SARFAESI Act, 2002 and the Indian Banking Industry.

Last couple of weeks has been good reading time going through the SARFAESI Act of 2002.

SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act was formed for the banking sector (including financial institutions) to allow them to seize underlying security such as hypothecated, mortgaged and pledged collaterals, without the court's intervention in secured loans category. This is really refreshing as now banks can focus on what they were meant to do rather than focusing on building distressed asset teams or in other cases were outsourcing it to specialized firms. A great relief for the PSU banks as they never would have amassed the toughness for the part.

Just to look at the numbers the stressed assets at banks (NPAs + restructured loans) had increased from Rs. 0.7 trillion in 2003 to Rs. 5.3 trillion in 2013. Banketing the asset sale to ARCs was not helping the cause. The AMCs (Asset Reconstruction Companies) were not helping much than just being a way of government recapitalization to reflect on the bank's balance sheets (I hope we were not thinking to fulfill the Basel III norms through it, pun intended)

The ARCs were crippled by too many unnecessary and myopic regulations, hail the RBI and the financial lawmakers :P . Oh just for the record, Indians are known to spoil the broth by bringing in too many cooks… All  the time  without exception, especially with Government machinery works. The banks should have never delved into peeking what the ARCs do with the sold distressed assets. The system should have let the ARCs function independently and not mire it with short-sighted RBI over regulations.

The manner in which the sales of the distressed NPA's to the banks were executed was opening up the wounds formed from the banks frailty, majorly Public Sector ones.

Predominantly, the banking system has norms driven more so attributed to regulatory compliances rather than risk assessment, simple example being even though an asset getting redundant and after being overdue on for 3 months period is declared as non-performing, the law lets the bank provision the loss amount across for 4 annual balance sheets just delaying the booking it in the balance sheets.

However, in reality when we effect a sale of the assets then we book the loss upfront for the year. This has lead the banks to play smart and hold on to the assets on their balance sheet till the book value is optimal to sell the asset. The ARCs do not get the asset till they have nothing left to salvage anything as value. The ARCs were doomed and this actually send the ARC industry to cripple away.

Ideally, the banking system should look at bad assets sale exercise in a more commercial viable approach and not just for salvaging lost pride for meagre cash, which at times don’t care of the transaction cost of the deal. We need to act upon some issues such as bringing in rigor (forgive my American spell errors) for the provisioning rules for the NPA.

We should be immediately condemn the shortsighted nature RBI/ of the 2 year time frame given to the CEO's of the PSU's. Every CEO just focusses on trying to not be in any bad news (Sale of NPAs) and play the musical chair game with his/her successors. Their major is just to avoid any dent in the balance sheet due to sale of NPAs.

The other reason for the dismal performance is the debt recovery tribunals (DRTs) and the process errors in the bankruptcy process. The outstanding amount for the DRTs has been hovering around the 15% recovery in the last two years. The SARFAESI Act didn't help the cause and push the number merely by another 5-6%. Restructuring these ARCs is still a laborious and time taking one, which calls for bringing in professional skills and long term financing, both of which ARCs may not currently possess. Given the time and cost involved in this type of restructuring, only NPAs with very high recovery potential will be selected for this type of resolution.

Oh the rabbit hole keeps on getting deeper …..

RBI please bring some political will to reign in some sense about the Acts or recruit better people to effect loopless change.