SARFAESI Act - Asset classification and definition of NPA

A host of petitions have been filed in the Supreme Court challenging the constitutional validity of SARFAESI ACT under Section 2(1) (o) of the said Act which is posted for argument soon after the contradicting judgments in the Madras High Court and Gujarat High Court.

Section 2 (1) (o) of The SARFAESI ACT states, ““Non Performing Asset” means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss assets,-

a. In case such bank or financial institution is administered or regulated by an authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body;

b. In any other case, in accordance with the directions or guidelines relating to assets classifications issued by Reserve Bank”;

As far as the banks and financial institutions are concerned, Reserve Bank of India being the controlling and supervisory authority, their norms and guidelines are the basis for the classification of an account as NPA. Considering this very important aspect, the definition as given under SARFAESI ACT under section 2(1) (o) differs from what the updated RBI circular DBOD.No.BP.BC.9/21.04.048/2014-15 July 1, 2014 addressed to All Commercial Banks (excluding RRBs) Master Circular on Prudential norms on Income Recognition, Asset Classification and provisioning pertaining to Advances states. As per the definition given in the said circular of RBI, non performing assets mean, “2. DEFINITIONS

2.1 Nonperforming Assets

2.1.1 An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.

2.1.2 A non performing asset (NPA) is a loan or an advance where;

i. interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan,

ii. the account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of an Overdraft/Cash Credit (OD/CC),

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

iv. the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,

v. the instalment of principal or interest thereon remains overdue for one crop season for long duration crops,

vi. the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.

vii. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.

2.1.3 In case of interest payments, banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.

2.1.4 In addition, an account may also be classified as NPA in terms of paragraph

4.2.4 of this Master Circular.”

Paragraph 4.2.4 states, “4.2.4 Accounts with temporary deficiencies

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 nonrenewal of the limits on the due date, etc. In the matter of classification of accounts with such deficiencies banks may follow the following guidelines:

i) 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. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months, would be deemed as irregular.

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.

ii) 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. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, 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.” It is thus obvious that there is a definite perceptional difference between the definitions of NPA as far the SARFAESI ACT and RBI directives are concerned.

A closer look would reveal the perception difference is in the matter of classification of Non Performing Asset and the definition of an account as Non Performing Asset as per RBI guidelines. As per RBI norms the assets are classified under the aforesaid circular of RBI dated 01.07.2014 as under which states, “

4. ASSET CLASSIFICATION

4.1 Categories of NPAs

Banks are required to classify nonperforming assets further into the following three categories based on the period for which the asset has remained nonperforming and the realisability of the dues:

i. Substandard Assets

ii. Doubtful Assets

iii. Loss Assets

4.1.1 Substandard Assets

With effect from March 31, 2005, a substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

4.1.2 Doubtful Assets

With effect from March 31, 2005, an asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, – on the basis of currently known facts, conditions and values – highly questionable and improbable.

4.1.3 Loss Assets

A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.”

The meaning of NPA as per SARFAESI ACT under Section 2(1) (O) which states, “An asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss assets” Here the emphasis is only classification of assets as per the guidelines issued by the controlling authority or RBI as the case may be. SARFAESI ACT does not mention anything about the asset which ceases to generate income for the bank. Besides, section 2(1) (O) of SARFAESI ACT does not define Substandard Assets, Doubtful Assets and Loss Assets. But RBI in their aforesaid circular defines the above referred categories of assets where in the period of assets under NPA category being less or equal to 12 months, equal to 12 months or “uncollectable and of such little value that continuance as a bankable asset is not warranted although there may be some salvage or recovery value.” as the case may be. The classification under SARFAESI ACT does not specify at what point of time the provisions of SARFAESI ACT can be invoked. But the banks and financial institution simply invoke SARFAESI ACT without considering the more important aspect of overdue positions of the loans as per the definition of RBI as contained in their aforesaid updated circular dated 01.07.2014 which has an overriding effect over the other circulars issued by RBI on the subject matter. The pertinent point is that considering the section 2(1) (o) of SARFAESI ACT under subsection (b), since RBI is the controlling authority of banks and financial institutions whose guidelines are mandatory for the banks and financial institutions to adhere to, the classification of secured assets as NPA shall be based on the definitions contained in the updated aforesaid circular dated 01.07.2014 where in the emphasis in on the overdue positions of the non performing assets and other factors as enumerated by RBI in the aforesaid circular.   

Last but not the least, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance, 2002 was promulgated on 21st June 2002 which gave enormous powers to banks and financial institutions “to realise long terms assets, manage problems of liquidity, assets liability mismatches and improve recovery by exercising powers to take possession of securities, sell them and reduce non-performing assets by adopting measures for recovery or reconstruction.”

The highlight of the ordinance is the fact that the banks and financial institutions can take possession of the securities and sell them without the intervention of the Court. Perhaps understanding the chances of abuse and misuse of this vast and unbridled power vested with the banks and financial institutions, Reserve Bank of India issued their circular DBS.CO.OSMOS/ B.C./ 4 /33.04.006/2002-2003 dated September 12, 2002 addressed to The Chairman/Managing Director /Chief Executive Officer of All Commercial Banks (Excluding RRBs) on Study on preventing slippage of NPA accounts wherein they have recommended certain steps to be taken to prevent slippage of accounts to NPA status and  “expected that banks will work out their strategic response in keeping with the broad thrust of these guidelines.”

Had the banks and financial institutions undertaken such an exercise as envisaged in the said circular and implemented them faithfully and diligently, the incidents of accounts becoming NPA could have been minimized to a great extent.

A minute scrutiny of the definitions of NPA as per RBI guidelines makes it very clear and without any ambiguity that the banks and financial institutions have to undertake a methodical and systematic study to overcome the many riders enshrined in the definitions (refer quotes from the circular marked in bold letters) before declaring the account as NPA. But the banks and the financial institutions neither undertake any such methodical and systematic study before declaring the account as NPA nor do they consider and rectify such mistakes when pointed out through the representation and objections submitted by the borrowers after the receipt of notice u/s 13(2) of SARFFAESI ACT. The most bizarre and unjustified acts of most of the presiding officers of DRT is the fact that they also overlook such fundamental violations of the provisions of RBI guidelines which are mandatory and allow the banks and financial institutions to infringe such mandatory guidelines with impunity thus cementing the general belief that they (P.Os of DRTs) are nothing but recovery agents of the banks and financial institutions. The common perception is that equity, justice and good conscience are the first casualty of the present prevailing ruthless system of NPA recovery  which does not distinguish between a willful defaulter and a honest borrower whose account was forced to become NPA due to circumstances beyond his or for that matter anybody’s control.

In view of what has been stated above, it is apparent and imperative that to uphold justice, equity and good conscience and also the principles of natural justice, the Hon’ble Supreme Court should consider such undeniable facts and take such steps to order a review of the provisions of SARFAESI ACT not only to deliver justice but also justice seem to have been delivered by all means to the borrowers with integrity and honesty who suffer due to circumstances beyond their control.

T.R.Radhakrishnan,

Banking & Management Consultant,

Facilitator: DRT & SARFAESI CASES and CONSUMER FORUM,

H.R.Trainer: Corporates, Colleges & Schools, & Freelance Writer,

 No. 8, Morya Gardens,                 

Kanadia Road,

Indoe.452016 (Madhya Pradesh)

E-mail: trrk1941@gmail.com