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SARFAESI Act, 2002:

Fatcs and Method of

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For JAIIB Exam

Siva Rama Prasad Sir

Notes EX-GM, SBI PO
36+ Years of Experience

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SARFAESI Act, 2002 Free e-book

SARFAESI Act, 2002

SARFAESI Act, 2002 is the acronym for Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002. This is one of
the most essential topics included in government exams such as IAS Prelims and
GS-III, as well as banking exams like JAIIB. Candidates preparing for any of
these exams must have in-depth knowledge of the topic, as questions on the
topic appear in both exams. To aid our readers in their preparation, we have
included the most pertinent information regarding the SARFAESI Act, 2002,
including its definition, significance, method of operation, and numerous other
facts. Continue reading to find out about the SARFAESI Act, 2002.

SARFAESI Act, 2002: Overview

The SARFAESI Act, 2002 is an Indian law that permits banks and other
financial institutions to efficiently recover outstanding debts. It empowers banks
and other financial institutions to auction off residential or commercial properties
in an effort to recoup loan balances. This act established the first asset
reconstruction corporation in India (ARCIL). Continue reading to learn more
about the SARFAESI Act, 2002.

SARFAESI Act, 2002: Facts

• The SARFAESI Act of 2002 allows the secured creditors to address the
issue of non-performing assets (NPAs) in a variety of ways. This, however,
only applies to secured loans.
• For unsecured loans, the bank may file a civil case for loan default in
court.
• Banks or financial institutions can enforce their security interests in the
way that is the most beneficial for them like seizing collateral (except
agricultural land), mortgaging, etc.
• In the case of secured loans, this act eliminates the need for court action.
• The Act permits banks and financial institutions to sell nonperforming
assets to asset reconstruction companies (ARCs) regulated by the Reserve
Bank of India.

In a nutshell, The SARFAESI Act aimed to address the issue of bad assets or
NPAs (Non-Performing Assets) through various processes and techniques. It only
applies to secured loans in which the bank can recover the underlying assets,
such as hypothecation, guarantee, and mortgages. Court involvement is not
required in these situations, with the exception of cases where the security is
faulty or fraudulent. But, if the security is an unsecured asset, the bank needs to
file a legal case in court against the defaulters.

SARFAESI Act, 2002: Objectives

The SARFAESI Act specifies the formation and activities of Asset Securitization
Companies (ASCs) and Asset Reconstruction Companies (ARCs).
The Act stipulates their activities, capitalization, and funding, among other
aspects. These companies are governed by the Reserve Bank of India. Several
SARFAESI Act, 2002 Free e-book

sections of the Act provide institutions with directives and authority to tackle the
problem of problematic assets. The following are the primary objectives of the

SARFAESI Act, 2002

• The Act establishes the legal foundation for securitization in India.

• It outlines the processes for transferring NPAs to ARCs (Asset
Reconstruction Companies) for the purpose of asset reconstruction.
• The Act enables the banks and financial institutes to enforce their security
interest without the intervention of the court.
• It grants them the authority to seize immovable property that has been
hypothecated or billed in order to recover the debt.

SARFAESI Act, 2002: Method of Working

The primary characteristic of SARFAESI is that it encourages the formation of

asset reconstruction companies (ARCs) and asset securitization companies
(ASCs) to manage NPAs collected by financial institutions and banks. The Act
provides three major powers to financial institutions and banks for the asset
management and recovering non-performing assets:
• Securitization of assets
• Reconstruction of assets
• Enforcement of security interests (meaning asset security interests)
without the court's intervention
To better understand the SARFAESI Act, let's first understand the meaning of
these terminologies.
SARFAESI Act, 2002 Free e-book

Securitization

Securitization is the process of converting existing illiquid assets (loans) into

marketable securities in the setting of poor asset management.
The securitization company assumes custody of the loan applicant's underlying
mortgaged assets. It can initiate the subsequent actions:
• Purchasing financial assets from the loan provider (bank), and
• The solicitation of funds from authorized institutional buyers through the
issuance of security receipts for acquiring the financial assets, or
• Fundraising in any authorized manner, and
• The acquisition of a financial asset may be paired with the repossession of
mortgaged property, structures, etc.

Asset Reconstruction

Reconstructing an asset is the process of transforming a bad asset or NPA into a

performing asset. The process includes a number of steps, such as the purchase
of a bad asset by an asset reconstruction company (ARC), the financing of the
process of bad asset conversion into a good asset utilizing debentures, bonds,
cash, or securities, and the fulfilment of returns from the hypothecated assets,
etc.

Since reconstruction must be carried out in compliance with RBI standards, the
SARFAESI Act, 2002 specifies the elements for the asset reconstruction, which
are as follows:
• taking over or altering the management of the borrower's business
• the sale or lease of all or a portion of the borrower's enterprise
• the postponement of the borrower's loan payments
• enforcement of a security interest according to the terms of the Act
• payment of debts owed by the borrower
• taking possession of assets according to the norms of the Act

Enforcement of Security Interests

If the borrower defaults, the Act authorizes the lender to notify the defaulting
borrower as well as the guarantor to repay the loan within sixty days of the
notice's date. If the borrower doesn't repay or reply to the notice, the bank or
financial institution may invoke the Act to protect its security interests and take
the following actions:
• Take control of the security
• Lease, sale, or assignment of the security's right
• Manage or appoint a Manager as the security administrator
• Request payment from the borrower's debtors for any amount owed to the
borrower
• In the case of many secured creditors, the lender may enforce SARFEASI
Act clauses only if 75% of creditors agree
SARFAESI Act, 2002 Free e-book

Under this act, the RBI is responsible for the registration and control of
securitization or restructuring companies. These companies are permitted to
raise capital by issuing security receipts to QIBs (Qualified Institutional Buyers).
The Act also allows banks and financial institutions to seize securities issued for
financial assistance and lease or sell the securities to take up management in
case of any default.

In addition, the act offers an exemption from security receipt registration.

This means that when a securitization company or a reconstruction company
provides receipts, the receipts' holders are eligible for indivisible interests in the
underlying financial assets. Also, registration is not needed unless required by
the Registration Act of 1908. However, the security receipt must be registered
under the following circumstances:
• There is a receipt transfer.
• The security receipt indicates, declares, assigns, limits, and negates any
right title or claim in any immovable property.

Amendment to the SARFAESI Act, 2002 in 2016

The government modified the SARFAESI Act in August 2016 to enable Asset
Reconstruction Companies (ARCs) to revive Debt Recovery Tribunals (DRTs),
and to improve the efficacy of asset reconstruction as per the new bankruptcy
law.
• The amendment expanded the RBI's regulatory authority over the
operation of ARCs. It also facilitated the reconstruction of assets and the
operation of DRTs within the context of the recently passed bankruptcy
law.
• RBI will obtain additional auditing and inspection authority over ARCs, as
well as the authority to dismiss any director or the chairman.
• It can designate officials of the central bank to the ARCs boards if needed.
• According to the modification, the registration that includes the
centralized database of all loans secured against properties by the lenders
was expanded to incorporate additional details.
• RBI will have the authority to impose fines on ARCs that do not comply
with central bank directives. Likewise, it can control the fees that ARCs
charge banks when dealing with nonperforming loans. The fine has been
enhanced from Rs 500,000 to Rs 1,000,000.
• Concerning DRTs, the amendment seeks to expedite DRT proceedings.
• The initiation of online processes, including the electronic filing of recovery
petitions, documents, and written statements are also added in the Act.
• The modification included hire purchase and financial leasing within the
scope of the SARFAESI Act.

These Act amendments are significant because they will give DRTs a key role
under the new bankruptcy law. DRTs will act as the bankruptcy law's backbone,
handling all individual insolvency proceedings. Before filing an appeal with a
DRT, a debtor must deposit 50% of the amount owed.
SARFAESI Act, 2002 Free e-book

SARFAESI Act, 2002: Borrowers' Rights

The SARFAESI Act provides appropriate methods for secured lenders to retrieve
their long-standing debts from nonperforming assets, but the law also gives
borrowers certain rights that cannot be overlooked.
• The borrowers may pay up the debt and avoid losing the collateral at any
time prior to the conclusion of the sale.
• If the Authorized Officer engages in any harmful or unlawful behaviour, he
will face legal consequences, and the borrowers will be compensated for
their actions.
• Borrowers can first appeal to the DRT and then to the DRAT for the
resolution of any complaints. The deadlines for filing an appeal are 45 and
30 days, respectively.

SARFAESI Act, 2002: Prerequisites

The Act establishes four pre-requisites for a creditor to enforce their rights.
• The debt is guaranteed
• The banks have classified the debt as non-performing.
• The outstanding balance exceeds one million rupees and exceeds twenty
per cent of the loan's principal and interest.
• The agricultural land is not as the security.

The SARFAESI Act applies to any movable or immovable asset pledged as

collateral via hypothecation, mortgage, or the formation of a security interest.
While Personal belongings are an exception to the act. If the property pledged as
security is the borrower's own mortgaged primary residence, it may be pursued
under the terms of the SARFAESI Act.
SARFAESI Act, 2002 Free e-book

Definitions
Now let us learn some definitions related to the SARFAESI Act, 2002:

Appellate Tribunal – It is a body, where a person dissatisfied with the decision

of the Debt Recovery Tribunal (DRT) may submit an appeal

Asset Reconstruction – An asset reconstruction refers to acquiring the rights

or interests of any bank or financial institution by an Asset Reconstruction
Company (ARC) in exchange for financial assistance. The purpose is to obtain
such financial help.

Bank – A bank is a licensed financial institution that accepts deposits and offers
further financial services. Bank refers to every financial institution, including
RRBs, nationalized banks, and cooperative banks.

Borrower – Any person individual who has been awarded financial aid upon
providing some guarantee is called a borrower.

Central Registry – According to the ARFAESI Act, all asset securitization,

reconstruction, and security interest generation operations must be recorded
with the Central Registry.

Debt Recovery Tribunal (DRT) – Debt Recovery Tribunals are the bodies
established to streamline the debt collection process involving banks and other
financial institutions. These were established after the Recovery of Debts Owed
to Banks and Financial Institutions Act of 1993 (RDBBFI) was passed.

Default: Default is the inability to fulfil the legal obligations of a loan, such as
when a homebuyer doesn't pay mortgage repayment or when a corporate or
government fails to pay a maturing bond.

Financial Assistance: When a bank or other financial institution issues a loan

or credit, subscribes to debentures or bonds, provides a guarantee, releases
credit letters, or offers other credit facilities, this is referred to as financial
assistance.

Non-Performing Asset: It is a loan that has defaulted or is near to defaulting.

Several loans turn non-performing after 90 days of default, but this might vary
depending on the conditions of the contract.

Secured Assets: The property on which a security interest is established is the

Secured Asset. The SARFAESI Act authorizes the enforcement of securities
against secured assets only.

Conclusion
The SARFAESI Act, 2002 has been extensively covered in this article to help
our readers prepare for their exams. We encourage them to study diligently,
thoroughly covering all of the exam's topics to score well in the competitive
exams.
SARFAESI Act, 2002 Free e-book

JAIIB GLOSSORY

Capital Funds Equity contribution of owners. The basic approach of capital adequacy
framework is that a bank should have sufficient capital to provide a
stable resource to absorb any losses arising from the risks in its
business. Capital is divided into different tiers according to the
characteristics / qualities of each qualifying instrument.

Revaluation Revaluation reserves are a part of Tier-II capital. These reserves arise
reserves from revaluation of assets that are undervalued on the bank's books,
typically bank premises and marketable securities. The extent to which
the revaluation reserves can be relied upon as a cushion for
unexpected losses depends mainly upon the level of certainty that can
be placed on estimates of the market values of the relevant assets and
the subsequent deterioration in values under difficult market conditions
or in a forced sale.

Leverage Ratio of assets to capital.

Capital reserves That portion of a company's profits not paid out as dividends to
shareholders. They are also known as undistributable reserves and are
ploughed back into the business.

BASEL Committee The BASEL Committee is a committee of bank supervisors consisting of

on Banking members from each of the G10 countries. The Committee is a forum for
Supervision discussion on the handling of specific supervisory problems. It
coordinates the sharing of supervisory responsibilities among national
authorities in respect of banks' foreign establishments with the aim of
ensuring effective supervision of banks' activities worldwide.

Risk Weighted The notional amount of the asset is multiplied by the risk weight
Asset assigned to the asset to arrive at the risk weighted asset number. Risk
weight for different assets vary e.g., 0% on a Government Dated
Security and 20% on a AAA rated foreign bank etc.

CRAR (Capital to Capital to risk weighted assets ratio is arrived at by dividing the capital
Risk Weighted of the bank with aggregated risk weighted assets for credit risk, market
Assets Ratio) risk and operational risk. The higher the CRAR of a bank the better
capitalized it is.

Non-Performing An asset, including a leased asset, becomes nonperforming when it

Assets (NPA) ceases to generate income for the bank.

Total income Sum of interest/discount earned, commission, exchange, brokerage and

other operating income.

Net operating profit Operating profit before provision minus provision for loan losses,
depreciation in investments, write off and other provisions.

Average Yield (Interest expended on deposits and borrowings/Average interest

bearing liabilities)*100
SARFAESI Act, 2002 Free e-book

Return on Asset Return on Assets (ROA) is a profitability ratio which indicates the net
(ROA)- After Tax profit (net income) generated on total assets. It is computed by dividing
net income by average total assets. Formula- (Profit after tax/Av. Total
assets) *100

Net Interest Income The NII is the difference between the interest income and the interest
( NII) expenses.

CASA Deposit Deposit in bank in current and Savings account.

Liquid Assets Liquid assets consists of: cash, balances with RBI, balances in current
accounts with banks, money at call and short notice, inter-bank
placements due within 30 days and securities under "held for trading"
and "available for sale" categories excluding securities that do not have
ready market.

Venture Capital A fund set up for the purpose of investing in startup businesses that is
Fund perceived to have excellent growth prospects but does not have access
to capital markets.

Held Till The securities acquired by the banks with the intention to hold them up
Maturity(HTM) to maturity.

Yield to maturity The Yield to maturity (YTM) is the yield promised to the bondholder on
(YTM) or Yield the assumption that the bond will be held to maturity and coupon
payments will be reinvested at the YTM. It is a measure of the return of
the bond.

CRR Cash reserve ratio is the cash parked by the banks in their specified
current account maintained with RBI.

SLR Statutory liquidity ratio is in the form of cash (book value), gold (current
market value) and balances in unencumbered approved securities.
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Siva Rama Prasad Sir Shubhi Ma’am Arvind Shukla Sir

EX-GM, SBI PO Insurance and Teaching Banking
36+ Years of Banking Expert & Finance from
Experience 3+ years experience 10 Years

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