The judgment was pronounced by a five-judge bench of the Apex Court, comprising of Justice Arun Mishra, Indira Banarjee, Vineet Saran, MR Shah, and Aniruddha Bose.
The bench held that the Co-operative banks are covered under the definition of Banks under Section 2(1)(c) of the SARFESI Act and are entitled to follow the same loan recovery process like the other lenders. The bench further ruled that co-operative banks are bound to follow the rules and regulations laid down in the Banking Regulation Act of 1949 and all the other legislations which apply to other banks. So as we can see, the judgement granted the co-operative banks with the same status of the other banks in the country.
When the country still holds the memory of the recent Punjab and Maharashtra Co-operative Bank Ltd. A crisis which left many customers in murky water, this judgment is a sigh of relief as this will allow the co-operative banks to handle loan defaulters more appropriately.
What is the SARFESI Act?
Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, or the SARFESI Act is an Act enacted by the Parliament of India which allows the banks or the financial institutions in India to sell or auction of commercial or residential properties to recover an unpaid loan. This Act was enacted to tackle the ever-increasing problem of Non-performing assets (NPA) in various banks due to the inability of the banks to recover vast amounts of the unpaid loan. Through various provisions of this Act, the banks or financial institutions can auction properties of those loan defaulters to recover their money in a lawful and regulated manner.
Role of SARFESI Act regarding Non-performing assets of lenders
The Banking sector in India is plagued with the problem of NPAs as in recent years, we have seen industrialists like Vijay Mallya, Subrata Roy of Sahara Group, and Nirav Modi defaulting on massive loan amounts they took from the lenders.
The quality of assets in any bank reflects the risk associated with loans and credit portfolios. If the asset quality is critically deficient, that leads to a host of problems, including revenue generation, credit ratings, and operations of the Bank. Critically deficient asset quality over an extensive period finally leads towards the accumulation of a high quantity of Non-performing assets or NPA.
The loan forwarded to various industrialists or customers is an invaluable asset of any Bank or Financial institution. However, surprisingly, a large number of Bank does not do a background check or risk analysis on whether the customer can pay the money back while sanctioning loans. This, in return, jeopardizes the entire debt collection process and credit administration of the Bank if the customer fails to pay.
To tackle these problems more effectively, the Parliament enacted the SARFESI Act in 2002 to deal with the problems of loan defaulters and NPA more effectively. Now let us take a brief look at some essential provisions of the SARFESI Act-
Section 2(1)(o) of the SARFESI Act defines NPA as “A Loan which has been classified by a bank or a financial institution as a sub-standard, doubtful or lost asset.” And as per an RBI Circular of 2014, a loan can be classified as doubtful if the debtor hasn’t paid any interest within 90 days of the original due date.
Earlier, the only way to recover debts was to go through a long drawn litigation process in the Court of law. It was highly unfair for any creditors as the litigation process was very tedious and ended up costing a lot of money for the lenders. Nevertheless, the SARFESI Act allows the lenders to send a notice to the defaulters to pay his dues, and if the defaulter does not pay within 60 days of such notice, the Bank gets the full liberty to acquire possession and control of the borrowers business and sell them off to recover their money (As per the Section 13 of SARFESI Act). This mechanism is much quicker and sophisticated than the previously existing litigation process.
However, one thing the banks and other financial institutions should keep in mind. While giving a loan, they do not do any thorough profile check of the debtor and loses control once the loan is discharged. By taking benefit of that, the debtors can divert those loans to some completely unrelated things other than his business or his personal gain. So the failure of the lender to keep track of the loan results in the debtor misappropriating the money, then ultimately being drowned in losses and not being able to pay the loan amount. So it will help if the lender adopts some sort of control mechanism to monitor the loan the grant (this can be done by inserting provisions in the SARFESI Act by amending it).
The operation cost of Banks and other financial institutions has increased a lot, so if their money or assets are blocked in NPAs or bad loans, their daily operation will be jeopardized. However, one way the banks can overcome this is by converting their financial assets in marketable securities and then selling them to other third-party investors in forms of Collateralized debt obligations (CDO). This process is called securitization, and the SARFESI Act provides for this in Section 5 of the Act. This effectively allows to Bank to create more capital if they are in need or distress.
So as you can see, the SARFESI Act is one of the most significant ammunition of a bank or a financial institution to deal with the problem of bad loans effectively. Recently the PMC Co-operative bank failed because it failed to recover bad loans from the customer, which is one of the biggest problems that any Co-operative banks face across India.
As they consist of a large portion of the credit market, they needed to have access to recover loans like any other bank or financial institution. The recent Supreme Court judgment of bringing the other banks under SARFESI can be a game-changer for all the co-operative banks across the country who have been tormented for a long time because of the high NPAs or corrupt credit administration.
More significantly, it will help to eliminate the possibility of another PMC bank crisis. No doubt that this inclusion will significantly reduce the chance of any Co-operative bank closing down because of bad loans and high NPAs. In case of any loan default, the Co-operative banks will be able to move quickly and recover their money by auctioning or selling the assets of the defaulter.
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