The Securitization and Reconstruction of Financial Assets and Enforcement of Securities Act, 2002 [SARFAESI] Act, 2002 was enacted to regulate securitization and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto.

Invocation of provisions of SARFAESI

The right of the banks/financial institutions to resort to the provisions of the SARFAESI arises only in the event where any borrower, who is under liability to a secured creditor under a security agreement, makes any default in payment of a secured debt or any installment thereof and his account in respect of such debt is classified by the secured creditor as non-performing asset. Therefore, classification of account as an NPA is a sine qua non and, the following eventualities can be culled out for recovery under the provisions of SARFAESI, that is,

  1. there must be a debt by a borrower from a secured creditor under a security agreement;
  2. there must be a default in repayment of secured debt or any installment thereof by the borrower;
  3. the borrower's account in respect of such debt is classified by the secured creditor as 'nonperforming asset';
  4. a notice in writing should be issued by the secured creditor to the borrower to discharge in full his liabilities within sixty days from the date of the notice;
  5. in terms of sub-section (3) of Section 13, the notice shall also give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor.

However a bank can not classify the account as an NPA arbitrarily and is bound by the guidelines issued by the Reserve Bank of India from time to time. Recently RBI issued a circular in this respect, which has been discussed in the following parts.

PRUDENTIAL NORMS ON INCOME RECOGNITION, ASSET CLASSIFICATION AND PROVISIONING PERTAINING TO ADVANCES TABLE OF CONTENTS DBOD. No. BP.BC. 1/21.04.048/2013-14 July 1, 2013:

In the master circular issued by RBI, Reserve Bank of India has classified Non performing Assets as 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;

  1. interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,
  2. the account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of an Overdraft/ Cash Credit (OD/CC),
  3. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
  4. the installment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
  5. the installment of principal or interest thereon remains overdue for one crop season for long duration crops
  6. the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitization transaction undertaken in terms of guidelines on securitization dated February 1, 2006.
  7. 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.

Para 4.2.4 of the master circular reads as

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

  1. 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.
  2. 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

Further 4.2.5 records that;

If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as nonperforming and may be classified as ‘standard’ accounts. With regard to upgradation of a restructured/ rescheduled account which is classified as NPA contents of paragraphs 12.2 and 15.2 in the Part B of this circular will be applicable.

Further it is obligatory on the part of the secured creditor to communicate the reasons for non acceptance of the representation/objections submitted by the borrower.

Conclusion

It is mandatory by the Banks to follow the RBI guidelines on asset classification before any account can be classified as an NPA and any irregularity in this regard can be fatal and can nullify the proceedings initiated under the SARFAESI Act. Further RBI keeps updating or modifying the guidelines governing asset classification.