Debt Recovery Tools Employed by Banks
Aiswaria P.J.
(4th year law student at The National University of Advanced Legal Studies, Kochi)
Non Performing Assets(NPA)
When an asset no longer generates income for the bank, it is considered a non-performing asset. Traditionally, an asset was classified as a non-performing asset (NPA) based on the concept of “Past Due.” A ‘non-performing asset’ (NPA) was defined as a credit for which interest and/or principal instalments have been ‘past due’ for a specified period of time. To move towards international best practices and ensure greater transparency, ’90 days’ overdue norms for identifying NPAs were made applicable beginning with the fiscal year ended March 31, 2004. Commercial loans that are more than 90 days past due and consumer loans that are more than 180 days past due are typically classified as non-performing assets by banks. In the case of agricultural loans, NPAs are declared if the interest and/or instalment of principal remains unpaid for two harvest seasons; However, this period should be atmost two years. Any unpaid loan/instalment will be classified as NPA after two years.
The classification of an asset as NPA should be based on the record of recovery. Bank should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, non- submission of stock statements and non-renewal of the limits on the due date, etc. Banks should ensure that drawings in the working capital accounts are covered by the adequacy of current assets, since current assets are first appropriated in times of distress. Drawing power is required to be arrived at based on the stock statement which is current. A working capital borrowal account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days even though the unit may be working or the borrower’s financial position is satisfactory.Regular and ad hoc credit limits need to be reviewed/ regularised not later than three months from the due date/date of ad hoc sanction. In case of constraints such as non-availability of financial statements and other data from the borrowers, the branch should furnish evidence to show that renewal/ review of credit limits is already on and would be completed soon. An account where the regular/ ad hoc credit limits have not been reviewed/ renewed within 180 days from the due date/ date of ad hoc sanction will be treated as NPA.
The Debt Recovery Tools
The loan recovery policies of a bank aim at maximizing the recovery of the dues and at safeguarding the interest of the Bank. One of the basic approaches towards the resolution of stressed assets is the initiation of quick action without losing time. The vast credit portfolio being segregated into Different SMA classifications enable the bank to provide priority attention on these, leading to the initiation of result-oriented steps.
Restructuring of Loans:
Loan restructuring refers to the process of modifying the terms and conditions of an existing loan agreement between a borrower and a lender. Loan restructuring can take various forms, depending on the specific circumstances and the type of loan involved. Extension of the loan term, Interest rate modification, principal reduction, moratorium period, and conversion to a different loan type are some common restructurings that enable the borrower to duly repay the loan. Such restructuring is offered when the Bank has reasonable certainty of repayment from the borrower and should generally be done within one month of the account turning NPA.
Compromise Settlements:
A compromise is a settlement of disputes reached by mutual consent. It is a negotiated settlement with sacrifice components on all the parties to the dispute. It is a non-legal remedy for the reduction of NPAs of the Bank. Negotiated compromise settlement is made to maximize the compromise amounts. Each Bank has to devise its own Recovery policy facilitating compromise settlement of dues in the NPA account. SIDBI, under its recovery policy, provides for various compromise settlement methods.
- OTS Scheme: If the NPA account has long-term structural deficiencies which do not allow them to perform above the mark of sustainable profit lines and restructuring of the account was considered but not possible, the bank, in order to protect its interest may admit an application of OTS by the borrower.
- Lok Adalat, though quasi-judicial, is considered as a compromise settlement method for simpler, quicker and cost-effective disposal of cases. Lok Adalats are organized under the Legal Services Authority Act, 1987 by the State and/or District and Taluk Legal Services Committee. Branches should consult Local Legal Services Committee and IBA chapter,if necessary, for organizing Lok Adalats. Lok Adalat is a process of administering justice without resorting to courts. The award of Lok Adalat has the effect of a decree of a civil court and binding on the parties to the dispute and no appeal can be made by either of the parties. The maximum claim amount that can be dealt with by Lok Adalat is Rs. 20 lakhs.
- Special Recovery Drive: A special recovery drive refers to a focused and intensified effort by financial institutions or debt recovery agencies and involves a targeted campaign or initiative to identify and pursue delinquent borrowers, employing various strategies to ensure the recovery of the owed funds. These initiatives are often implemented when financial institutions observe a higher than usual default rate or when they want to address a specific group of delinquent borrowers.
Legal Measures:
Only when the compromise settlement methods fail, the banks opt for legal measures. This might be because of how time-consuming the legal proceedings are, which in a way results in the erosion of value of assets and hence, dragging it for a long time is not in the interest of the bank. Anyhow, the legal measures are of great importance since they help in recovering the debt from borrowers who are non-cooperative in nature.
- Debt Recovery Tribunal: The low rate of loan recoveries has a bearing on the accounting standards as well as on the current operations of banks. It is in this context the Recovery of Debts due to Banks and Financial Institutions (RDDBFI) Act, 1993‟ was passed on August 17, 1993, that facilitated the establishment of Debt Recovery Tribunals for expeditions adjudications and recovery of a debt due to any bank or financial institutions.DRTs aim to expedite the resolution of debt recovery cases. The RDDBFI Act mandates strict timelines for the disposal of cases, ensuring that the proceedings are conducted efficiently and effectively. DRTs have jurisdiction over matters related to the recovery of debts due to banks, financial institutions, and other specified entities. They handle cases involving defaulted loans and outstanding dues, providing a dedicated forum for the resolution of such disputes. They have the authority to adjudicate and pass judgments on claims related to loan defaults. DRTs issue recovery certificates, which act as an order for the recovery of the outstanding debt. Once a recovery certificate is issued, it enables the recovery officer to take necessary steps for the recovery of the dues, including the attachment and sale of the defaulter’s assets. DRTs also encourage the settlement of disputes through negotiations and conciliation between the parties involved. They facilitate discussions and mediate between the borrower and the lender to arrive at mutually acceptable repayment terms, debt restructuring plans, or settlements.
- SARFAESI Act 2002:The SARFAESI Act, also known as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, empowers banks and financial institutions in India to recover their loans by enforcing the security interest held against the borrower’s assets. The SARFAESI Act grants banks the power to enforce the security interest held against the borrower’s assets. If a borrower defaults on their loan, the bank can take possession of the secured assets and sell them to recover the outstanding amount, thereby providing a mechanism to recover the outstanding dues in a more efficient and timely manner. The Act specifies the procedures and mechanisms for the enforcement of security interests, including the appointment of authorized officers by the banks.
Before initiating any enforcement action, the bank is required to issue a demand notice under section 13(2) of the Act to the borrower, specifying the outstanding amount and providing an opportunity to cure the default within a specified period. This gives the borrower an opportunity to repay the dues and avoid further action. If the borrower fails to cure the default within the specified period, the bank can exercise its right to take possession of the secured assets and sell them. The Act empowers banks to do so without the intervention of the court or any other authority. The Act provides guidelines for the process of taking possession, valuation of assets, and the manner of sale. These assets can include immovable property (land, buildings, etc.), movable property (vehicles, machinery, equipment, etc.), receivables, or any other assets specified in the loan agreement. It’s important to note that the SARAESI Act has provisions to protect the rights of borrowers as well. If a borrower feels that the possession and sale process was not conducted in compliance with the Act, they can approach the Debt Recovery Tribunal (DRT) for redressal under section 17 of the Act.
- The Insolvency and Bankruptcy Code (IBC) is a comprehensive legislation in India that provides a framework for resolving insolvency and facilitating loan recovery. The IBC streamlines and expedites the resolution process, benefiting both lenders and borrowers. Under the Code, financial and operational creditors can initiate Corporate Insolvency Resolution Process (CIRP) against a corporate debtor when there is a default in loan repayment. The Code mandates a requirement of One Crore rupees as the minimum amount of default for the purposes of initiating CIRP against a corporate debtor. Once the CIRP is initiated, a moratorium period is declared, during which no legal action can be taken against the corporate debtor. This provides a breathing space for the debtor to restructure its debts and facilitates a smooth resolution process. The NCLT appoints an Insolvency Professional (Resolution Professional) to manage the affairs of the corporate debtor during the CIRP. The Resolution Professional takes control of the company’s assets and operations, ensuring the protection of the lenders’ interests. Claims from all the creditors will be invited and a Committee of Creditors (CoC) will be formed.
The CoC takes important decisions during the resolution process, including the approval or rejection of a resolution plan. The IBC lays down a time-bound process for the submission, evaluation, and approval of resolution plans by the CoC. The resolution plan outlines the proposed restructuring or repayment terms for the outstanding loans. If a resolution plan fails or is not approved within the specified timeframe, the NCLT may order the liquidation of the corporate debtor. In the liquidation process, the assets of the debtor are sold, and the proceeds are distributed among the creditors according to the priority laid down in the IBC.
The Code also contains provisions that deal with the resolution of insolvency and bankruptcy cases involving individuals and partnership firms. To facilitate this process, individuals are categorized into three distinct groups:
(i) Personal guarantors to corporate debtors (CDs),
(ii) Partnership firms and proprietorship firms, and
(iii) Other individuals.
This categorization allows for the phased implementation of individual insolvency, taking into account the broader implications of these provisions. The Pre-packaged Insolvency Resolution Process (PIRP) is a time-bound mechanism introduced under the Code that allows financially distressed companies to prepare a resolution plan with the approval of creditors before initiating formal insolvency proceedings. The PIRP can be initiated by the corporate debtor with the consent of its directors or by a resolution passed by the company’s shareholders or partners, as applicable. The procedure for approval of PIRP is similar to that of CIRP except that the application for initiation is made by the debtor. The PIRP is designed to provide a faster and more efficient resolution process for financially distressed companies. By allowing the debtor to prepare a resolution plan with the consent of creditors before initiating insolvency proceedings, it aims to facilitate a smoother and consensual restructuring or resolution process.
Write off
A write-off of loans by banks refers to the accounting practice of removing a loan from the bank’s books when it is determined that the loan is unlikely to be repaid fully or at all. When a loan account is considered to be a loss asset, i.e., the chances of recovery are slim, the bank maydecide to write off the loan. Writing off the loan does not mean that the borrower is no longer obligated to repay the debt; it is an internal accounting process that removes the loan from the bank’s balance sheet. Writing off loans is a common risk management practice for banks to maintain accurate financial records and assess their actual exposure to potential credit losses. However, it does not absolve the borrower of their obligation to repay the debt, and the bank will continue to pursue debt recovery measures whenever possible.
Conclusion
In conclusion, banks employ various recovery tools to mitigate the risks associated with non-performing loans and ensure the retrieval of funds. Legal measures such as the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act(SARFAESI Act) and the Insolvency and Bankruptcy Code (IBC) have significantly strengthened the recovery framework in the banking sector. These measures have instilled discipline among borrowers, as the fear of losing assets or facing insolvency proceedings acts as a deterrent against loan defaults. Moreover, these frameworks have improved transparency, accountability, and investor confidence in the banking system. They also strike a balance between the rights of banks and borrowers. However, the most efficient among these recovery mechanisms are compromise settlements, like the OTS scheme, that are arrived at after due consideration of the value of the secured assets and the capability of the borrower to repay.
References
Gautami, S. (2017) Credit recovery methods of scheduled commercial banks in India, Researchgate. Available at: https://www.researchgate.net/publication/326058842_Credit_Recovery_Methods_of_Scheduled_Commercial_Banks_in_India (Accessed: 29 June 2023).
Interrelationship between Non-Performing Assets (NPAs) and Debt Recovery Tools in India”, pp. 83-100, Think India Journal (Special Issue – Indian Economic Association). Volume 22, Issue 26, 2019 [ISSN : 0971-1260].
EditorSV, I.L. (2023) Read more: IBC Laws – Debts Recovery Appellate Tribunal (procedure) rules, 1994 (drat procedure rules 1994), IBC Laws. Available at: https://ibclaw.in/drat-procedure-rules-1994/ (Accessed: 18 June 2023).
Raj, K.M. and Raju, B.Y. (2017) How banks misuse sarfaesi act provisions for loan recovery, KNN Knowledge & News Network. Available at: https://knnindia.co.in/blog/blogdetails/how-banks-misuse-sarfaesi-act-provisions-for-loan-recovery (Accessed: 18 July 2023).
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