The government has listed the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill, 2011, for consideration and passing during the current session of Parliament. This Bill amends two Acts: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Sarfaesi Act), and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act). This Bill was not referred to the Parliamentary Standing Committee for examination.

The Bill aims to achieve a few objectives. It permits asset reconstruction companies and securitisation companies to convert loans of borrower companies into equity shares. It permits banks to purchase immovable assets of borrower companies in lieu of their loan obligations. It includes multi-state cooperative banks within the definition of banks. Currently, banks and financial institutions need to respond to representation from borrowers within seven days; the Bill increases this to 15 days. It enables banks or any person to file a caveat, so that they are heard by the Debt Recovery Tribunal before granting a stay. It enables the central government to require by notification, the registration of all transactions of securitisation or asset reconstruction or security interest, which are subsisting before the creation of the Central Registry. The Bill provides the central government with the power to direct, in public interest, that the provision of the Sarfaesi Act may not apply or may apply with modifications to a class or classes of banks or financial institutions.

The first two proposals listed above may need careful scrutiny by Parliament when it considers the Bill.

The first one is an addition to the power of securitisation and reconstruction companies. Asset reconstruction works in the following manner. Suppose a company has taken a loan from a bank, say for R100, and the company is likely to default (or has defaulted) on its loan related payments. Asset reconstruction company (ARC) will buy the loan from the bank, at a discount (say, R60). It expects to recover the money from the company through liquidating the security against the loan. It would expect to recover an amount greater than the price it paid for the loan. The Sarfaesi Act provides the ARC with certain powers. It may enforce a change in the management of the company, require the company to sell or lease its business, reschedule debt related payments, take possession of the secured assets etc.

This process ensures greater liquidity with banks. Their funds will not be tied up in non-performing loans but can be sold (at a loss) to an ARC, which builds expertise in recovering such assets.

The amendment Bill adds a new power to the ARC. It enables the ARC to convert any part of the debt of the company into equity. Such conversion would imply that the ARC would now be an equity holder, and not a creditor of the company. The ARC will not get the first charge on the assets (as a secured debt holder) but the last charge (as the equity holder). Its incentive to liquidate any assets to recover the loan (to the extent possible) will be lower if it becomes an equity holder. Therefore, this proposal needs careful deliberation.

The second proposal is with respect to the sale of any immovable asset of the borrower. If the sale of such asset is postponed due to lack of a bid at the reserve price, the secured creditor (including banks) may bid for the asset at a subsequent sale, and adjust the amount paid against the amount due to it. This enables the bank to secure the asset in part fulfilment of the defaulted loan. The bank will have to conform to the Banking Regulation Act, 1949, which requires it to transfer the asset within seven years. However, the bank would recover the amount paid for this asset only if it succeeds in selling it above the price paid. Given that no other party was willing to pay a higher price during the sale, it would recover this amount only if the price for the property rises over time. The risk with this provision is that banks may pay a higher price to show a higher recovery rate, and understate their non-performing assets.