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Measures to Control and Counter NPA, Credit

Rating Agencies, SARFAESI Act and Insolvency
Non-performing asset (NPA)
NPAs can be classified as a substandard asset, doubtful asset, or loss asset, depending on the
length of time overdue and probability of repayment.
Non-Performing Assets (NPA)
A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or in
arrears.
• A loan is in arrears when principal or interest payments are late or missed.
• A loan is in default when the lender considers the loan agreement to be broken and the debtor is
unable to meet his obligations.
• A Non-Performing Assets (NPA) is generally classified on the bank’s balance sheet and the % of NPA
out of the total advances has become a vital ratio for the banks to keep a check on before making the
results public.
• More than 90 days where payment is due on the banks’ loans and advances move to non-performing
assets (NPA).
• As we note from above, Bank of America has an NPA of around $4,170 million that has accrued for
90 days or more.
NPA Control & Counter Steps
Various steps taken to tackle NPAs
There have been several steps taken by the GOI on legal, financial, policy level reforms. In the year
1991, Narsimham committee recommended many reforms to tackle NPAs. Some of them were
implemented.
1. The Debt Recovery Tribunals (DRTs) – 1993
• To decrease the time required for settling cases. They are governed by the provisions of the
Recovery of Debt Due to Banks and Financial Institutions Act, 1993.
• Their number is not sufficient therefore they also suffer from time lag and cases are pending for
more than 2-3 years in many areas.
2. Credit Information Bureau – 2000
• A good information system is required to prevent loan falling into bad hands and therefore
prevention of NPAs.
• It helps banks by maintaining and sharing data of individual defaulters and willful defaulters.
3. Lok Adalats – 2001
• They are helpful in tackling and recovery of small loans however they are limited up to 5 lakh rupees
loans only by the RBI guidelines issued in 2001.
• They are positive in the sense that they avoid more cases into the legal system.
4. Compromise Settlement – 2001
• It provides a simple mechanism for recovery of NPA for the advances below Rs. 10 Crores.
• It covers lawsuits with courts and DRTs (Debt Recovery Tribunals) however willful default and fraud
cases are excluded.
5. SARFAESI Act – 2002
• The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAESI) Act, 2002 – The Act permits Banks / Financial Institutions to recover their NPAs without
the involvement of the Court, through acquiring and disposing of the secured assets in NPA accounts
with an outstanding amount of Rs. 1 lakh and above.
• The banks have to first issue a notice. Then, on the borrower’s failure to repay,
6. ARC (Asset Reconstruction Companies)
• The RBI gave license to 14 new ARCs recently after the amendment of the SARFAESI Act of 2002.
These companies are created to unlock value from stressed loans. Before this law came, lenders could
enforce their security interests only through courts, which was a time-consuming process.
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7. Corporate Debt Restructuring – 2005

• It is for reducing the burden of the debts on the company by decreasing the rates paid and
increasing the time the company has to pay the obligation back.
8. Joint Lenders Forum – 2014
• It was created by the inclusion of all PSBs whose loans have become stressed. It is present so as to
avoid loan to the same individual or company from different banks. It is formulated to prevent the
instances where one person takes a loan from one bank to give a loan of the other bank.
9. Mission Indradhanush – 2015
• The Indradhanush framework for transforming the PSBs represents the most comprehensive reform
effort undertaken since banking nationalization in the year 1970 to revamp the Public Sector Banks
(PSBs) and improve their overall performance by ABCDEFG.
10. Strategic debt restructuring (SDR) – 2015
• Under this scheme banks who have given loans to a corporate borrower gets the right to convert the
complete or part of their loans into equity shares in the loan taken company.
• Its basic purpose is to ensure that more stake of promoters in reviving stressed accounts and
providing banks with enhanced capabilities for initiating a change of ownership in appropriate cases.
11. Asset Quality Review – 2015
• Classify stressed assets and provisioning for them so as the secure the future of the banks and
further early identification of the assets and prevent them from becoming stressed by appropriate
action.
12. Sustainable structuring of stressed assets (S4A) – 2016
• It has been formulated as an optional framework for the resolution of largely stressed accounts.
• It involves the determination of sustainable debt level for a stressed borrower and bifurcation of the
outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to
provide upside to the lenders when the borrower turns around.
13. Pubic ARC vs. Private ARC – 2017
• This debate is recently in the news which is about the idea of a Public Asset Reconstruction
Companies (ARC) fully funded and administered by the government as mooted by this year’s
Economic Survey Vs. the private ARC as advocated by the then deputy governor of RBI Mr. Viral
Acharya.
• Economic survey calls it as PARA (Public Asset Rehabilitation Agency) and the recommendation is
based on a similar agency being used during the East Asian crisis of 1997 which was a success.
14. Bad Banks – 2017
• Economic survey 16-17, also talks about the formation of a bad bank which will take all the stressed
loans and it will tackle it according to flexible rules and mechanism.
• It will ease the balance sheet of PSBs giving them the space to fund new projects and continue the
funding of development projects.
Credit Rating Agencies in India
What is credit rating agency?
• A credit rating agency does assessment of the financial strength of companies and other government
entities.
• They help investors identify the companies ability to pay debts and their level of risk.
Note: All the credit rating agencies in India are regulated by SEBI (Credit Rating Agencies)
Regulations, 1999 of the Securities and Exchange Board of India Act, 1992.
There are a total of six credit agencies in India viz, CRISIL, CARE, ICRA, SMREA, Brickwork Rating,
and India Rating and Research Pvt. Ltd.
How Credit Rating Agencies Work
Credit rating agencies assign ratings to an organization or an entity. The entities that are rated by
credit rating agencies comprise companies, state governments, non-profit organisations, countries,
securities, special purpose entities, and local governmental bodies. Credit rating agencies take into
consideration several factors like the financial statements, level and type of debt, lending and
borrowing history, ability to repay the debt, and the past debts of the entity before rating their credit.
Once a credit rating agency rates the entities, it provides additional inputs to the investor following
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which the investor analyses and takes a sound investment decision. Poor credit rating indicates that
the entity is at a high risk of defaulting. The credit ratings that are given to the entities serve as a
benchmark for financial market regulations. Credit ratings are published by agencies like Moody’s
Investors Service and Standard and Poor’s (S&P) based on detailed analysis.
Some of the Top Credit Rating Agencies in India are:
1. Credit Rating Information Services of India Limited (CRISIL)
CRISIL is one of the oldest credit rating agencies in India. It was launched in the country in 1987
following which the company went public in 1993. Headquartered in Mumbai, CRISIL ventured into
infrastructure rating in 2016 and completed 30 years in 2017. CRISIL acquired 8.9% stake in CARE
credit rating agency in 2017. It launched India's first index to benchmark performance of investments
of foreign portfolio investors (FPI) in the fixed-income market, in the rupee as well as dollar version in
2018. The company’s portfolio includes, mutual funds ranking, Unit Linked Insurance Plans (ULIP)
rankings, CRISIL coalition index and so on.
2. ICRA Limited
ICRA Limited is a public limited company that was set up in 1991 in Gurugram. The company was
formerly known as Investment Information and Credit Rating Agency of India Limited. Before going
public in April 2007, ICRA was a joint venture between Moody’s and several Indian financial and
banking service organisations. The ICRA Group currently has four subsidiaries - Consulting and
Analytics, Data Services and KPO, ICRA Lanka and ICRA Nepal. At present, Moody’s Investors
Service, the international Credit Rating Agency, is ICRA’s largest shareholder. ICRA’s product portfolio
includes rating for - corporate debt, financial rating, structured finance, infrastructure, insurance,
mutual funds, project and public finance, SME, market linked debentures and so on.
3. Credit Analysis and Research limited (CARE)
Launched in 1993, CARE offers credit rating services to areas such as corporate governance, debt
ratings, financial sector, bank loan ratings, issuer ratings, recovery ratings, and infrastructure ratings.
Headquartered in Mumbai, CARE offers two different categories of bank loan ratings, long-term and
short-term debt instruments. The company also offers ratings for Initial Public Offerings (IPOs), real
estate, renewable energy service companies (RESCO), financial assessment of shipyards, Energy
service companies (ESCO) grades various courses of educational institutions. CARE Ratings has also
ventured into valuation services and offers valuation of equity, debt instruments, and market linked
debentures. Moreover, the company has launched a new international credit rating agency ‘ARC
Ratings’ by teaming up with four partners from South Africa Brazil, Portugal, and Malaysia. ARC
Ratings has commenced operations and completed sovereign ratings of countries, including India.
4. Brickwork Ratings (BWR)
Brickwork Rating was established in 2007 and is promoted by Canara Bank. It offers ratings for bank
loans, SMEs, corporate governance rating, municipal corporation, capital market instrument, and
financial institutions. It also grades NGOs, tourism, IPOs, real estate investments, hospitals, IREDA,
educational institutions, MFI, and MNRE. Brickwork Ratings is recognised as external credit
assessment agency (ECAI) by Reserve Bank of India (RBI) to carry out credit ratings in India.
5. India Rating and Research Pvt. Ltd.
India Ratings is a wholly-owned subsidiary of the Fitch Group. It offers credit ratings for insurance
companies, banks, corporate issuers, project finance, financial institutions, finance and leasing
companies, managed funds, and urban local bodies. In addition to SEBI, the company is recognised
by the Reserve Bank of India and National Housing Bank.
6. Small and Medium Enterprises Rating Agency of India (SMERA)
Established in 2005, SMERA is a joint initiative of SIDBI, Dun & Bradstreet India and leading banks in
India. SMERA has joined hands with prominent institutions such as IIT Madras, The Bangladesh
Rating Agency Limited, CAFRAL, CoinTribe, and SIES. Apart from its shareholder banks, SMERA has
also entered into MoUs with over 30 Banks, Financial Institutions and Trade Associations of the
country.

SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002)
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The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAESI) Act, 2002 is a law that helps financial institutions to ensure asset quality in number of
ways. This means that this act or legislation was framed to address the problem of NPAs (Non-
Performing Assets) or bad assets through different processes and mechanisms.
The SARFAESI Act gives a comprehensive provision for the formation and activities of Asset
Securitization Companies (SCs) and Reconstruction Companies (RCs). The act has also given the
scope of activities, capital requirements, funding etc. The regulator of these institutions is RBI.
The Act addresses the interests of secured creditors (like banks) as a legal mechanism to insulate
assets. Several provisions of the Act give directives and powers to various institutions to manage the
bad asset problem.
Objectives of the SARFAESI Act
SARFAESI Act is used by banks as an effective tool for bad loans (NPA) recovery. The main objectives
of this act are as under:
• SARFAESI Act provides the legal framework for securitization activities in India.
• It provides procedures for the transfer of NPAs to asset reconstruction companies for the
reconstruction of the assets.
• The Act implements the security interest without Court’s intervention.
• The Act empower banks and financial institutions to take over the immovable property that is
hypothecated or charged to enforce the recovery of debt.
Features
Major feature of SARFAESI is that it helps in setting up of asset reconstruction (RCs) and asset
securitization companies (SCs) to deal with NPAs accumulated with the banks and financial
institutions. The other salient features of this act are as under:
• Incorporation & Registration of Special Purpose Vehicles
• Enforcement of security interest
How SARFAESI Act recover NPAs?
The Act upholds three methods for recovery of NPAs. They are as follows:
i. Securitization;
ii. Asset Reconstruction; and
iii. Enforcement of Security without the intervention of the Court.

These three methods work as an important tools/ powers into asset management of financial banks
and institutions by securitization of assets, reconstruction of assets and powers for enforcement of
security interests (means asset security interests).
Securitization: Securitization is the process of pooling and repackaging of financial assets such as
loans into marketable securities that are to be sold to the investors. Also, in the situation of bad asset
management, securitization is the process of conversion of existing fewer liquid assets (loans) into
marketable securities. The securitization company takes custody of the underlying mortgaged assets
of the loan taker.
Following steps are initiated under this:
• Acquisition of financial assets from any originator (bank)
• Raising of funds from qualified institutional buyers by issue of security receipts (for raising money)
for acquiring the financial assets.
• Raising of funds in any prescribed manner.
• Acquisition of financial asset may be coupled with taking custody of the mortgaged land, building
etc.

Asset Reconstruction: Asset reconstruction is the process of converting a bad or non-performing

asset into performing asset. Asset reconstruction process 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. It is done with the
regulations of RBI.
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SARFAESI Act provides the following component for reconstruction of assets:

• Taking over or changing the management of the business of the borrower.
• Sale or lease of a part or whole of the business of the borrower.
• Rescheduling of payment of debts payable by the borrower.
• Enforcement of security interest in accordance with the provisions of this Act.
• Settlement of dues payable by the borrower.
• Possession of secured assets in accordance with the provisions of this Act.
Enforcement of Security: Enforcement of Security empowers the lender (banker) to issue notice to
the defaulting borrower and guarantor calling to repay the debt within 60 days from the date of the
notice. If the borrower is not able to comply with the notice, the bank or the financial institution may
enforce security interests (means interest of the bank/creditor). This is donw without the intervention
of the court.
Here are the provisions of the Enforcement of Security under the SARFAESI Act:
• Take possession of the security
• Sale or lease or assign the right over the security
• Appoint Manager to manage the security
• Ask any debtors of the borrower to pay any sum due to the borrower
Note: If there are more than one secured creditor, the decision about the enforcement of SARFEASI
provisions will be applicable only if 75% of them are agreeing.
Documents Required
For Registration of creation and Modification of charge, e-Form CHG-1 or e-Form CHG-9 is required to
be filed. The documents required in this context are given below:
• Particulars of charges
• Certificate of registration
• An Instrument created for the charge
• Copy of the instrument – creating or modifying the charge
• Hypothecation Deed
• Sanction Letter
If in case any e-Form is to be digitally signed, the documents that are required in this case are as
follows:
• DSC of the charge holder
• Director Identification Number of the Director
• Permanent Account Number [PAN] of the manager, CEO, CFO
• Membership Number of the Company Secretary
Further amendment to the SARFAESI Act in 2016
Government has amended the SARFAESI Act in August 2016 in order to empower the ARCs (Asset
Reconstruction Companies) with rejuvenating Debt Recovery Tribunals (DRTs) as well as enhancing
the effectiveness of asset reconstruction under the new bankruptcy law.
The new amendment has provided more regulatory powers to the RBI on the working of Asset
Reconstruction Companies. The act was also amended to empower asset reconstruction and the
functioning of DRTs in the context of the newly enacted bankruptcy law.
Here are the features of the new amendment:
• The scope of the registry that contains the central database of all loans against properties given by
all lenders has been widened to include more information through this amendment.
• RBI will have more powers to audit and inspect ARCs and will get the freedom to remove the
chairman or any director. It can also appoint central bank officials into the boards of ARCs.
• RBI will get the power to impose penalties on Asset Reconstruction Companies (ARCs) when the
latter doesn’t follow the central bank’s directives.
• RBI can regulate the fees charged by ARCs from banks while dealing with NPAs. The penalty amount
has been increased from Rs 5 lakh to Rs 1 crore.
• The new amendment has brought high purchase and financial lease under the coverage of the
SARFAESI Act.

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• If we talk about Debt Recovery Tribunals (DRTs), the amendment focuses to speed up the DRT
procedures.
• Online procedures including electronic filing of recovery applications, documents and written
statements can be initiated.
• DRTs will be the backbone of the bankruptcy code and deal with all insolvency proceedings involving
individuals. The defaulter must deposit 50 per cent of the debt due before filing an appeal at a DRT.
Insolvency
Insolvency is the state of being unable to pay the money owed, by a person or company, on time;
those in a state of insolvency are said to be insolvent.
There are two forms: cash-flow insolvency and balance-sheet insolvency.
Cash-flow insolvency is when a person or company has enough assets to pay what is owed, but
does not have the appropriate form of payment.
Balance-sheet insolvency is when a person or company does not have enough assets to pay all of
their debts. The person or company might enter bankruptcy, but not necessarily. Once a loss is
accepted by all parties, negotiation is often able to resolve the situation without bankruptcy.
• A company that is balance-sheet insolvent may still have enough cash to pay its next bill on time.
However, most laws will not let the company pay that bill unless it will directly help all their creditors.
For example, an insolvent farmer may be allowed to hire people to help harvest the crop, because not
harvesting and selling the crop would be even worse for his creditors.
• It has been suggested that the speaker or writer should either say technical insolvency or actual
insolvency in order to always be clear - where technical insolvency is a synonym for balance sheet
insolvency, which means that its liabilities are greater than its assets, and actual insolvency is a
synonym for the first definition of insolvency.
Insolvency and Bankruptcy Code, 2016
The process of insolvency resolution in India has evolved through the simultaneous operation of
several statutory instruments. Bankruptcy is the legal status of an entity or a person where the debt
owed to the creditors cannot be repaid. A court order imposes bankruptcy in most of the jurisdictions
which is mostly initiated by the debtor. It is important to note that bankruptcy is not synonymous
with insolvency. The Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India
which seeks to consolidate the existing framework by creating a single law for insolvency and
bankruptcy.
What is Insolvency and Bankruptcy Code?
Insolvency and Bankruptcy Code, 2016 is one of the biggest insolvency reforms in the economic
history of India which was enacted for reorganisation and insolvency of corporate persons,
partnership firms and individuals in a time bound manner for maximization of the value of assets of
such persons. It provides for a time-bound process to resolve insolvency.
The Code has provisions to form a common forum for debtors and creditors of all classes to resolve
insolvency.
Origin of IBC
Prior to, various scattered laws related to insolvency and bankruptcy which caused inadequate and
ineffective results with undue delays were there. Some of them are below:
• Sick Industrial Companies Act, 1985
• Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act
SARFAESI –for security enforcement.
• The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI) for debt recovery
by banks and financial institutions.
• Companies Act for liquidation and winding up of the company.
Ineffective implementation, conflict in one of these laws and the time-consuming procedure in the
laws, made the Bankruptcy Law Reform Committee draft and introduce the Insolvency and
Bankruptcy Law bill.
IBC Facilitators
There are various facilitators that will handle this process. They are as follows:

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Insolvency Professionals: Licensed professionals of a specialised cadre is proposed to be created

who will administer the resolution process, manage the assets of the debtor, and provide information
for creditors to assist them in decision making.
Insolvency Professional Agencies: The licensed insolvency professionals will be registered with
insolvency professional agencies which will conduct examinations to certify the insolvency
professionals and enforce a code of conduct for their performance.
Information Utilities: Creditors will report financial information of the debt owed to them by the
debtor. Such information will include records of debt, liabilities and defaults.
Adjudicating authorities: The resolution process proceedings will be settled by the National
Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for
individuals. This will also include approval to initiate the resolution process, appoint the insolvency
professional, and approve the final decision of creditors.
Insolvency and Bankruptcy Board: IBC Board will regulate insolvency professionals, insolvency
professional agencies and information utilities. It will consist of representatives of Reserve Bank of
India, and the Ministries of Finance, Corporate Affairs and Law.
IBC Amendment Bill, 2019:
The Bill amends the Insolvency and Bankruptcy Code, 2016.
This Code provides a time-bound process for resolving insolvency in companies and among
individuals. Insolvency is a situation where individuals or companies are unable to repay their
outstanding debt.
Under the new Code, a financial creditor may file an application before NCLT for initiating the
insolvency resolution process within 14 days. Thereafter, a Committee of Creditors (CoC) consisting of
financial creditors will be constituted for taking decisions regarding insolvency resolution which will
either decide to restructure the debtor’s debt by preparing a resolution plan or liquidate the debtor’s
assets.
The CoC will appoint a resolution professional with a resolution plan that must be completed within
180 days. This may be extended by a period of up to 90 days if the extension is approved by NCLT.
If the resolution plan is rejected by the CoC, the debtor will go into liquidation.
The Bill addresses three issues. It strengthens provisions related to time-limits. Second, it specifies
the minimum pay-outs to operational creditors in any resolution plan. Third, it specifies the way the
representative of a group of financial creditors (such as home-buyers) should vote.
Representative of financial creditors: The Code specifies that, in certain cases, such as when the
debt is owed to a class of creditors beyond a specified number, the financial creditors will be
represented on the committee of creditors by an authorised representative. These representatives will
vote on behalf of the financial creditors as per instructions received from them. The Bill states that
such representative will vote based on the decision taken by a majority of the voting share of the
creditors that they represent.