidelines
and framed policies whereby 40% of the total advances must go to priority sector. Here only the
quantity of advances is emphasized ignoring the quality of lending. The Narasimham committee
report assets “Directed Credit has proportionately higher share in NPA portfolio of banks and has
been one of the factors responsible for erosion in the quality of banks assets”. In this connection
Narasimham Committee Report 1998 quotes “the causes of high proportion of NPAs are varied.
Poor credit decision by bank management, difficult recovery environment and changes both
cyclical and structural in the larger economic environment represent some of the micro and
macro aspects of this. This is not all. Often, as international experience has shown, a high
incidence of NPAs could be traced by policies of direct credit, not to speak of crude form of
behest lending. There is no inherent mistake in setting out social priorities for bank lending.
Social banking need not conflict with canons of sound banking but when banks are required by
directive to meet specific quantitative targets, there is, as our experience has shown, the danger
of erosion of the quality of loan portfolio.”
ii. New NPAs.
A critical analysis of NPAs in various banks reveals that in addition to priority sector, advances
to large industries also forms part of NPAs. The share of small advances of rural sector is very
small compared to the large advances. NPAs in percentage terms in some of the priority sector
advances may be higher but quantum wise, its contribution to total NPAs is not very significant.
Whereas percentage of NPAs in case of large advances may be lower but it forms the major
chunk of the total NPAs. Priority sector advances, as a percentage of NPAs may be higher, but
quantity-wise, are not a high figure. Large advances, as a percentage of NPAs are lower, but
quantity-wise is a higher figure. b. Non-performing Asset (NPA) has emerged since over a
decade as an alarming threat to the banking industry in our country sending distressing signals on
the sustainability of the affected banks. The positive results of the chain of measures affected
under banking reforms by the Government of India and RBI in terms of the two Narasimham
Committee Reports in this contemporary period have been neutralized by the ill effects of this
surging threat. Despite various correctional steps administered to solve and end this problem,

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concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on
banking and financial institutions. The severity of the problem is however actually suffered by
Public Sector banks, Private Sector Banks & Co-operative banks & NBFC.
1.5 Development and Comparisons of Banks and Non Banking Financial Institution:
Public banks brought about a structural change in the banking industry with the commitment of
the government to implement social control on banks to make them realise the national goal of
developing the economy. The major segment of banking sector came under the control of the
government. Social control measures were also implemented such as priority sector lending
targets. This led to the massive expansion as a banking industry to borrowers across the country.
These developments created a strong network of public Sector banks meant to bring about a
socio economic transformation in the society. The share of credit to agriculture which constituted
a small portion for a long time improved significantly with the onset of lead bank scheme and
district plan. Indian banking sector have come a long way when it competitive and complex in
nature. The Implementation of Basel II has had a positive impact on the capital profile of the
Public sector banks. In base l Uniform risk rate was equally attached to all advances irrespective
of degree of risk. In India number of Private banks increased and their financial operations also
increased considerably. Though the banking principles and rule and regulation followed were the
same between Public sector banks and private sector banks but the competition spirit in banking
sector increased to a greater extent with the result the advances and selection of borrowers varied
with the result the profitability and quality of the assets varied from public sector to the private
sector, Hence the study involved the comparison between the private sector and the public sector
banks. Private Banks charge high rate of interest and also issue large number of credit card to the
individual as compared to public sector banks. Cooperative banks are expected to support
economically backward section of the society especially in rural areas. The advance or finance
provided to the borrowers may be to start new business or for the purpose of agriculture or
farmers. There is a study increase in the quantity of advances but there should also be increase in
the quality of advances and recovery. The study has been conducted on Urban Scheduled bank
situated. Since the number of cooperative bank is large in number and they have been classified
as Scheduled Urban Cooperative Bank, State cooperative banks, District Cooperative Bank,
Rural Cooperative banks, Local Cooperative Banks. Hence the research study has been

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compared to Public banks, Private Banks along with Cooperative banks. The Reserve Bank of
India is more stringent in framing banking rules and regulations. Inspite of the strict banking
laws the cooperative banks are able to meet the required formalities. The comparison is required
to find out the scope of improvement in scheduled Urban Cooperative banks so as to be as
competitive as Public Sector banks and Private sector banks Today schedule Urban Cooperative
banks are expected to support all sections of borrowers by financing them to start a new business
or for agricultural purpose the banks accepts deposits from the members and lend money to
needy persons. Since their main objective is to support priority sector, farmer, agriculturist, SSI,
artisans, small traders and salary earners. Recovery becomes difficult and leads to NPA.
Generally cooperative banks do not issue credit cards but they issue Kissan card which is may
prove to be doubtful debts. Non Banking Finance Company is not a regular bank but they raise
the capital through public issues. Hence Reserve Bank of India is very stringent in passing rules
and regulations. The Non Banking Financial Institution is more careful in lending loans. They
prefer only collateral security and also and along with collateral security they also insist on
Guarantors. The research study involves those Non Banking Finance who provides general loans
.Some Non Banking Finance lend specific kind of loan which may not be appropriate to the
research study. The comparison enabled to bring about striking features of success on recovery
proceedings and quality of the assets with reduction in NPA or not.
1.6 Non-Banking Financial Company
In consolidation of the banking sector, one has to focus on the nonbanking financial sector like
NBFCs and Unincorporated Bodies and thinks in terms of integrating them in financial system
along with the banks. In India, moneylenders, chits and other type of financial institutions play a
very large role in the credit markets for the unorganised sectors in trade, restaurants, transport,
construction, and service activities. It is to be noted that the market knowledge and information
regarding these activities like retail trade are not fully available with the commercial banker on
updated basis. By and large public sector banks have been geared to ‘Asset Based Lending’
rather lending based on the forecast cash flows. Activities like trade, transport, hotels and
restaurants, constructions etc, there are significant fluctuations in cash flows on a daily basis. In
other words risk assessment capabilities are not adequate in the context of these activities. Also
funds need to be available to these players without much paper work and based on personal

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assessment. Hence, the NBFC mostly finances these activities in consolidation of banking sector
should focus on integrating credit markets which comprises of banking and non banking sector.
Any consolidation should evaluate the following:
 Reduction in interest cost, and hence benefits the ultimate consumer;
 Enhancing the credit delivery mechanisms;
 Introduction of rating processes at retail level
 Creating a level playing field when global players enter the Indian markets;
 Reversing the inverse relationship between the size of borrowing and the cost of borrowing.
Hence it is necessary for the Indian financial market to bring about the restructuring of the
banking sector by comparing or merging banking sector and non banking sector ensure the
growth of the economy along with the adequate availability of the credit to the fast growing
sectors of the economy.
1.7 Co operative Banking Sector
In a competitive environment, the size of the organisation is going to matter very much as it
provides a lot of advantage to the organisation. The size helps the banks in terms of cost
advantage, technological advancement, competitive pricing, better resistance against market
attacks, portfolio expansion and so on. At times, sheer size helps one to face the tough
environment. Now the Indian banking has moved close to complete technology banking as it
provides many advantages. Starting from fund transfer to settlements, all are done through
technology banking. Cooperative banks cannot remain silent on this very important issue
Adoption of technology and asset management is not a choice but a compulsion for survival.
Some cooperative bank with a modern banking facilities, loan modules, etc which enables the
cooperative banks to earn desired profits. Consolidation will surely help cooperative banks in
this direction.
There are many operational concerns and problems cropping with the consolidation of banks.
The important one are with regard to the customers like interest rates of deposits, loans and
advances, asset quality(NPA levels) difference in the competency level of the employees of the
acquirer and acquired banks and so on. These issues need to be carefully listed out and analysed
in order to synchronise ll these operational issues and make things hassle free for the customers

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of both the banks, particularly the acquired bank. The cooperative banks should maintain high
capital adequacy ratio to meet the loss and also maintain capital to risk weighted assets ratio of
the acquired banks. The study has been compared to Public Banks, Private Banks, Co operative
banks and Non Banking Financial institutions on policies, appraisal stage, sanctioning stage and
disbursement stage and post disbursement stage. The comparison is also made on level of NPA
in these sectors and also importance is given to priority lending, non priority lending, SSI, and
agricultural lending.
1.8 Credit and Risk Framework of Indian Banks
Credit is the backbone of the banking structure. Diminishing growth rates for credit with rising
NPAs are not good news for the banking system in general. Measures need to be put in place to
arrest this downward slide, and the deceleration of lending is definitely not the answer.
The future of the banking system will depend largely on the risk management dynamics and the
management of credit risk is the most critical component of that framework. As Indian banks
move into the new high-powered world of financial operations and trading, there will be a
requirement for more sophisticated and consistent models of risk assessment – as well as post-
disbursement monitoring. Credit risk is about 70% of a bank’s total risk, the rest of the 30%
being shared between market risk and operational Risk. Not much can be done about market risk,
but operational risk and credit risk must be managed by banks.
As presented in a study done by Standard & Poor’s, mid-corporate and small and medium-sized
enterprise (SME) lending are the key areas of challenge for Indian Banks. The non-performing
loans of these segments range between 8 – 12% per annum.
There are several key reasons banks possess such a high rate of NPAs – which can be
outlined as follows:
Speculation – Investing in High Risk Assets
Default
Fraudulent practices
Diversion of funds

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Internal factors such as inefficient management, and inappropriate systems and technology
External factors
The question going forward really is: what can be done to address these issues?
Managing Risk: A Proactive Approach
Jasrin Singh, Director, Business Development, South Asia Omega Performance The following
list of measures is a suggested intervention program to bring about change that ensures that
Indian banks create healthy and sustainable loan portfolios:
A stable and standard international credit assessment framework
Indian banks would need to adopt a standard, international credit assessment framework which is
designed to take into account all elements of credit risk, including: business risk, operational
risk, industry risk and market risk. Despite each country market’s unique needs, the banking
sector’s credit risk assessment must be of a global standard.
The DNA of the bank: preventive measures or curative measures
The two dimensions of managing risk are preventive measures and curative measures.
Preventive measures include pre-disbursement policies, risk assessment, risk measurement, and
risk-based pricing. These are worth much more in their weight than any curative measures,
which are a reactionary form of risk management. The preventive measures and credit
assessment framework should become part of the bank’s DNA and the curative measures should
be utilised only in unforeseen circumstances
Post-disbursement loan monitoring
Credit risk is not entirely addressed at the time a loan is disbursed. While preventive measures
will have a great impact on improving loan quality, early detection and management of problem
loans is fundamental to ensuring a high quality, sustainable credit portfolio. Appropriate tools for
post-disbursement loan monitoring must become an essential part of the credit risk assessment
framework.

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Training of credit and sales personnel
Training is required to help bank employees understand and implement an objective credit risk
assessment framework. To encourage transformation, organisations will need to invest in
training. First, bank employees are required to understand core credit principles, bank growth
objectives, and customers business goals and challenges. Second, staff must be able to apply this
knowledge effectively to better serve customers, armed with specific techniques required to drive
profitable business opportunities. Third, staff must be able to differentiate themselves and their
bank from the competition. This can be achieved through the deployment of proven-effective
training solutions and a thorough training culture.
Alignment of interests between credit and sales staff
It is as important that front-line staff such as salespeople, relationship managers, and branch
managers are well-versed with the credit decisioning process as their underwriting and credit
management colleagues. Sales team revenue-and-reward models should account for portfolio
quality, not purely sales volume.
If Indian Banks were to consider looking at all these five measures, the future probability of an
expanding NPA volume is likely to be reduced.
1.9 Role of CRA in credit risk assessment and its impact in terms of information value
Information value of credit ratings:
In the last couple of years, as NPA levels and SAs have grown considerably in the economy, a
significant proportion is skewed towards corporates. Consequently, credit risk assessment, credit
administration and monitoring has come increasingly into focus. The suitability of current credit
risk assessment has often come into question. Credit rating agencies across the world are
increasingly becoming an important component in the value chain of credit risk assessment.
Credit rating is an indicator to measure the creditworthiness of borrowers and acts as an
intermediary between the issuer (borrower) and investor (banks) to minimise information
asymmetries about the riskiness of investment products on offer. In general, credit rating
provides a third party with independent information on default risk i.e. the likelihood of default

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of an issuer on a debt instrument, relative to the respective likelihoods of default of other issuers
and therefore becomes a useful ready-to-use tool for assessing credit risk. In the case of
sanctioning loans, banks use ratings as a filter and sometimes perform an additional check
through an independent due diligence review or credit matrix. So, banks may use the credit
rating issued by CRAs to the debtor as important information during the credit appraisal. The
RBI’s regulatory framework requires banks to have their own credit risk assessment framework
for lending and investment decisions and not rely only on ratings assigned by credit rating
agencies. The Indian banking system’s mandated reliance on external credit ratings is limited to
capital adequacy computation for credit risk and general market risk under standardised approach
of Basel II. As banks develop their internal ratings model as mandated by the Advanced Basel
framework, they can validate the credit rating for a particular borrower generated from that
model with that of the publicly available ratings by CRAs. Banks can also seek information from
CRAs if there is wide variation in its credit assessment vis-a-vis the rating agencies. Banks and
CRAs should be able to contribute to developing an ecosystem where credit assessments become
more effective. Current RBI regulations stipulate that if a bank has decided to use the ratings of
chosen credit rating agencies for a given type of claim (loans), it can use only the ratings of the
same credit rating agencies (for subsequent reviews), despite the fact that some of these claims
may be rated by other chosen credit rating agencies whose ratings the bank has decided not to
use. In respect of exposures and obligors having multiple ratings from chosen credit rating
agencies, for risk weight calculation, banks will use higher risk weight if there are two ratings
accorded by chosen credit rating agencies that map into different risk weights. Similarly, if there
are three or more ratings accorded by chosen credit rating agencies with different risk weights,
the ratings corresponding to the two lowest risk weights should be referred to and the higher of
those two risk weights should be applied. RBI guidelines also stipulate that as a general rule,
banks need to use only solicited ratings from chosen credit rating agencies and cannot consider
any ratings given on an unsolicited basis by CRAs for risk weight calculation as per the
standardised approach. While external credit rating for corporate loans is not compulsory under
Basel II, banks have to assign 100% for unrated corporate claims (both long- and short-term)
which was relaxed from 150 to 100% during the 2008 financial crisis. The regulation has brought
many smaller firms within the fold of credit rating. In this paper, we have only considered
exposures of banks for corporate loans greater than 5 crore INR as any loan upto 5 crore INR is

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considered as retail exposure. Borrowers can benefit from the rating exercise as this can help
them tone up their management systems and business models. Banks also provide loans as social
obligation to institutions with a weak balance sheet like such as state electricity boards, etc. The
credit risk on the balance sheet of the lending banks and institutions could be far higher than
what is declared, considering the weak financials of those companies. CRAs could play a vital
role in assessing these risks.
2.0 Business models of credit rating agencies and their impact
It is imperative that the business model of the CRAs need to ensure that credit ratings are of high
quality, accurately measure creditworthiness and should be the product of a strong and
independent process. A possible inaccuracy in ratings can pose a threat to financial stability by
underestimating the riskiness of investments of regulated entities. In case of a bank loan rating of
a borrower, the problem of underestimation of risk can lead to inaccurate capital calculation due
to inflated ratings and could pose a significant threat to the financial stability of individual
financial institutions as well as the whole financial system. Conversely, ratings that
overestimated risk will impose excessive capital requirement on banks, increasing costs to the
economy as a whole and reducing shareholder returns.
Functions of CRAs and associated business models:
Post the sub-prime crisis in 2008, the CRAs have come under fire for their inability to detect the
flaws in the system and also conflict of interest in their business models. In India, most of the
credit rating agencies have rating and non-rating businesses. CRAs in India rate a large number
of financial products including the following:
1. Bonds and debentures
2. Commercial paper
3. Structured finance products
4. Bank loans
5. Fixed deposits and bank certificate of deposits

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6. Mutual fund debt schemes
7. Initial public offers (IPOs)
CRAs also undertake customised credit research of a number of borrowers in a credit portfolio,
for the use of the lender. Their to understand the business and operations coupled with the
expertise of building frameworks for relative evaluation puts them in good stead.
Feasibility of an umbrella regulator model
The multiplicity of regulators has necessitated the need for interregulatory co-ordination. It has
become necessary for policy makers to look at the fact that there are apprehensions about
regulatory arbitrage taking advantage of lack of co-ordination among various regulators. Policy
makers need to identify areas where they could facilitate an optimal environment for removal of
asymmetric information. It relates to the design, structure and extent of the regulatory structure
pertaining to the operations of CRAs, and an enquiry as to whether the prevailing policy
regulatory regime has helped or harmed their functioning. While SEBI currently regulates credit
rating, such ratings are much more used by other regulators where rating advisory is often a part
of the regulations. SEBI’s jurisdiction over the CRAs only covers securities as defined under the
Securities Contract (Regulation) Act, 1956 and does not cover the activities governed by other
regulators. Existing SEBI regulations may not be adequate to cover the issues and concerns put
forth by other regulators. The SEBI report further suggests the need for a lead regulator. In the
awake of increasing NPAs in the system, it needs an overhaul. The feasibility of forming an
umbrella regulator with representations from respective regulators, SEBI, RBI, IRDA, PFRDA
and others can be looked into. While independent regulators can frame their guidelines
applicable to sectors they regulate, a holistic regulatory framework needs to be developed
considering inputs from all participants. Currently, a standing committee for CRAs has been
constituted which comprises of representations from regulatory bodies of the securities market
(SEBI), banking sector (RBI), insurance sector (IRDA) and pension funds (PFRDA). The
committee has met at several occasions to deliberate on various regulatory issues.

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Regulatory role for improving efficacy of CRAs
Globally, the need for strong regulations governing CRAs has come into focus post the 2008
subprime crisis. Subsequently, significant regulatory changes have been observed in the
developed economies (OECD). In USA, the Credit Rating Agency Reform Act and Dodd-Frank
Wall Street Reform and Consumer Protection Act have enhanced the Security Exchange
Commission’s (SEC) power to regulate Nationally Recognised Statistical Rating Organisations’
(NRSROs) by adopting several rules. The areas covered under the rules include record-keeping,
conflict of interest with respect to sales and marketing practices, disclosures of data and
assumptions underlying credit ratings, statistics, annual reports on internal controls and
consistent application of ratings symbols. However, the law prohibits the SEC from regulating an
NRSRO’s rating methodologies. Banks having inter-state licences are generally required to make
assessments of a security’s creditworthiness to determine its ‘investment grade.’ and remove
references to external credit ratings. The Federal Deposit Insurance Corporation (FDIC) ensures
depository institutions using IRB (Internal Ratings Based) supplement the use of CRAs with
internal due diligence processes and additional analyses to demonstrate that CRAs are used only
in an auxiliary role in the calculation of final rating values. For the ‘Standardised Approach’,
banks use alternatives to CRA as well as alternative standards for assessing whether securities
are of investment grade or not. In Australia, major banks use (IRB) approaches to assess credit
risk and are required to form their own views on creditworthiness of the borrowers even though
external ratings may constitute an input in that view as opposed to relying solely on CRA ratings.
The banks are also subjected to continuous monitoring and review mechanism by the Australian
Prudential Regulation Authority (APRA). While other authorised deposit taking institutions
(ADIs) use a more simplistic approach, they are also required to supplement CRA ratings when
determining the credit risk exposures. The EU has also formulated regulations on CRAs (CRA
Regulation III) to reduce reliance on external ratings. The Capital Requirements Directive (CRR)
require credit institutions to have strong credit evaluation framework and credit decision
processes in place irrespective of whether they grant loans or incur securitisation exposures.
However, for calculation of regulatory bank capital requirements, rating agency assessments may
be, in certain cases applied as a basis for differentiating capital requirements according to risks,
and not for determining the minimum required quantum of capital itself. The CRD framework as
a whole provides banks with an incentive to use internal rather than external credit ratings even

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for calculating regulatory capital requirements. In India, the question of improving the efficacy
of CRAs needs to be looked from a holistic perspective where all participants in the ecosystem;
the regulators, CRAs, corporates and investors (banks) needs to work jointly towards a better
system of credit risk assessment and monitoring. From a regulatory perspective it is important
that apart from putting up a strong regulatory framework, they also upgrade their skills for
greater due diligence to evaluate effectively the ratings that are given by CRAs. The banks need
to move towards risk based pricing whereby they can use rating as more than just a mandatory
exercise by identifying greater incentives for them to adopt ratings. It has been observed that
globally, self-regulation for CRAs has not worked effectively due to revenue and profitability
pressures and loss of market share. Also, the fact that there remains conflict of interest from the
Issuer Pay Model and the entire gamut of non-rating services provided by the CRAs need to be
evaluated.
In the last couple of years, as Indian economy witnessed downturn trends, the banks have been
straddled with high NPAs and restructured assets. Macro-economic dynamics may be a major
contributor, however we also believe that inadequate credit assessments and monitoring during
the upturn in the economy has also contributed to the same. All participants in the ecosystem, the
banks, regulators, borrowers and CRAs need to take responsibility. Our view is while we cannot
undo the mistakes or errors that have been committed in terms of credit assessment and
monitoring, effective steps needs to be taken and a holistic approach is the best way forward. All
stakeholders in the ecosystem need to proactively contribute towards a better credit assessment
and monitoring framework with the regulator enabling such initiatives. Some of our major
recommendations include the following:
• Effective use of early warning systems as the monitoring mechanism by the banks to
proactively detect and resolve issues related to the credit risk of the borrower. For the resolution
of NPAs, an end to end NPA lifecycle management can also help.
• To create a holistic regulatory framework for credit ratings along with an umbrella regulator.
• To minimise the opportunity of regulatory arbitrage.
• Efficacy of CRAs being monitored by the regulator through adoption of remedial measures for
resolving conflict of interest of CRAs.

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• Encouraging CRAs to develop industry specific expertise.
• Banks moving towards true risk based pricing thus encouraging borrowers to get themselves
rated (solicited ratings). Currently banks also monitor market risks, however it is imperative that
banks use this information also in conjunction with credit assessment to have a true evaluation of
the borrower.
• Banks should also be encouraged to develop their internal rating models and validate these
ratings by comparing them with publicly available ratings and also seek more information from
the rating agencies, if necessary to be doubly sure of their credit assessment process.
• Feasibility of creation of a centralised platform for credit ratings, where issuers can approach to
get themselves rated and allocation of the work can be done to CRAs based on industry expertise
and their previous experience amongst others. This will also reduce the conflict of interest and
can prevent rating shopping by borrowers.
• CRAs also need to effectively use market information in their credit ratings methodology and
put in place a strong corporate governance so that conflict of interest can be effectively resolved.
The Financial Stability Board (FSB) which includes members from G20, had set up the
Implementation Group on Credit Rating Agencies (CRAs) to assess the position of compliance
of regulatory framework in the country vis-à-vis the FSB principles for reducing reliance on
CRA ratings. The FSB in its progress report to the St Petersburg G20 Summit titled Credit
Rating Agencies: Reducing reliance and strengthening oversight, states that “The Principles
recognise that CRAs play an important role and their ratings can appropriately be used as an
input to firms’ own judgment as part of internal credit assessment processes. But any use of CRA
ratings by a firm should not be mechanistic and does not lessen its own responsibility to ensure
that its credit exposures are based on sound assessments”. The FSB, in its recently published
peer review report on national authorities’ implementation of the FSB Principles for Reducing
Reliance on CRA Ratings finds that Indian regulatory regime has put in place systems and
procedures to develop internal credit risk assessment and due diligence by the market
participants. We also strongly believe with the participation and contribution of all stakeholders,
a holistic credit assessment and monitoring is the way forward to rein in the high level of NPAs
and restructured assets.

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India is seeing a regulatory upheaval in the way the Government is addressing the NPA “crisis”.
The efforts are visible, but the results may be achieved only on a medium- to longterm basis.
According to the survey respondents, stricter penal measures for fraudulent borrowers, e.g.,
restricting access to additional bank borrowing and restructuring, prompt reporting of cases to
law enforcement agencies etc., would act as deterrents and help prevent larger exposures of bad
accounts in the banks’ books. Widening of the scope of “wilful defaulter” ably supported by
Securities and Exchange Board of India (SEBI) would assist in restricting defaulting borrowers
from accessing the equity and debt markets. The creation of the Central Fraud Registry would
benefit banks in obtaining access to critical details of frauds reported by other banks and thereby
avoid lending to tainted borrowers. The boards of the banks will conduct a detailed scrutiny of
the quarterly and annual fi.nancial results, review NPA management and reported NPA and
provisioning integrity. The new RBI circular on “Framework for dealing with loan frauds”
demonstrates its commitment to addressing concerns pertaining to detection, reporting,
mitigating and accountability with regards to loan frauds. Significant expansion in the role of
“Fraud Monitoring Group” (FMG) within the banks is expected based on the circular. Further,
importance has also been laid on implementing a strong whistle-blower policy to encourage
employees to report concerns. Also, the recent circular around “Strategic Debt Restructuring
Scheme” is a firm step by RBI giving strong clutches to the bankers to take-over management
control of the defaulters. This would be where they feel the incapability of the borrower
company to come out of stress due to operational/ managerial inefficiencies

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Addressing NPA problem of Indian Banks:
Root of the NPA problem in Indian Banks is post 2009 – when World was doing QE to stave off
2008 recession and India was not in any kind of need for a QE (since GDP growth had lowered
down but there was no recession in India) – Congress still did QE in India on pretence of World
doing QE – and gave massive loans to crony businessmen close to Congress – just see the list of
who’s who – Mallya, Jindals, Jaypee, Ruias of Essar etc – when global Trade had tanked, where
would this money go, to create capacities for which there was no end demand, or to be siphoned
off by these Crony capitalists.
With giving a free hand to Raghuram Rajan (R3) – who told Banks – do whatever it takes to
recover this money – and first of all, recognize all such bad loans. Result – Debt for Equity
swaps, selling of assets, Wilful Defaulter tag, Name & Shame defaulters and recognition of
NPA’s with concurrent huge losses of Banks.
Clearly, nationalization of Banks by Indira Gandhi was a colossal mistake. PSU Banks are prone
to arm twisting by Ministers, their Management is for short-term and hence is disinterested in
long-term health of the Bank, most often Chairman position of PSU Banks is bought by corrupt
Bankers and hence their foremost interest is to earn while on the job, our Judicial system being
stuck in backlog of cases and prone to misuse – even good Acts like Sarfaesi & DRT’s are not
working. The new Bankruptcy Act is a welcome step and amendments to Sarfaesi & DRT Acts
in next session of Parliament will aid recoveries.
Crux of the problem also lies in the fact that Project Funding as the term goes is not feasible in
India, due to Judiciary being in permanent Coma. Project Funding abroad means Banks take
project risk (Primary Collateral being Charge on cash flows and Charge on fixed & variable
assets being created). But in India, since project risk is traditionally sky high (because Judiciary
is unreliable), Banks interpret Project Funding to mean inclusion of Personal Guarantees,
Corporate Guarantees, Charge on personal assets of Promoters etc.

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NPA problem of Indian Banks
While this is understandable, but look at history of Banks trying to enforce such Guarantees and
charge on assets to recover bad loans – Loopholes in Judicial process and delays are exploited to
the hilt by Promoters who have loads of money siphoned off from the Loans to their company!
Reality is – Promoter overstates value of assets to create a bigger project – so that when Loan
comes in, he siphons off this loan and re-routes this as equity. In reality – Promoters takes off his
initial equity completely and the entire project is, in fact, funded by Bank loan. This is the dark
truth! When project goes bad, what can Bank do? Sell off those assets or try to run the company?
Both prove a failure. And NPA’s result.
Resolution to the problem – as currently happening – recognize all such bad loans to get the
extent of the problem. Get Bankruptcy Act, amendments to Sarfaesi & DRT Acts in place (which
will happen soon), then since de-nationalization of PSU Banks is not possible (lack of BJP
majority in Rajya Sabha), first merge Banks to reduce their number from 27 to a decent 6. Then
offload stakes in these 6 big Banks by keeping Government stake at 51%. Simultaneously, force
Promoters to offload their assets and pay back the Banks.

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About 12 percent of Indian banks' assets are currently stressed. What this means is that for every
Rs 100 they have lent, chances of getting Rs 12 back are less. The more worrying fact is that
over 90 percent of this stress is on the books of the country’s state-run banks. These lenders,
traditionally, have weaker autonomy in lending operations, tendency to engage in reckless
lending and are more vulnerable to the corporate-political nexus.
There is no magic wand to make NPAs disappear. It is not easy, said a senior banker, who was
present at the meeting. “It all depends upon how fast the economy comes back on track, stressed
assets revive and companies start paying back. Till then, the only option for banks is to avoid
further lending,” said the official. That doesn’t augur well for an economy, which desperately
needs funds to kick off the growth-phase.
The slowdown in credit growth is already visible.
There has been no major corporate lending in the past 2-3 years and most banks have shifted
their focus to the safer retail lending to grow their books. Indian banks’ loan growth to industries
shrank 1.1 percent in the first six months of this fiscal compared with a negative growth of 0.4
percent in the corresponding period of last year.
The problem
In some cases, like United Bank of India and Chennai-based Indian Overseas Bank (IOB), the
level of gross NPAs has zoomed to painful proportions. IOB’s stressed loans escalated to 11
percent in the September quarter from 9.4 percent in the preceding quarter. In the case of United
Bank, the RBI had to even impose a temporary lending ban on account of high NPAs.
Even bigger banks like Bank of Baroda saw a sharp jump in GNPAs to 5.56 percent from 4.13
percent in the first quarter. The only major exception to this trend is State Bank of India (SBI).
The tangible part of the bad loan pain on the government banks and, in turn, on their owner (the
government) is the immense capital burden.
The estimated (moving) capital requirement of India's state-run banks to meet the Basel-III
norms over the next five years is about Rs 2,40,000 crore. Incidentally, that’s only a tad less than

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the GNPAs of India's 40-listed banks (Rs 300,000 crore), most of which are on state-run lenders'
balance sheets.
After much persuasion from the RBI, Jaitley later agreed to increase the capital infusion to Rs
70,000 crore. But, experts say even that is too little.
“The government is now batting like Sehwag without seeing the ball,” said Abhishek Kothari,
equity research analyst at Anand Rathi Securities. “On the one hand, they need PSBs to clean up
their balance sheets, on the other aid growth through increased lending. A steroid injection so
late won’t help in quick healing,” Kothari said.
The bad loan scenario of Indian banks hasn’t improved significantly in the recent years on
account of three factors. One, the revival in the investment cycle hasn’t taken strong hold yet.
And the second, the process of rebooting of the delayed projects hasn’t yet translated into
improved cash flows for companies.
Does the Modi government have the wherewithal to fulfil its commitment towards India's state-
run banks? Experts are doubtful on account of its fiscal constraints.
State-run banks’ capital requirement appears to be well beyond the capacity of the government
coffers, especially when the fiscal situation doesn’t look healthy with higher cash out go if the
7th Pay Commission proposals on compensation to public sector staff and pensioners are
accepted. Especially since revenue from corporate tax collection is likely to decline. The
government’s ability to raise funds from divestment is critical.
How did the NPAs pile up?
It didn’t happen overnight.
Besides the overall economic slowdown, one major reason why the NPAs shot up is the reckless
lending resorted by state-run banks, between 2008-09 to 2011-12, without adequately assessing
the risks. The focus was on volume growth and not quality, said the banker quoted earlier.
“It was high competition that was driving the credit operations and not prudence. The idea by
every bank chairman appeared to grow the loan book as quickly as possible by sanctioning large

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ticket loans and not the quality of assets. The hope was an economic boom, thereafter, which
never happened,” the banker said.
Adding as many zeroes in their total business numbers and advertising it on the mastheads of
national newspapers have become an annual ritual for India's public sector banks, more of an
exercise aimed at appeasing the political bosses and ensuring a post-retirement berth, rather than
giving a true account of business to the shareholders.
Secondly, interested party lending and the role of middlemen played a key role. The banker-
middleman-corporate nexus operated in full swing. Most often than not, these interested parties
are those linked to influential politicians and business groups.
There have been several occasions, which bankers typically fear to say in the open, when they
have received informal missives from ministers to lend to a particular company, wherein that
minister has some interest. Middle-level bank officials at state-run banks often succumbed to
such pressures
Third, a new set of promoters, who wouldn’t pay back loans to banks despite having the ability
to do so emerged more often. The RBI called them wilful defaulters. Once a company or
promoters is tagged as wilful defaulter, no other financial institution will lend to such parties, nor
can these promoters be part of any other organizations.
The latest such case is liquor baron, Vijay Mallya, whose grounded airline, Kingfisher, owes
over Rs 7,000 crore to some 17 banks. Recently, SBI classified Kingfisher and its guarantors as
wilful defaulters after a prolonged legal battle. Other banks too are likely to follow the suit.
As per the data obtained from the All India Bank Employees Association, there are 7,035 cases
of wilful defaults with a bad loan pile to the tune of Rs 58,792 crores as on 31 March, 2015.
Fourth, bad loan picture turned grim after banks started pushing loans to the restructured
category to prevent them becoming NPAs. This only postponed the problem and started to
backfire. Many of these loans were close to NPAs when they were admitted to recasts.
This practice, however, came to an end when the RBI withdrew special regulatory dispensation
for rejigged loans, forcing banks to treat newly restructured loans on par with bad loans.

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The chunk of fresh NPAs emerging from restructured loans have been on the rise since many
such accounts failed to revive. Banks did this cover-up largely in the infrastructure sector. On a
conservative basis, about Rs 6 lakh crore loans are currently being restructured both under the
CDR channel and on a bilateral basis.
Under the RBI norms, for every loan that turns bad (when dues remain unpaid for 90 days or
more), banks have to set aside money in the form of provisions. This ranges from 20 percent to
100 percent of the loan value, depending on how bad the state of the underlying asset is.
That means if a Rs 100 loan goes bad to the loss category, the bank needs to set aside Rs 100
from its kitty to cover that loss. If the loan is restructured, the provision is 5 percent of the total
value. Such high provisions make additional capital a must for banks.
The solution
A slew of corrective measures initiated by the Modi government such as cleaning up the power
discom mess with state-supported revival package, increasing the tenure of bank chiefs and
creation of a bankruptcy code can aid the reduction in bad loans over a period of time.
But, the actual implementation of these promises is critical, says analysts.
“Measures such as bankruptcy law and strict action on wilful defaulters may aid in lowering
NPAs,” said Kothari of Anand Rathi Securities. “But, despite the promise of doing necessary
steps in power and other stressed sectors, nothing has happened in the one and a half years,”
Kothari said.
Speedy judicial resolution of cases involving large-ticket bad loans is critical for banks to
recover their dues. Many a times, after long years of litigation, the sharp erosion in the value of
underlying asset leaves nothing much for the lender to recover.
It is also crucial for the Modi government to give a serious thought to privatisation of
government banks. So far, this government has shown an aversion to the privatisation of banks.
It should learn from the experience of the private sector banks and show the guts to moot radical
reforms in the banking sector by privatising state-run banks. Arguably, the two-stage

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nationalisation of state-run banks has clearly failed to achieve the desired impact and its time for
the government to exit the business of banking and focus on governance.
It doesn’t make sense for the government to run banks for the simple reason that it doesn’t have
the fiscal ability to continue feeding the capital-starved lenders, especially in the backdrop of
high stress on their balance sheets.

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DIFFICULTIES WITH THE NON-PERFORMING ASSETS AND REVIEW OF
LITERATURE AND GENISIS OF COMMITTEES.

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2. DIFFICULTIES WITH THE NON-PERFORMING ASSETS:
1. Owners do not receive a market return on their capital. In the worst case, if the bank fails,
owners lose their assets. In modern times, this may affect a broad pool of shareholders.
2. Depositors do not receive a market return on savings. In the worst case if the bank fails,
depositors lose their assets or uninsured balance. Banks also redistribute losses to other
borrowers by charging higher interest rates. Lower deposit rates and higher lending rates repress
savings and financial markets, which hampers economic growth.
3. Non performing loans epitomize bad investment. They misallocate credit from good projects,
which do not receive funding, to failed projects. Bad investment ends up in misallocation of
capital and, by extension, labour and natural resources. The economy performs below its
productionpotential.
4. Non performing loans may spill over the banking system and contract the money stock, which
may lead to economic contraction. This spillover effect can channelize through illiquidity or
bank insolvency; (a) when many borrowers fail to pay interest, banks may experience liquidity
shortages. These shortages can jam payments across the country, (b) illiquidity constraints bank
in paying depositors e.g. cashing their paychecks. Banking panic follows. A run on banks by
depositors as part of the national money stock become inoperative. The money stock contracts
and economic contraction follows (c) undercapitalized banks exceeds the banks capital base.
Lending by banks has been highly politicized. It is common knowledge that loans are given to
various industrial houses not on commercial considerations and viability of project but on
political considerations; some politician would ask the bank to extend the loan to a particular
corporate and the bank would oblige. In normal circumstances banks, before extending any loan,
would make a thorough study of the actual need of the party concerned, the prospects of the
business in which it is engaged, its track record, the quality of management and so on. Since this
is not looked into, many of the loans become NPAs.
The loans for the weaker sections of the society and the waiving of the loans to farmers are
another dimension of the politicization of bank lending.

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Most of the depositor’s money has been frittered away by the banks at the instance of politicians,
while the same depositors are being made to pay through taxes to cover the losses of the bank.
2.2 REVIEW OF LITERATURE AND GENISIS OF COMMITTEES
RBI and Govt. of India had appointed various committees and Study Groups from time to time to
study in depth different aspects on Banks Credit, , Legal Reform and Non-Performing Assets.
All these subject matters are co-related and interconnected to this research study and hence it is
necessary to know, in brief, about the purpose of appointment of such Committees, their terms of
reference and some of the valuable recommendations made by them. Non- performing Assets
have been plaguing the Indian financial sector since long but were not in the public domain till
early nineties. By that time, significant amount of loan assets involving uncertainly with respect
to ultimate collection piled up creating concerns with the opinion makers about health of Indian
banking and financial sector. NPAs reflect natural waste of any economy. In advanced
economies the financial markets are well developed and segmented; with various players
operating in identified niches, catering to various users/risk segments. This constitutes an
effective institutional mechanism for targeting risks to players with appetite for such risks.
Commercial bank is conducted in a highly risk managed and mitigated ambience, unlike their
Indian counterparts who are often required to take unmitigated risk as a part of business policy.
2.3 VARIOUS COMMITTEE REPORTS – ON CREDIT
2.3.1 Thakkar Committee on Employment Potential (1970) The then Union Finance Minister
Shri Y.B. Chavan, while meeting the Chairman/ Custodians of the Public Sector Banks on 22nd
July 1970 indicated that the committee might be constituted to review the special credit schemes
of banks, with particular reference to their employment potential. The terms of reference were to
identify the types of selfemployed persons who should be considered for special financing.To
evolve guidelines in respect of security, rate of interest, period of repayments and other terms
and conditions.
2.3.2 Tandon Committee (1974) Till nationalization of the 14 major commercial banks in July
1969, the main contenders for banks credit were large and medium scale private industries and
internal and external trade. Nationalisation of the major commercial banks, called for a new
policy, both for deposit mobilization through accelerated branch expansion and for suitable

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disbursal of credit. Its terms of reference were to suggest guidelines for commercial banks to
follow up and supervise credit from the point of view of ensuring proper endures of funds and
keeps watch on the safety of the advances and to suggest the type of operational data and other
information that may be obtained by banks periodically from such borrowers by the Reserve
Bank of India from the lending banks. To make suggestions for prescribing inventory norms for
different industries both in the private and public sectors and indicate the broad criteria for
deviating from these norms.
2.3.3 Puri Committee on SSI (1975) Consequent to the discussions at the meeting of the
Standing Committee on credit facilities of the Small Scale Industry (SSI) Board and the
discussion that took place at the 33rd meeting of the Board in September, 1975, regarding credit
problems faced by small scale industries, the Government of India appointed High Powered
Committee under the Chairmanship of Shri I.C.Puri, the Development Commissioner (SSI), with
the following terms of reference: To examine the possibility of introducing a measure of
uniformity in the terms and conditions of finance and to suggest measures that should be taken
by small scale units to facilitate the flow of institutional finance.
2.3.4 N.K. Ambegaonkar Committee (1976) At the meeting of the regional consultative
committee for the North Eastern Region, held at Gauhati on 5th July, 1976, it was decided that
the RBI should appoint a small Working group to examine, inter-alia, the factors impending the
flow of bank credit in the Region and make recommendations for necessary changes in the
procedures and practices of banks so as to bring about rapid and all round banking development
in the region. The terms of reference were to identify the factors impeding the flow of bank
credit in the North Eastern Region. To recommend, in the context of the socio-economic features
of the region, suitable arrangements for expeditious disbursal of credit by commercial banks.
2.3.5 Raj Committee on lending to priority sector (1976-77) The nationalisation of the 14 major
scheduled commercial banks in July. brought in its wake a rapid growth in branch expansion,
particularly in the rural areas, accompanied by considerable rise in the deposits and advances.
RBI set up a Committee in June 1977 to study all aspects of the functioning of the Public Sector
of Banks under the Chairmanship of Shri James S. Raj. The terms of reference were to assess the

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impact of branch expansion that had taken place since 1969 and to examine whether any change
in the tempo and direction of such expansion is called for and to inquire into the present pattern
of branch expansion of public sector and to suggest the future course of action keeping in view
the need for rural development and removal of regional imbalances.
2.3.6. Chore Committee (1979) RBI appointed the Working Group to review the system of cash
credit in all its aspect under the Chairmanship of Mr. K.B. Chore, Additional Chief Officer,
Department of Banking Operations and Development, RBI. The terms of reference were to
review the operation of the cash credit system in recent years particularly with reference to the
gap between sanctioned credit limits and the extent of their utilization, to suggest modifications
in the system with a view to making the system more amenable to rational management of fund
by commercial banks.
2.3.7. Dr.K.S.Krishnaswamy Committee (1985) At the meeting of the Finance Minister with the
Chief Executive Officers of the Public Sector Banks held on 6th March, 1980.The terms of
reference to identify the specific groups which are to be assisted under the 20 Point Programme.
To identify the ways and means of rendering assistance to the beneficiaries. To look into the
question of fixing subtargets (within the enhanced overall target of 40% for assistance to priority
sectors) to the beneficiaries.
2.3.8 Dr. P.D. Ojha Committee (1988) Governor, RBI suggested to the Chief Executives of
Public Sector Banks at a meeting held on 17th October, 1987 that a field study would be carried
out with their personal participation in different districts all over the country and the findings
would be discussed in a Seminar. The terms of reference were to examine and recommend the
necessary procedures for effective co-ordination between the three institutional agencies viz.
Commercial Banks, Regional Rural Banks and Cooperative under the new area approach.

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2.4 VARIOUS COMMITTEE REPORTS ON NPA
1. Narsimhan Committee – Reform I (1991) The development of the financial sector is a major
achievement and it has contributed significantly to the increase in our savings rate, especially of
the household sector. The terms of reference were to examine the existing structure of the
financial system and its various components and to make recommendations for improving the
efficiency and effectiveness of the system with particular reference to the economy of operations,
accountability and profitability of the commercial banks and financial institutions.
2. Khan Committee on Financial Reforms (1997) RBI had constituted a 7 member Working
Group on 15th Dec. 1997 under the Chairmanship of Shri S.H. Khan, Chairman and Managing
Director of IDBI, keeping in view the need for evolving an efficient and competitive financial
system. The terms of reference were to review the Role, Structure and Operations of DFIs and
Commercial Banks in the emerging operating environment and suggest changes and to examine
whether DFIs could be given increased access to short term funds and the regulatory framework
needed for the purpose.
3. Tarapore Committee on Capital A/c Convertibility (1997) The Union Finance Minister,
Shri P. Chidambaram, in his Budget Speech for 1997-98 had indicated that the regulations
governing foreign exchange transactions need to be modernized and replaced by a new law
consistent with the objective of progressively liberalizing capital account transactions.
Committee on Capital Account Convertibility under the Chairmanship of Shri S.S. Tarapore was
appointed. The terms of reference were to review the international experience in relation to
Capital Account Convertibility and to indicate the preconditions for introduction of full Capital
Account Convertibility and to specify the consequences and time frame in which such measures
are to be taken.
4. Pannir Selvam Committee on NPA (1998) Banking Division constituted a 3 Member
Committee under the chairmanship of Shri A.T. Pannir Selvam, Chairman, IBA and Chairman &
Managing Director, Union Bank of India. The terms of reference assigned to the above
Committee were Causes of NPAs, factors for slump in recovery of loans; measures to be taken

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for effective recovery of bank dues and reduction of NPAs and banks wise study on factors
responsible for the NPAs and banks specific suggestions for recovery.
5. Narsimhan Committee – Reform II (1998): Reform of the Indian banking sector is now
under way following the recommendations of the Committee on Financial System (CFS), which
reported in 1991. The second generation of reform could be conveniently looked at in terms of 3
broad interrelated issues and actions that need to be taken to strengthen the foundation of the
banking system and structural changes in the system suggested capital adequacy, asset quality,
prudential norms, systems and methods in banks.
6. RBI Panel on DRT’s (1998) The RBI had set up Working Group in the month of March 1998
to review the functioning of Debt Recovery Tribunals under the Chairmanship of Shri N.V.
Deshpandey. The objectives of the panel were to look into various issues and problems
confronting the functioning of DRTs in expeditious recovery of banks dues and to examine the
existing statutory provisions and suggest necessary amendments to the Recovery of Debts due to
Banks and Financial Institutions Act, 1993 and Rules framed there under with a view to
improving efficacy of legal machinery.
7. Special Report on NPA by RBI (July 1999) In order to study some aspects and issues
relating to NPAs in Commercial Banks, RBI has prepared a report in the Department of Banking
Supervision. Shri A.Q.Siddiqui, Chief General Manager, was in charge of this project whereas,
Shri A.S. Rao and R.M. Thakkar, both Deputy General Managers, assisted this project. This
study has been carried out using the RBI inspection reports on Banks, information / data obtained
from public sector banks and 6 private sectors banks and those collected from the files on
borrowable accounts maintained in banks for assessing comparative position on NPAs and their
recoveries in banks. The causes for sickness /weak performance and consequently the account
turning NPA in respect of Public sector banks and private sector banks.
2.5. Conclusions
In this Chapter, attempt is made to learn in brief, purpose, terms of reference and findings of
various Committees, Study Groups, and Research work relating to the task of Credit, Legal

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Reforms and NPAs which is very useful in this present research study. All these tasks are
discussed in detail in following Chapters where ever applicable.

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COMPARATIVE STUDY WITH OTHER COUNTRIES AND SCOPE OF THE STUDY

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3.1 Comparative Study With Other Countries:
I. China: (a) Causes: (i) The State Owned Enterprises (SOE’s) believe that there the government
will bail them out in case of trouble and so they continue to take high risks and have not really
strived to achieve profitability and to improve operational efficiency. (ii) Political and social
implications of restructuring big SOE’s force the government to keep them afloat,(iii) Banks are
reluctant to lend to the private enterprises because while an NPA of an SOE is financially
undesirable, an NPA of a private enterprise is both financially and politically undesirable,(iv)
Courts are not reliable enforcement vehicles.
(b) Measures: (i) Reducing risk by strengthening banks, raising disclosure standards and
spearheading reforms of the SOE’s by reducing their level of debt, (ii) Laws were passed
allowing the creation of asset management companies, foreign equity participation in
securitization and asset backed securitization, (iii) The government which bore the financial loss
of debt ‘discounting’. Debt/equity swaps were allowed in case a growth opportunity existed, (iv)
Incentives like tax breaks, exemption from administration fees and clear cut asset evaluation
norms were implemented. The AMCs have been using leases, transfers, restructuring, debt- for-
equity swaps and asset securitization, among other methods, to dispose of non-performing loans
II. Korea: (a) Causes: (i) Protracted periods of interest rate control and selective credit
allocations gave rise to an inefficient distribution of funds,(ii) Lack of Monitoring ..... Banks
relied on collaterals and guarantees in the allocation of credit, and little attention was paid to
earnings performance and cash flows,
(b) Measurers: (i) The speedy containment of systemic risk and the domestic credit crunch
problem with the injection of large public funds for bank recapitalization, (ii) Corporate
Restructuring Vehicles (CRVs) and Debt/Equity Swaps were used to facilitate the resolution of
bad loans, (iii) Creation of the Korea Asset Management Corporation (KAMCO) and a NPA
fund to fund to finance the purchase of NPAs, (iv) Strengthening of Provision norms and loan
classification standards based on forward-looking criteria (like future cash flows) were
implemented; (v) The objective of the central bank was solely defined as maintaining price
stability. The Financial Supervisory Commission (FSC) was created (1998) to ensure an

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effective supervisory system in line with universal banking practices.
III. Japan: (a) Causes: (i) Investments was made real estate at high prices during the boom. The
recession caused prices to crash and turned a lot of these loans bad, (ii) Legal mechanisms to
dispose bad loans were time consuming and expensive and NPAs remained on the balance sheet,
(iii) Expansionary fiscal policy measures administered to stimulate the economy supported
industrial sectors like construction and real estate, which may further exacerbated the problem,
(iv) Weak corporate governance coupled with a no-bankruptcy doctrine, (v) Inadequate
accounting systems.
(b) Measures: (i) Amendment of foreign exchange control law (l997) and the threat of
suspension of banking business in case of failure to satisfy the capital adequacy ratio prescribed,
(ii) Accounting standards – Major business groups established a private standard-setting vehicle
for Japanese accounting standards (2001) in line with international standards, (iii) Government
Support - The government’s committed public funds to deal with banking sector weakness.
III. Pakistan: (a) Causes: (i) Culture of "zero equity" projects where there was minimal due
diligence was done by banks in giving loans coupled with collusive lending and poor corporate
governance, (ii) Poor entrepreneurship, (iii) Chronic over-capacity/lack of competitive
advantage,(iv) Directed lending where the senior management of the public sector banks gave
loans to political heavy weights/ military commanders.
(b) Measures: (i) The top management of the banks was changed and appointment of
independent directors in the board of directors , (ii) aggressive settlements were done by banks
with their defaulting borrowers at values well below the actual debt outstanding and/or the
amount awarded through the court process ..... i.e., large haircuts/ write offs, (iii) setting up of
Corporate and Industrial Restructuring Corporation (CIRC) to take over the non-performing loan
portfolios of nationalized banks on certain agreed terms and conditions and issue government
guaranteed bonds earning market rates of return,(iv) The Banking Companies (Recovery of
Loans, Advances, Credits and Finances) Act, 1997 was introduced in February 1997.
3.2 The Need for the Study

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Need for the research study after observation that generally the authors take separately Public
Sector Banks, Private Sector Banks and Cooperative Bank. Indeed the researcher have noticed
similarities and dissimilarities in these banks and also would like to perform detailed study on
NBFC along with these sectors and compare their NPA level and their success.NPA is not only
in Indian scenario but it is also existing in foreign countries. Inspite of legal frame work and
regulatory have been appointed still NPA exist. As the need of time to regain trust in all the
sectors of as well as the Financial Institution the detailed comparative analysis on policies, Cause
for NPA at different stage and level of NPA on priority, Non priority and SSI has been selected.
Many of the researchers studied the related topic only on Commercial banks or separately on
Private Banks or exclusively on Co operative Banks. It is necessary to do the comparative
analysis on all the sectors to get a fair view of these related issues.
3.3 Statement of the Problem
The study relates with the credit advances and recovery of loans by banks and financial
institutions. Recovery of loan is very important in the success of performance of individual
banks as well as sectors as a whole. Failure to recover leads to overdues by the borrower. The
research study has been carried out to find out the measure to reduce the bad loans in different
sectors and the techniques to control the level of bad loan in banking sectors and Financial
Institution. In the era of globalization the entire banking sector and financial institution is facing
lot of problem. These problems include severe competitions, advanced technology, modern
management methods etc. To reduce the bad loan or nonperforming assets efficient and
standardised activities must be adopted. Bad loans and nonperforming assets can be implemented
only after realising deficiency in the existing system. Hence the strength and weakness can be
studied by comparative analysis in the entire banking system. The researcher has tried to analyse
the gaps in each sector on financial and non financial issues.
3.4 Objectives of Study:

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 To identify and analyze the trends of loans and advance with respect to Public sector
banks, Private sector banks, Co operative sector banks and Financial Institutions in
India.
 To understand the cause and factors that are responsible for lower profitability and
operational efficiency &improve the same.
 To analyze, the trend of NPA’s & profitability of banks of Public sector banks,
Private sector banks, Co operative sector and Financial Institutions.
 Measures to reduce existing NPAs with respect to different sectors.
 To suggest improvement in monitoring and reducing the overdue
3.5 Limitation of the Study
The study suffers from the limitations which are inherent due to economic value and not physical
value. The study is based on primary data which carries its own limitations. The analysis is based
on data published by banks submitted to RBI. The cooperative banks are spread over widely it is
not possible to cover majority of the cooperative banks. Cooperative banks are further classified
into State Cooperative Banks, Schedule Cooperative Banks, District Cooperative Banks, Local
cooperative banks and Bhatti petti. The data is related to last 10 years only. The research study
mainly is based on Scheduled Urban Cooperative banks. The study concentrated only on non
performing assets and related issues. The study is a combination of explanatory and empirical.
3.6 Methodology of the study:
Methodology relates to plan of study, which includes steps of data collection, types of
Questionnaire, process of data and finally interpretation of data Data is collected from public
Sector Banks, Private Sector Banks, and Scheduled Urban Co-operative Sector Banks and NBFC
a. Primary Data: The Primary data is collected through Questionnaire, which is divided into two
parts:
a. Questionnaire which deals with the general policy of the banks
b. Annexure questionnaire is divided into three stages viz:
 PART-A : APPRAISAL STAGE
 PART B: SANCTION & DISBURSEMENT STAGE

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 PART C : POST DISBURSEMENT STAGE
i. Primary data was collected through unstructured Interviews with Bank Officials from
Public Sector Banks, Private sector Banks, and Scheduled Urban Cooperative Banks
& Financial institution. Their views regarding NPA was collected
ii. Opinions of Banks Facilitators (Chartered Accountant, Advocates, Industrial
borrowers, Individual Borrowers, Collection Agents).
3.7 Conclusion
The distribution of NPAs in the system follows 80-20 rule whereby 20% by number of
borrowers are responsible for 80% of value of impaired assets and conversely. The large
impaired assets comprise industrial assets having good restructuring potential Arcil experience
shows in value terms more than 60% of the impaired assets are amenable to be restructured or
sold as a going concern. The small assets however have to be put through a recovery process,
where the collateral based financing system followed in the country offers a fair recovery
potential. The seed of success of managing the impaired asset in any economy lies in the speed
of recycling these assets and their realization into cash. In achieving objective the legal
environment should adequately possess empowered system and structure, support from the
government and finally accessibility to new domestic and foreign capital. Only then Indian
banking shall be in full throttle to take up on the challenge to de-stress the system and prepare for
future growth by fueling the SMEs which is the growth engine for Indian economy in the future
era. The long tradition of political consensus with required legislation, fund support and prompt
action helped to resolve the crisis minimising the loss. It is preferable to opt for a structured
model to handle risky capital separately. The crucial factor is to quickly identify the problem and
approach professionally utilising the lessons from the past experience prudently and
pragmatically.

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LEGAL FRAME WORK AND NOTIFICATION

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4.1 Introduction
Globalization has resulted into the rapid transformation of the financial system all over the
world. As a result capital market, money market and debt market are getting widened deepened.
The growth of financial market has increased the need for innovative instruments for raising
funds. There is increasing from investors, for high quality, low risk securities. Today the
toughest problem faced by the entire banking industry in India is the NPAs, i.e. the loans, where
the principal and interest cannot be recovered, thus the assets stop earning any income. The
unbearable level of NPAs has led to lower interest income and loan loss provisioning
requirements which have destroyed the profitability of the banks to great extent. Besides the
recycling of funds is restricted, thus leading to serious asset liability mismatches. The supply of
credit to potential borrowers have been blocked which is having a harmful effect on the capital
formation and hampering the economic activity of the country. So the NPA problem is an issue
of public debate and of national priority.
India’s legal system has traditionally been friendly towards borrowers and famously slow and
inefficient. In 1993, Debt Recovery Tribunal (DRTs) was set up precisely to avert the said
problem, to give bank faster access to justice. In 2002, a major step in empowering banks in their
loan recovery effort came in the form of the NPA Ordinance, later turned into the Securitization
and Reconstruction of Financial Assets and Enforcement of security Interest (SARFAESI) Act.
The Act paves the way for the establishment of Assets Reconstruction Companies (ARCs) that
can take the NPAs off the balance sheets of banks and recover them.
4.2 Purpose of the Act
Securitization, the process of converting illiquid loans into tradable securities, has emerged as an
important tool for financing worldwide. Securitization has gained increased acceptance in India
over the years. Securitization emerged as an important tool for fund raising by Indian Banks and
non banking financial institutions. Success of securitization depends upon proper implementation
of the Act. Priority sector lending requirement of Indian bank was the key driver behind the retail
securitization transaction during 2009.A majority of the retail loan pools securitised in 2009 were

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backed by priority sector loan originated by NBFCs. Transactions through direct assignment
route dominated the market in 2009, as this route facilitates the transfer of priority sector loans
directly to the acquirer’s loan book instead of investment book and thereby fulfilling priority
sector lending requirement.
4.3 The Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 - An Overview of the Provisions.
Financial indiscipline is the hallmark of Indian industry. The ever-growing Non-Performing
Assets ('NPA'), a fine euphemism coined to describe the bad loans, prompted the passing of the
Recoveries of Debts due to Banks and Financial Institutions Act, 1993 whereby a special Debt
Recovery Tribunal ('DRT') was set up for the recovery of NPA. However, this could not speed
up the recovery on one hand and on the other the strict civil law requirements rendered almost
futile the attachment and foreclosure of the assets given as security for the loan. Further, the
balance sheets of the banks and financial institutions were turning red due to heavy mandatory
provisions for NPAs .
Realizing that every fifth borrower is a defaulter, the Government was under pressure to make
adequate provisions for the recovery of the loans and also to foreclose the security. The
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 ('the Securitisation Act') aims to achieve these twin objectives besides providing for a
broad legal framework for asset securitisation and asset reconstruction.
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

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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 securitisation
transactions.
 Offences & Penalties.
 Boiler - plate provisions.
 Dilution of provisions of SICA.
 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

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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.
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.

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 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 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.

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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 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.

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