BANKING ASSIGNMENT

Topic: DEBT RECOVERY MECHANISM VIS-A- VIS

TABLE OF CONTENTS

1
 INTRODUCTION 3

LENDING MECHANISM: SOME UNWARRANTED

DRT AND SARFAESI: A REFUGE TO BANKS 5

CRITICAL ISSUES IN DEBT RECOVERY 8

CONCLUSION 9

BIBLIOGRAPHY 11

INTRODUCTION

For a well-developed financial system smooth flow of savings and investments is a pre-
requisite which supports economic growth. A healthy financial system helpsin achieving
efficient allocation of resources by reducing inefficiencies arising out of market inconsistencies

2
and other socio-economic factors.1Indian legal system has been friendly towards borrowers
which can be easily seen from the move of nationalising major banks with the motto of catering
the needs of priority sector. However, eventually it led to a situation where banks were left
with very little bargaining power in recovering their loans back or enforcing the assets that
actually securitized the loan.2

LENDING MECHANISM: SOME UNWARRANTED CONSEQUENCES

Formation of Non Performing Asset (NPA) is one of the most undesirable features of a well
functioning financial system. NAPs are a cause of concern for the financial institutions which
with time has attracted the attention of policy makers, as mounting NPAs affect the smooth
flow of credit which is essential for promoting economic development. The Banks raise
resources not just from fresh deposits but by also recycling the funds received from the
borrowers. Therefore, a non-performing loan affects recycling of credit and credit creation
thereof. At the same time NPAs affect profitability of banks as well, as higher NPAs require
higher provisioning requiring a large part of the profits to be kept aside as provision against
bad loans. In our country as mentioned earlier, due to the social banking motto, the problem of
non-performing or bad loans did not initially received priority from policy makers. However,
with the onset of reforms in the financial sector and the adoption of international banking
practices the whole issue of NPAs received its due focus.3

The Reserve Bank of India provides that a non performing asset is the one which ceases to
generate income for banks. In order to move towards international practices and to ensure more
transparency the 90 days' overdue norms have been made applicable for identification. With
effect from March 31, 2004, a NPA shall be a loan or an advance where:

1
Meenakshi Rajeev And H P Mahesh “ Banking Sector Reforms And NPA: A Study Of Indian Commercial
Banks” Working paper 252 ,The Institute for Social and Economic Change, Bangalore available at
http://www.isec.ac.in/WP%20252%20-%20Meenakshi%20Rajeev%20and%20H%20P%20Mahesh.pdf (visited
on 30th Oct 2015)
2
Rajesh Chakrabarti “ Banking In India – Reforms And Reorganization” available at
npan1.un.org/intradoc/groups/public/documents/.../unpan025796.pdf (visited on 30th Oct 2015)
3
Supra note 1.

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(i) In case of a Term Loan interest or instalmenthas not been paid for a period of more than 90
days.

(ii) In case of an overdraft / cash credit if the account remains 'Out of orderfor a period of more
than 90 days.

(iii) In the case of bills purchased and discounted where the bill remains overdue for a period
of more than 90 days,

(iv) In case of direct agricultural advances:

a) A loan granted for short duration crops will be treated as NPA, if the instalment of principal
or interest thereon remains overdue for two crop seasons.

b) A loan granted for long duration crops will be treated as NPA, if the instalment of principal
or interest thereon remains overdue for one crop season.

(v) Any amount to be received remains overdue for a period of more than 90 days in respect
of other accounts.4

Then there is a concept of Gross NPA and Net NPA also. Gross NPA is an advance which is
considered irrecoverable and for whom the bank has made provisions and which is still held in
banks' books of account. Net NPA is obtained by deducting items like interest due but not
recovered, part payment received and other income kept in suspense account from Gross NPA.

Many reasons have been attributed to NPAs like intentionally defaulting, frequent changes of
government policies, loan taken for business which is non performing (agriculture), negligent
pre-enquiry by the bank for sanctioning the loan to a customer. NPA leads to many adverse
effects on any financial institution. It causes draining of profits, harms the goodwill of bank,
negative growth of share value and restricts cash flow because of the provision of fund created
against it.5

4
Available atHttps://Rbi.Org.In/Scripts/Bs_Viewmascirculardetails.Aspx?Id=8996#21(visited on 30th Oct 2015)

5
Supra note 1.

4
DRT AND SARFAESI: A REFUGE TO BANKS

Since the usual measures for recovering debts and dues were time consuming and causing
grievous losses to banks, as in economic market time is money, the Government of India in
order to speed up the recovery process, constituted a committee under the chairmanship of late
ShriTiwari in 1981 to examine the various difficulties faced by banks and other financial
institutions and to suggest remedies for the same. The committee recommended setting up of
‘Special Tribunals’ to expeditiously decide the debt recovery cases. And later in the year 1991
Narasimham Committeealso endorsed this view, and suggested setting up of the Asset
Reconstruction Fund (ARF). It was also suggested that the Government of Indiashould
establish this fund by special legislation, if necessary, to take over the NPAs from banks and
financial institutions at a discounted rate and recover the dues. Therefore on recommendations
of the Tiwari and the Narasimham Committees, The Recovery of Debts Due to Banks and
Financial Institutions Act (RDDBFI) was passed in the year 1993 under which “Debt Recovery
Tribunals” (DRT) and “Debt Recovery Appellate Tribunals” (DRATs) were established in
various parts of the country for expeditiously adjudicating the debt recovery cases and
facilitating recovery of same to the banks and other financial institutions and to decide all the
other related and incidental matters.6However the legality of the Act was challenged in the
High Court of Delhi in case of Bar Association v. Union of India7 in which the RDDBFI Act
was held unconstitutional on the grounds that- the Act does not provide for set off, counter
claims or transfer of cases from one to another tribunal; the Tribunals have been placed at a
higher pedestal than High Courts in terms of monetary jurisdiction; and in the appointment of
Presiding Officers no role has been given to judiciary. Though in a Special Leave Petition
before the apex court, the Tribunals were allowed to resume their functions and
subsequentlythe Act was amended in the year 2000, bringing necessary changes in the
legislation.

As per the RDDBFI Act for the debts or claims of Rs. 10 lac or more the DRT has the exclusive
jurisdiction to try such cases and the cases involving dues/claim of less than the afore
mentioned amount can be tried by the civil courts. The Act expressly ousts the jurisdiction of

6
Supra note 1
7
AIR 1995 Del 323.

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any other court or authority to exercise the jurisdiction, powers and authority to accept and
decide the applications from banks and financial institutions for recovery of debts
due.8However section 18 entitles the Supreme Court and High Court to exercise writ
jurisdiction under article 226 & 227 of the Constitution of India against the action under the
Act. But at the same time it also a settled principal that when an alternate remedy is available
a writ petition cannot be entertained. It is only when all the other remedies are exhausted that
a writ petition should be filed. Therefore for an appeal against the order of DRT an appeal to
the DRAT is to be preferred than a writ petition. However it is only under exceptional cases
like- lack of jurisdiction, non observance of principles of natural justice or arbitral decision-
that the High Court can entertain petitions even if the alternate remedy is available.9

To initiate the process for debt recovery the bank or the financial institution has to make an
application with the prescribed documents, evidence and fees to the Tribunal having
jurisdiction to try the matter. The tribunal then shall summon the defendant to show cause that
why relief should not be granted on the application, within thirty days. The defendant then may
present his written statement in his defence in which he can claim for set-off or counter claim.
Then on the perusal of the claims the Tribunal can make an interim order and can also direct
the defendant to furnish a security which may be sufficient to satisfy the certificate for recovery
of debt. And where the defendant fails to furnish such security the Tribunal may order for
attachment of the property or any portion which is claimed by the applicant as the property
secured in his favour. And on breach or disobedience of the orders of Tribunal, the Tribunal
may order to detain such person in civil prison for a term of not more than three months.10

Later in the year 2002 the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act (SARFAESI Act) was passed to provide the banks and the
financial institutions the power of securitisation, reconstruction and enforcement by taking
possession of securities and selling them off for recovering their debts. The preamble to the
Act states it to be regulator of securitisation and reconstruction.

Securitisationof asset implies changing assets into securities and securities into liquidity. It
involves a lending institution which can be a bank or any other financial institution which is
referred to as originatorwhose loans will be converted into securities and a Special Purpose

8
The RDDBFI Act, s. 17
9
Tata Iron & Steel Co. Ltd v. Presiding Officer (2006) 3BC 494, DRT, (Jharkand)
10
Supra note 8 s.19

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Vehicle (SPV) or a trust, which liquefies the assets. The originator create a pool of assets which
are homogenous in nature and lifts it from its balance sheet and passes to SPV by way of
outright sale for consideration or for a collateralised loan, which in turn converts them into
marketable securities for the purpose of investment. The cash flow to the originator enables it
to create further assets. There are other parties also which are involved in this process such as
the merchant banker, credit rating agency, serving agency, original borrowers and buyers of
securities.11 The Act further provides for establishing reconstruction companies to take
possession of the assets and take over the management of the business of the borrower. The
validity of the Act was upheld in the case of Mardia Chemicals Ltd. V. Union of India12except
subsection 2 of section 17 which was held ultra vires as the provision required deposit of
seventy-five percent of the amount claimed before entertaining appeal by the DRT against an
action taken under section 13 (4). Subsequently an ordinance was made doing away with such
a requirement and enabling the borrower to approach the DRT without depositing any amount
whereas for preferring an appeal against the order of DRT an amount of fifty per cent of the
debt due from him or as determined by the DRT shall be deposited to the DRAT.

Section 13 provides for enforcement of security interest and states that in accordance with the
provisions of SARFAESI Act any security interest created in favour of any secured creditor
can be enforcedwithout the intervention of court or tribunal on any default in repayment of
secured debtor instalment by the borrower and the account has been declared as a NPA. A
60days’ notice can be served by the secured creditor asking the borrower to discharge his
liabilities, if the borrower raise objectionsthen that shall be considered by the creditor and in
case if those objections are not accepted then that has to be communicated to the borrower
within prescribed time. And if borrower does not pay the dues then the secured creditor can
take possession of the asset; take over the management of the business of the borrower; appoint
any person to manage the secured asset; can require any person who has acquired assets from
the borrower to pay the secured creditor.13However an appeal can be filed before a DRT having
jurisdiction against such a notice and a subsequent appeal to DRAT against the order of the
DRT by virtue of section 17 and 18 respectively.

11
M L Tannan, Tannan’s Banking Law & Practice in India 2016 (Lexis NexisButterworthsWadhwa Nagpur,
Haryana, 23rdedn., 2010).
12
(2004) 4 SCC 311.
13
The SARFAESI Act s.13.

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CRITICAL ISSUES IN DEBT RECOVERY

The significance of recovery of dues to banks and other financial institutions is very much
apparent and has been duly acknowledged by the policy makers and the judiciary time and
again, as these are considered as backbone of an economy and particularly of a developing
country like India. But at the same it also ought to be considered that whether in this entire
mechanism of recovery of dues keeping in mind the special legislations (RDDBFI &
SARFAESI Act) which on one hand establishes special tribunals exclusively dealing such
matters ousting regular civil courts from entertaining such cases and aimed at providing speedy
recovery and on the other increasing the powers of banks and financial institutions to the extent
of securitising, reconstruction and enforcement of secured assets without the intervention of
judiciary, the right of consumer of protection against wrong doing is protected or not?

It is an established practice of law that special legislations prevail over general law and amongst
two special legislations the one which is latter in time prevails, which leads to the fact that the
RDDBFI and SARFAESI Act are to be observed in case of any conflict pertaining to debt
recovery even over other special legislations like Consumer Protection Act. The consumer
Dispute Redressal Forum has no jurisdiction to provide any kind of relief in the recovery
process. Whereas the judiciary has time and again admitted that these legislations are harsh.14

Another facet of the entire debt recover mechanism is the abuse and harassment by recovery
companies and agents. Most of the banks have in-house debt recovery department who
undertakes the work of recovering debts from the customers. Many times banks and financial
institutions delegate other recovery companies or agents to recover on their behalf. And even
extra incentives are offered to the agent who recovers more money, which in turn motivates
them to the extent of resorting to illegal and unfair means. The atrocities caused by such people
have been reported time and again. One such case is of a Mumbai resident PrakashSarvankar,
who was a customer of ICICI Bank and has taken a personal loan of Rs. 50,000. Mr. Sarvankar
was being harassed and insulted such recovery agents in such a way that it prompted him to
commit suicide and end his life.15

14
Mardia Chemicals Ltd.vUnion of India (2004) 4 SCC 311.
15
Available at http://timesofindia.indiatimes.com/city/mumbai/Recovery-agents-drive-man-to-
suicide/articleshow/2381387.cms (visited on 30th Oct 2015)

8
Such scenario on being highlighted by media and otherwise led to issuance of many guidelines
by different authorities. The Reserve Bank of India, the apex institution regulating the banking
system of the country came up with its guidelines for fair practices code for lenders in the year
2003.16Also it issued directions to banks which are expected to be followed while engaging
recovery agents engaged in the year 2008.17 Banks have their own code of conduct also which
the employees are expected to abide. But all these are mere guidelines which are suggestive in
nature; they don’t have any binding and punitive effect, which in turns does not lead to
adherence.

Another critical issue is the issuance of credit cards which are issued without any collateral
security. And on delay of payment of dues, since it is not a secured debt, they rely more on
recovery agents/companies which leads to further problems.

CONCLUSION

No doubt there are number of guidelines which seek to regulate banks and financial institutions
in process of debt recovery but it is also well established that these guidelines are not sufficient
to stop the harassment caused by banks and their recovery agents to bona fide customers. It is
high time for India to evolve legislation for fair debt recovery practices. Here it would be
appropriate to cite the example of US’s Fair Debt Collection Practices Act which was designed
to eliminate abusive, deceptive, and unfair debt collection practices. Since banking officials do
not hesitate much in offering personal loans or credit cards to people as they are given targets
to achieve and incentives for business brought to banks that many times customers are not
properly briefed up about the entire terms and conditions pertaining to repayment of loans.
Therefore it is right time to have a concrete legislation providing and defining the rights and

16
Guidelines on Fair Practices Code for Lenders available
athttps://www.rbi.org.in/scripts/NotificationUser.aspx?Id=1172&Mode... (visited on 30th Oct 2015)
17
Considerations while engaging recovery agents by Reserve Bank of India available at
https://rbi.org.in/scripts/NotificationUser.aspx?Id=4141&Mode=0(visited on 30th Oct 2015)

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liabilities of both customers and banks & financial institutions so that a proper balance can be
reached between banks & financial institution’s right to recover their dues and consumer’s right
of protection against wrong doing.

BIBLIOGRAPHY

PRIMARY SOURCES
● Acts

- The Recovery of Debts Due to Banks and Financial Institutions Act,

SECONDARY SOURCES
● Articles

- Meenakshi Rajeev And H P Mahesh “ Banking Sector Reforms And

10
 - Rajesh Chakrabarti “ Banking In India – Reforms And
Reorganization” available at
npan1.un.org/intradoc/groups/public/documents/.../unpan025796.pdf

● Books

- M L Tannan, Tannan’s Banking Law & Practice in India (Lexis

● Web

https://rbi.org.in/(visited on 30th Oct 2015)

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