CENTRAL UNIVERSITY OF SOUTH BIHAR

GAYA-824236

SCHOOL OF LAW & GOVERNANCE

TOPIC-

SARFESI, Regulation of Financial Asset of Banks and Financial Institution

Under the Supervision of -Mrs. Pragya Singh

Submitted by:-

Sankalp Raj

B.Sc. L.LB(H)- 7th Sem.

Enrollment- CUSB1513115013

1|Page
 Preface
It is a matter of great pleasure for me to present this project. This project has
provided me an opportunity to know something new with the subject matter and
bring it up to date.
In this project an effort has been made to put the related concept at one place and
explain the principal and case laws in as simple language as possible.
I appreciate the help and cooperation rendered by my honorable professor Mrs.
Pragya and my friend Mr. Sonu without which the project could not have been
brought out in the present form.
At the end I apologize, I have hurt feeling of any person while making comments
or observation while expressing my views in the project. I take entire
responsibility for any error or omission in the project.

-Sankalp Raj

2|Page
S.No Index Page No

1. Introduction 4-5

2. SARFESI, Three in One 6-8

3. Asset Reconstruction its History 8-9

4. Enforcement of Security Interest 10

5. Scope of Application 11-13

6. Financial Asset of Bank and Financial Institution 13-14

7. Conclusion 15

8. Bibliography 16

3|Page
“SARFAESI law will be a quicker way to recover our dues instead of going through regular
court. The entire recovery process will get accelerated. It will also put us on par with other
players in the housing finance industry who already use SARFAESI law,”------------- Anil Kothuri1

Introduction

The banking industry in India is progressively complying with the international prudential
norms and accounting practices, there are certain areas in which the banking and financial
sector do not have a level playing field as compared to other participants in the financial
markets in the world. Acting on the suggestions of Narasimham Committee I and II and
Andhyarijuna Committee constituted by the Central Government for the purpose of
examining banking sector reforms, a new legislation for securitization and empowering banks
and financial institutions to take possession of the securities and to sell them without the
intervention of the court, was enacted. The Securitization and Reconstruction of Financial
Assets and Enforcement of Interest Ordinance, 2002 was promulgated on the 21st June, 2002
to regulate securitization and reconstruction of financial assets and enforcement of security
interest matters connected therewith or incidental thereto the ordinance, which enable and
financial institutions to realise an asset, manage problem of liquidity, liability mismatches and
improve by exercising powers to take possession of securities, sell them and reduce non-
performing assets by adopting measures recovery or reconstruction, has now replaced by an
Act. The Central Government had promulgated an ordinance called “The Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance, 2002”
(securitisation ordinance) on 21/06/2002. Government had also introduced a bill to this effect
in the Parliament during the last monsoon session but the same could not be taken up for
discussion due to several factors including disturbances in the Parliament proceedings.
Thereafter to keep its continuity, the Government had to re-promulgate this ordinance, which
has since been passed by the Parliament2. It received the assent of the President on
17/12/2002 and has now become an Act. The securitization ordinance was up the debt

1
thehindubusinessline.com
2
http://shodhganga.inflibnet.ac.in

4|Page
recovery process of banks, institutions by attachment of their assets to obtain a decree
through normal legal competent court of law. Although had a mixed reaction after the
ordinance, one of the reasons for which cured with the ordinance was that make any
difference between the normal business defaulters. The various factors including the
economic country for the last couple of years made banks and financial institutions beyond
their control but as per the Central Government an estimated amount of about Rs. 1 lakh into
Non-Performing Assets (NPAs). Banks, Financial institutions, and committees after
committees have recommended introduction of such kind of law which will provide faster
mechanism to the lenders to recover their dues and to be able to not only attach the assets
of the defaulters but also to encash them. The present law does not provide such a relief and
it was taking a very long time in realization of dues, which was detrimental to public interest
and affected national growth. With this back-ground, the Central Government has brought in
the securitization law and this has sent right signals not only to the defaulters concerned but
also Reserve Bank of India Act, 193 Government may specify for the Act.

SARFESI, THREE-IN-ONE

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security

Interest (SARFAESI) Act, 2002, empowers banks and financial institutions to attach pledged
assets of the borrower in the event of the non-repayment of dues by the borrower, on the
other hand we can also say that this modern legislation that assist the financial institutions to
ensure the quality of asset in multiple ways. The whole and sole intention of the law maker
before making this Act was to address the problem of NPAs (Non-Performing Assets) or bad
assets through different processes and mechanisms.

The SARFAESI Act gives detailed provisions for the formation and activities of Asset
Securitization Companies (SCs) and Reconstruction Companies (RCs). Scope of their activities,
capital requirements, funding etc. are given by the Act. RBI is the regulator for these
institutions.

As a legal mechanism to insulate assets, the Act addresses the interests of secured creditors
(like banks). Several provisions of the Act give directives and powers to various institutions to
manage the bad asset problem. Following are the main objectives of the SARFAESI Act.

 The Act provides the legal framework for securitization activities in India

5|Page
  It gives the procedures for the transfer of NPAs to asset reconstruction companies for
the reconstruction of the assets.

 The Act enforces the security interest without Court’s intervention

 The Act give powers to banks and financial institutions to take over the immovable
property that is hypothecated or charged to enforce the recovery of debt.

Major feature of SARFAESI is that it promotes the setting up of asset reconstruction (RCs) and
asset securitization companies (SCs) to deal with NPAs accumulated with the banks and
financial institutions. This Act merges into one three separate, and far most parts, unrelated
pieces of draft legislation. These three parts are: (a) Securitization; (b) Setting up of asset
reconstruction companies; and (c) Provisions relating to registration and enforcement of
security interests.

The Act, thus brings three important tools/powers into asset management of financial banks
and institutions – securitization of assets, reconstruction of assets and powers for
enforcement of security interests (means asset security interests). To understand the
SARFAESI Act, we should know the meaning of these terms as well.

SECURITIZATION

A prominent development in international finance in recent years has been the growing
importance of securitization. Securitization is the process of pooling and repackaging of
financial assets (like loans given) into marketable securities that can be sold to investors. In
the other words it can also be said that Securitization is related to conversion of financial
assets into capital market securities which is, for most purposes, unconnected with resolution
of nonperforming assets. In effect, securitization is a combination of traditional secured
financing and securities offering, involving the issuance of asset-backed securities. Virtually
every asset that has a predictable stream of cash payments could be securitized3. The purpose
of law-maker in this field could not have been but enabling, to iron out difficulties created by
common law. The central feature of securitization is therefore, the fact there is a segregation
of assets and issuance of securities which are either collateralized by such assets or represent
beneficial interest in such assets. There are several cases where there is a segregation of

3
https://www.taxmann.com

6|Page
assets, but there is no creation of securities -, for example if A transfers financial assets to B,
that is the end of the story. B’s acquiring financial asset is not securitization – it is a loan or
portfolio transfer. A securitization implies creation of securities premised on such assets –
because the central theme in securitization is the conversion of a financial relation into a
financial product, viz, a security4.

In the context of bad asset management, securitization is the process of conversion of existing
less liquid assets (loans) into marketable securities. The securitization company takes custody
of the underlying mortgaged assets of the loan taker. It can initiate the following steps:

i. Acquisition of financial assets from any originator (bank), and

ii. Raising of funds from qualified institutional buyers by issue of security receipts (for raising
money) for acquiring the financial assets or

iii. Raising of funds in any prescribed manner, and

iv. Acquisition of financial asset may be coupled with taking custody of the mortgaged land,
building etc.

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.

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.

4
http://shodhganga.inflibnet.ac.in

7|Page
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/RCO5.

Asset Reconstruction and its History

Asset reconstruction is the activity of converting a bad or non-performing asset into

performing asset. The process of asset reconstruction involves several steps including
purchasing of bad asset by a dedicated asset reconstruction company (ARC) including the
underlying hypothecated asset, financing of the bad asset conversion into good asset using
bonds, debentures, securities and cash, realization of returns from the hypothecated assets
etc. Asset reconstruction companies, or asset management companies as they are globally
called, exist for a distinct purpose-acquisition and resolution of sticky debts. Such companies
have in number of countries, also securitised their assets but their primary motive is not
securitization but resolution. The purpose of law making here was to confer special powers
to enable ARCs to recover non – performing loans.

“Asset Reconstruction” means acquisition by any securitisation company or reconstruction

company of any right or interest of any bank or financial institution in any financial assistance
for the purpose of realization of such financial assistance. A short history of the word “Asset
Reconstruction”: In global banking jargon, the word “asset reconstruction” is not commonly

5
http://www.mondaq.com

8|Page
used. The more common word is “asset management” or “resolution”. There is a brief history
as to how the internationally – prevalent word “asset management companies” changed to
“asset reconstruction companies” in India. There was a proposal in the Narasimham
Committee I to set up an “asset reconstruction fund” supported by the Government into
which assets of banks with high NPAs will be transferred. By the time of Narasimham II, a lot
of international activity had already been seen in resolution of NPAs in several Asian
countries. Therefore, Narasimham II recommended setting up of resolution companies on the
lines of what had been done in Asia. These companies, in the earlier time, were called Asset
Reconstruction Companies. The Budget 1999-2000 announced the decision of the
Government to set up an ARC on a pilot basis for which the modalities were to be worked out.
Since then, the ARC proposal has been a permanent fixture on each union Budget, and it is
only after more than 3 years that legislative steps have been taken to enable formation of
ARCs. Till very recently, it appears that the Government was not certain about the exact
mechanism of ARCs. As recently as in April 2002, RBI Deputy Governor G.P. Muniappan said
in a CII meeting in Mumbai on April 1, 2002:“An Asset Reconstruction company with an
authorized capital of Rs.2,000 crore and initial paid up capital Rs.1,400 crore is to be set up as
a trust for undertaking activities relating to asset reconstruction. It would negotiate with
banks and financial institutions for acquiring distressed assets and develop markets for such
assets. Government of India proposes to go in for legal reforms to facilitate the functioning
of ARC mechanism”. The Deputy Governor was clearly hinting at one ARC for several banks,
and that too, in a trust format, while the theme of the present legislation seems to be
separate ARCs for separate banks, in a corporate format.

Reconstruction, is to be done with the RBI regulations and the SARFAESI Act gives the
following components for reconstruction of assets: –

a) Taking over or changing the management of the business of the borrower,

b) The sale or lease of a part or whole of the business of the borrower;

c) Rescheduling of payment of debts payable by the borrower;

d) Enforcement of security interest in accordance with the provisions of this Act;

e) Settlement of dues payable by the borrower;

9|Page
f) Taking possession of secured assets in accordance with the provisions of this Act.

Enforcement of Security Interests

The Act empowers the lender (banker), when the borrower defaults, to issue notice to the
defaulting borrower and guarantor, calling to repay the debt within 60 days from the date of
the notice. The second objective of the Securitisation Act is to provide for the enforcement of
security interest i.e. taking possession of the assets given as security for the loan. Section 13
of the Securitisation Act contains elaborate provisions for a lender (referred to as 'secured
creditor') to take possession of the security given by the borrower6. If the borrower fails to
comply with the notice, the bank or the financial institution may enforce security interests
(means interest of the bank/creditor) by following the provisions of the Act:

a) Take possession of the security;

b) Sale or lease or assign the right over the security;

c) Appoint Manager to manage the security;

d) Ask any debtors of the borrower to pay any sum due to the borrower.

If there are more than one secured creditors, the decision about the enforcement of
SARFEASI provisions will be applicable only if 75% of them are agreeing.

The amendment has brought hire purchase and financial lease under the coverage of the
SARFAESI Act. Regarding DRTs, the amendment aims to speed up the DRT procedures. Online
procedures including electronic filing of recovery applications, documents and written
statements will be initiated. The amendments are important for DRTs as they can play an
important role under the new Bankruptcy law. DRTs will be the backbone of the bankruptcy
code and deal with all insolvency proceedings involving individuals. The defaulter has to
deposit 50 per cent of the debt due before filing an appeal at a DRT7.

6
http://www.mondaq.com/india
7
https://www.indianeconomy.net/splclassroom/what-is-sarfaesi-act-2002/

10 | P a g e
 8

In short from this Picture we can also understand this modern act.

Scope of Application

The provisions of this Act are applicable only for NPA loans with outstanding above Rs. 1.00
lac. NPA loan accounts where the amount is less than 20% of the principal and interest are
not eligible to be dealt with under this Act. Non-performing Asset (NPA) means an asset for
which Interest or principal (or installment) is overdue for a period of 90 days or more from
the date of acquisition or the due date as per contract between the borrower and the lender,
whichever is later. NPA should be backed by securities charged to the Bank by way of
hypothecation or mortgage or assignment. Security Interest by way of Lien, pledge, hire

8
https://cleartax.in/s/sarfaesi-act-2002

11 | P a g e
purchase and lease not liable for attachment under Sec.60 of Civil Procedure Code, 1908 are
not covered under this Act.

1. Non-Applicability in certain cases:

a. a lien on any goods, money or security given by or under the Indian Contract
Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in
force;

b. a pledge of movable within the meaning of Section 172 of the Indian Contract
Act, 1872;

c. creation of any security in any aircraft as defined in clause(1) of Section 2 of

the Aircraft Act, 1934;

d. creation of security interest in any vessel as defined in clause (55) of Section 3

of the Merchant Shipping Act, 1958;

e. any conditional sale, hire-purchase or lease or any other contract in which no

security interest has been created;

f. any rights of unpaid seller under Section 47 of the Sale of Goods Act, 1930;

g. any properties not liable to attachment or sale under Section 60 of the Code
of Civil Procedure, 1908;

h. any security interest for securing repayment of any financial asset not
exceeding one lakh rupees;

i. any case in which the amount due is less than 20% of the principal amount and
interest thereon9.

9
http://www.rna-cs.com/the-securitization-and-reconstruction-of-financial-assets-and-enforcement-of-
security-interest-act-2002-sarfaesi/

12 | P a g e
 The Process to be followed10

Financial Asset of Bank and Financial Institution

The main problem with the bank and other Financial institution is that they are not getting their
money back from the borrower and they are suffering from the NPA( Non-Performing Asset).
In order to understand the regulation of SARFESI Act in Bank and Financial Institution, we
have to go with NPA. The three letters “NPA” Strike terror in banking sector and business
circle today. NPA is short form of “Non -Performing Asset”. The dreaded NPA rule says
simply this: when interest or other due to a bank remains unpaid for more than 90 days, the
entire bank loan automatically turns a non performing asset. The recovery of loan has always
been problem for banks and financial institution. An asset, including a leased asset, becomes
non-performing when it ceases to generate income for the bank.
Accordingly, with effect from March 31, 2004, a non-performing asset (NPA) shall be a loan
or an advance where;

10
https://cleartax.in/s/sarfaesi-act-2002

13 | P a g e
  Interest and/ or instalment of principal remain overdue for a period of more than
90 days in respect of a term loan,

 The account remains ‘out of order’ for a period of more than 90 days, in respect
of an Overdraft/Cash Credit (OD/CC),

 The bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,

 Interest and/or instalment of principal remains overdue for two harvest seasons
but for a period not exceeding two half years in the case of an advance granted for
agricultural purposes, and

 Any amount to be received remains overdue for a period of more than 90 days in
respect of other accounts.

As a facilitating measure for smooth transition to 90 days norm, banks have been
advised to move over to charging of interest at monthly rests, by April 1, 2002. However, the
date of classification of an advance as NPA should not be changed on account of charging of
interest at monthly rests. Banks should, therefore, continue to classify an account as NPA only
if the interest charged during any quarter is not serviced fully within 180 days from the end of
the quarter with effect from April 1, 2002 and 90 days from the end of the quarter with effect
from March 31, 2004.
Now here question arises what the role play by SARFESI in collecting money from these NPA.
Basically this Act provide a new way to solve the problem without involving through the
process of Court. The Bank does not able to recover the money so it transfer the NPA to Asset
Reconstruction Company and now from here the company take those asset and here the
company gain capital in form of asset. As we already know that company issue share and here
those share are subscribe by the bank and profit to company means profit to its shareholder so
in short hand we can say that bank is in Profit after giving NPA to the company. However it is
the duty of the company to recover the money from the borrower and the company does this
work with some rate of interest.

14 | P a g e
 Conclusion

As per my view, There is an element of commonality, as well as confusion that has resulted
from the fusion of these three elements into a single piece of legislation. For example, the
requirements for asset reconstruction companies have been applied to securitization companies
as well. Provisions for registration of security interests have also been made applicable to
transfers in connection with securitization, and provisions which ought to have excluded the
applicability of the security interest matters have apparently eluded securitization and
reconstruction transactions as well. If one looks at the legislative history it is evident that the
purposes of the three elements of the present law were discernibly distinct. ™ Securitization is
related to conversion of financial assets into capital market securities which is, for most
purposes, unconnected with resolution of nonperforming assets. The purpose of law-making in
this field could not have been but enabling, to iron out difficulties created by common law. ™
Asset reconstruction companies, or asset management companies as they are globally called,
exist for a distinct purpose-acquisition and resolution of sticky debts. Such companies have in
number of countries, also securitised their assets but their primary motive is not securitization
but resolution. The purpose of law making here was to confer special powers to enable ARCs
to recover non – performing loans. ™ Enforcement of security interests is apparently
completely unconnected and it is very difficult to understand the purpose of clubbing this along
with the above two elements- except probably, the political convenience of giving this
important change in law the garb of being related to securitization and reconstruction and thus
making it easy to ‘push through’ as something technical and hence, politically insensitive. At
last what I conclude from my entire research that it provide a new mechanism to regulate the
entire banking system smoothly.

15 | P a g e
Bibliography:-

 Internet Site Preferred

 thehindubusinessline.com
 http://shodhganga.inflibnet.ac.in
 https://www.taxmann.com
 http://www.mondaq.comhttps://www.indianeconomy.net/splclassroom/what-
is-sarfaesi-act-2002/
 https://cleartax.in/s/sarfaesi-act-2002
 http://www.rna-cs.com/the-securitization-and-reconstruction-of-financial
assets-and-enforcement-of-security-interest-act-2002-sarfaesi

16 | P a g e