RBI against PPP model for central loan registry

Vrishti Beniwal

The Reserve Bank of India (RBI) has expressed
its reservations on the government’s proposal
to set up a computerised central registry for
keeping records of loans mortgaged against
securities in a public private partnership (PPP) mode.


The banking regulator is of the view that a
government official should head the registry
and that a PPP model will not be suitable
for running it.

The registry, once operationalised, would
help check frauds in the sale and mortgage
of properties by providing details to the
bank or the buyer at the click of a mouse.
“Both the Indian Banks’ Association (IBA)
and the finance ministry are proposing PPP
for the registry. However, RBI has some issues
on the way we want to structure it. So, we have
suggested that it could be a special purpose
vehicle (SPV) headed by a government servant,”
said a senior government official.

IBA’s chief legal advisor MR Umarji said as
the database would be similar to a corporate
registry, private sector participation
would bring in the expertise required to
handle electronic records.

The registry is proposed to be implemented
in two phases. In the first phase, all the
securities of banks will be registered to
help the lenders verify the documents while
giving loans against properties.

In the second phase, the registry
will provide a link to the database
of state governments and municipalities.
A customer planning to buy a house will get
the details about the property by paying a small fee.
Work on the first phase has already started.
And, states like Karnataka, Tamil Nadu,
Andhra Pradesh, Madhya Pradesh and
Maharashtra have even begun computerising
their records in preparation for the second
phase. The concept of a central registry was
introduced in the Section 20-26 of the SARFAESI
(Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest) Act.
The Act came into force in 2002, but the government
has not yet notified the above sections on
establishing the registry.

A central registry is maintained in most
countries.

In India, the absence of such
a registry has led to borrowers taking loans
from other banks using duplicate title deeds.

Also, there have been complaints of banks
losing the deeds and/or not returning the same
in case there is any other loan outstanding.

Banks will soon be in a better position to recover ...

Lenders may tighten stand on defaulters

Banks will soon be in a better position to recover
their dues from defaulters.
The Reserve Bank of India (RBI) and the government have

agreed to give claims by secured lenders priority
over similar claims made by a
state sales tax authority.

The government is also considering an amendment
to the Debt Recovery Tribunal Act or DRT Act, which
will make it necessary for the tribunal to hear the
lenders before it issues a stay order on
attachment of assets.

The government has agreed to amend the Securitisation and
Reconstruction of Financial Assets and
Enforcement of Security Interests
(Sarfaesi) Act and the DRT Act to bring
about these changes, said a person
with knowledge of the matter.

Once the amendments are in place, any secured
lender who disposes assets
of a defaulter will be able to use the proceeds
to settle the loan outstanding.

Currently, the sales tax authorities in states
such as Madhya Pradesh, Maharashtra,
Rajasthan and Kerala have staked a first
claim on the sale proceeds. The amendment
made in the Sarfaesi Act and the DRT will
supersede state laws, thus helping the lenders.

However, to protect the interest of the
sales tax authority, it has been proposed
that the sales tax authority will have
the first right over sale proceeds
if they have made a claim
on the company before the security
was created by the bank.
Banks create a security over
assets at the time of granting
a loan to the company.

“This will not only speed-up the recovery
process but also bring our foreclosure
standards on par with developed nations,”
said AC Mahajan, chairman and
managing director of Canara Bank
commenting on the proposed amendment.

Often when a bank tries to dispose the
assets (of defaulting borrowers),
the sale tax authorities stake first
claim over the sale proceeds.
As a result,
the bank is able to recover just
a small part of its due even though they put
in a lot of effort to recover the money.

The other issue facing lenders was that of
exp-parte hearings. Banks have
complained to the central bank that many
defaulters are obtaining ex-parte
orders which delay the recovery process.

“Recovery efforts through the Sarfaesi Act has
been very successful and it
helped in reducing the level of bad loans.
But at the same time defaulting
borrowers are cornered and they are trying
to find way to delay recovery
process by creating such irritants.
Hence there is a need plug these loopholes
so that a conducive environment is
created for speedy recovery of dues,”
said Mr MR Umarji, former executive
director of the Reserve Bank of India
and now legal advisor to the
Indian Banks’ Association (IBA).

The government has agreed to amend the
recovery act following suggestions
made by IBA relating to the loopholes
in the Sarfaesi Act and the DRT Act.

Till March 2009, under the Sarfaesi Act,
banks have issued 3.41 lakh notices
for an amount of Rs 68,127 crore. Of this
the lenders have recovered
Rs 19,396 crore involving 2.10 lakh notices and while settling

Auction Sale of Properties by Banks - 1st week of October 2009

Basel Norms & Indian Banking System

Amidst globalisation Banking System in India
has attained vital importance.
Day by day there has been increasing
banking complexities in banking transactions,
capital requirements, liquidity, credit and risks associated with them.

The World Trade Organisation (WTO), of which India is a member nation,
requires the countries like India to get their banking systems at par with the
global standards in terms of financial health, safety and transparency,
by implementing the Basel II Norms by 2009.

BASEL COMMITTEE:

The Basel Committee on Banking Supervision provides a forum for regular
cooperation on banking supervisory matters. Its objective is to enhance
understanding of key supervisory issues and improve the quality of banking
supervision worldwide. It seeks to do so by exchanging information on national
supervisory issues, approaches and techniques, with a view to promoting common
understanding. The Committee’s Secretariat is located
at the Bank for International Settlements (BIS) in Basel, Switzerland.

NEED FOR SUCH NORMS:

The first accord by the name .Basel Accord I. was established in 1988
and was implemented by 1992. It was the very first attempt to introduce
the concept of minimum standards of capital adequacy.
Then the second accord by the name Basel Accord II was established
in 1999 with a final directive in 2003 for implementation by 2006 as Basel II Norms.
Unfortunately, India could not fully implement this but, is now gearing
up under the guidance from the Reserve Bank of India to implement it from 1 April, 2009.

Basel II Norms have been introduced to overcome the drawbacks of Basel I Accord.
For Indian Banks, its the need of the hour to buckle-up and practice banking
business at par with global standards and make the banking system in India
more reliable, transparent and safe. These Norms are necessary since India
is and will witness increased capital flows from foreign countries and there
is increasing cross-border economic & financial transactions.

FEATURES OF BASEL II NORMS:

Basel II Norms are considered as the reformed & refined form of Basel I Accord.
The Basel II Norms primarily stress on 3 factors, viz. Capital Adequacy,
Supervisory Review and Market discipline. The Basel Committee calls these
factors as the Three Pillars to manage risks.

Pillar I: Capital Adequacy Requirements:

Under the Basel II Norms, banks should maintain a minimum capital adequacy
requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated
maintaining of 9% minimum capital adequacy requirement. This requirement is
popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

Pillar II: Supervisory Review:

Banks majorly encounter with 3 Risks, viz. Credit, Operational & Market Risks.

Basel II Norms under this Pillar wants to ensure that not only banks have adequate
capital to support all the risks, but also to encourage them to develop and use better
risk management techniques in monitoring and managing their risks.
The process has four key principles:

a) Banks should have a process for assessing their overall capital adequacy
in relation to their risk profile and a strategy for monitoring their capital levels.

b) Supervisors should review and evaluate bank’s internal capital adequacy assessment
and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios.

c) Supervisors should expect banks to operate above the minimum regulatory
capital ratios and should have the ability to require banks to hold capital in excess of the minimum.

d) Supervisors should seek to intervene at an early stage to prevent capital from
falling below minimum level and should require rapid remedial action if capital
is not mentioned or restored.

Pillar III: Market Discipline:

Market discipline imposes banks to conduct their banking business in a safe, sound
and effective manner. Mandatory disclosure requirements on capital, risk exposure
(semiannually or more frequently, if appropriate) are required to be made so that market
participants can assess a bank’s capital adequacy. Qualitative disclosures such as risk
management objectives and policies, definitions etc. may be also published.

CONCLUSION:

Basel II Norms offers a variety of options in addition to the standard
approach to measuring risk. Paves the way for financial institutions to
proactively control risk in their own interest and keep capital requirement low.

But . . .

Requires strategizing risk management for the entire enterprise, building huge
data warehouses, crunching numbers and performing complex calculations
and poses great challenges of compliance for banks and financial institutions.

Increasingly, banks and securities firms
world over are getting their act together.


By: Anand Wadadekar,
M.A Economics, MBA Finance & Banking,
AMFI, DIT, GCIPR

Not Interested-Banks are flush with funds but why are they reluctant to give loans?

Shekhar Ghosh


LAST month, an Aurangabad-based engineering firm
received a query from a Thai export house about
a large consignment of alloy gaskets.

Some three years ago, a spate of similar orders
had forced the company to import brand
new machinery worth Rs 20 crore.

Almost the entire cost was borne
by bank borrowings.
Then came the slowdown in both
export orders and domestic demand:
the company has been unable to repay
even the interest on the loan every year.


Banks need to lend the cash
out for a profit but memories
of bad loans are still fresh and
so they aren't lending.



Instead, working capital loans have risen
further. So last month, when the owner
visited his bank for another Rs 10-crore
working capital loan for the Thai order
which would translate to a roughly Rs 30-crore profit,
the bankers refused. With the Thai economy itself
in doldrums, even the export order could not
be properly trusted. Last week, the promoter
finally informed the Thai company of his
inability to meet the order.

India's corporate backyard is currently
littered with such tales of woe.
"What's worse, you can neither blame
the bankers nor the corporates for
such cul-de-sacs,"
says the executive director
of a nationalised bank.

That there has been a slowdown
in certain sectors of the economy
is well-established. Many corporate
houses—big and small—are finding it
extremely difficult to service their debt.

At the same time, banks are flush with cash.
Deposits have been growing every month.
Over June 1997, deposits increased by
18 per cent in May this year, reaching
a whopping Rs 61,545 crore.

At the same time, bank credit to the
commercial sector is on a decline.
In May, it was only 68.5 per cent of
bank deposits. The 1997-98 bank results
are indeed a cause for worry.
While profits of 29 major banks
have jumped by over 40 per cent,
there isn't much to cheer.
The deposit growth for the banking
industry during 1997-98 was way ahead
of the growth in advances at 15.5 per cent,
according to figures released by the RBI.

Indeed, the pressure on spreads for the
banks—the difference between interest
earned on loans by banks and interest paid
on deposits—has been increasing.

In all cases, spreads declined last fiscal
year or, at best, remained stagnant as banks
competed to attract short-term deposits.
By reducing the interest rates and the
cash reserve ratio, the RBI has put
further pressure on banks.

They had to slash lending rates
following an increase in liquidity,
but could not reduce deposit rates for
fear of losing customers.


Says Rajiv Verma, banking analyst at W.I. Carr:
"The structure of Indian banking is such
that spreads come under pressure when
the rates drop. SBI has been the most
vulnerable in this matter because of
the large proportion of long-term deposits
which it has not been able to re-price,
despite falling lending rates."

It's a strange situation: top-rated companies
can easily borrow from banks, but they have
access to even cheaper alternatives like external
commercial borrowings (ECBs),
private placement and commercial paper,
while small and medium-sized corporates
which need funds most are starved of resources.

These corporates attribute stringent pre-disbursement
conditions set by the financial institutions to be
largely responsible for their inability to get funds
against even those loans that are already sanctioned.


Some banks and institutions also demand promoter's
contribution upto 75 per cent of the project cost.
"If we had that kind of money, we wouldn't
need any loans," says a victim promoter.

The bankers, in turn, blame the history of India's
smaller companies. Explains a consultant to a leading
private bank: "Several companies had overstretched
their capacities expecting a higher rate of economic
growth.

More pertinently, they raised huge
amounts from stockmarkets and banks
to put up large projects.

Many smaller and midsize companies took
the investing public for a ride during the
primary market boom. Promoters are known to
have run away. It would be worse if the
banks did not ensure their commitment."

Today when the bottom has fallen out of
the stockmarket and over 3,000 companies
are trading below or at par, the investing
public is finding it safer to put their money
in banks and earn between 8 and 10 per cent rate
of interest. That's why deposits are growing so fast.

Banks need to lend this cash out to make
a profit, but memories of all those bad
loans are still fresh. And blue-chip companies
with high credit ratings cannot use all the
funds available with the banks either due to the
recessionary environment or because they are
already cash-rich.

Banks are now trying to find novel modes
of investment for their surplus cash.
For instance, overseas money markets,
where returns from short-term instruments
are at least 150-200 basis points (1.5 to 2 per cent)
higher than those on similar domestic instruments.

But as per RBI guidelines, banks can only deploy
funds to the extent of their nostro limits
(non-resident deposits plus the overseas investment
limits which is 15 per cent of the banks'
net worth or US $10 million, whichever is higher).


Says S. Gopalkrishnan, executive director of Bank of India:
"To take advantage of the integration of money,
forex and gilt markets, we have started an
integrated treasury branch. We are also taking
steps to integrate the bank's dealing room worldwide
to have a global treasury in Mumbai."

The government is not unaware of the problems.
One way it is trying to tackle the situation
is by giving banks far greater freedom.


Says K. Kannan,
chairman-cum-managing director
of Bank of Baroda:

"To cut down on bad debts and for the recovery
of loans, the RBI has decided to offer banks a
broad set of directives within which they can
determine an approach for recovery of overdue
loans best suited for the bank."


The finance ministry has already
clarified that there will be no end-use
restrictions on banks wishing to invest
in bonds floated by companies,
even if they are meant for takeover
of companies. Several mergers and
takeovers may now be initiated by banks
themselves.

For example, several mid-size cement
companies which are unable to pay off
their loans are almost expecting their
banks to find a white knight for them.

"Such need-based merger activities prompted
by Indian banks might yet become a trend,
" says Anand Vasudevan, banking analyst
at UTI Securities.

The SBI has also launched the
"general purpose corporate loan",
a normal banking procedure in developed
markets. It has cleared a Rs 200-crore
seven-year loan to ITC for which the end
use is not specified. The interest charged
on such loans will be higher than normal
term loans. However, analysts fear that
even if this becomes a trend, such loans
will only be given to bluest of the blue chips.

This won't solve the problems of the mid-cap
and smaller corporates. Having realised that
the small-scale sector was the worst hit by
the tightening of bank's credit, the RBI had
set up a one-man high-level committee headed
by S.L. Kapur, former secretary in the industry ministry,
to suggest steps for improving the delivery
system and simplification of procedures for
credit to SSIs. While the committee submitted
its report to the RBI on June 30, it was only
last week that the RBI accepted 35 of its
126 recommendations.

Bank branch managers will now have more
power to grant ad hoc limits, and banks
will now be free to decide their own norms
for assessment of credit requirements.


Loan limits have also been raised—application
forms prescribed for loans up to Rs 2 lakh
can now be used for Rs 10 lakh loans and
those for Rs 50 lakh and more can now be used
to ask a loan up to Rs 2 crore.

The central bank has also asked banks to
delegate powers to branch managers to grant
ad hoc facilities to the extent of 20 per cent
of the limits sanctioned.

The most important part of the
recommendations, however, is RBI's circular
to the banks that the flow of credit to SSIs
will now be assessed by using data on
disbursement rather than outstanding balances.

Banks have, therefore, been advised to shore
up their disbursement targets along with their
outstanding balances.

Will all this be enough?


Some are sceptical. For example,
M.S. Verma, chairman, SBI,
who says banking in India in the next
millennium will be very different
from what we have been used to till now:

"By changing procedures and interest rates,
we might get some incremental advantage.
To change the growth rate, we have to
look at strategic issues rather than
procedural ones."

In other words,
response of a totally different order.

Loan waived by lender is not taxable in the hand of borrower

SUMMARY OF CASE LAW

Remission of a debt by the lender which was not
claimed and allowed as a deduction to the borrower
in any manner in any earlier previous year cannot
be brought to tax either under section 41(1) or
under section 28(iv) of Income-tax Act, 1961.

CASE LAW DETAILS

Decided by: ITAT, `C’ BENCH, MUMBAI,
In The case of: Cipla Investments Ltd. v. ITO ,
Appeal No.: ITA No. 1996/Mum/2008,
Decided on: August 28, 2009

RELEVENT PARAGRAPH

9. We have considered the issue.
As the facts indicate the holding company
has advanced funds to the assessee company
in 1998 which was received as share application money,
later on transferred to unsecured loan.

The amounts were utilised in investments and
the incomes thereon were offered under the head
‘capital gains’ and not as ‘business income’.
As rightly held by the CIT(A), provisions of
section 41(1) invoked by the A.O. does not apply.

For attracting the provisions of section 41(1)
the first requisite condition to be satisfied
is that the assessee should have got the deduction
or benefit or allowance in respect of loss, expenditure
or trading liability incurred by it and consequently,
during any previous year the assessee should have
received any amount in respect of such loss,
expenditure or trading liability by way of
remission or cessation thereon.

The remission would become income
only when the assessee has
claimed deduction earlier. In the instant case
the assessee has not got any deduction on account
of acquisition of capital assets as the same has
been reflected in the Balance Sheet and not in
the P 8s L Account and hence, applicability of
provisions of section 41(1) are not there.

The CIT(A)’s order to that extent is correct both
on facts and on law. However, the wrongly invoked
the provisions of section 28. We are not sure how
the provisions of section 28 will apply.

It is the contention of the assessee that
the assessee has not done any trading activity
nor shown any income as business income on the
investments made. The findings of the CIT(A)
that the amount was received in the course of
its business is against his findings given while
considering the addition under section 41(1).

The assessee’s business activity may comprise
investment in shares and securities, but as
far as computation of income is concerned the
profit and loss in that transactions are said
to be under the head ‘capital gains’ but not
as ‘business income’, hence, the gain earned by
the assessee in the course of business in
investment and advance of loans is in the capital
field but cannot be on the revenue field.

As rightly held by various decisions above,
remission of a debt by the holding company
which was not claimed and allowed as a deduction
in any manner in any earlier previous year could
not be brought to tax either under section 41(1)
or under section 28(iv). There is no benefit or
perquisite arising to the assessee in this regard.

Moreover, the assessee has to write off the amount
in the books of account and the amount was still
outstanding at the end of the year.

As rightly pointed out by the learned counsel
the decision of the Hon’ble Bombay High Court
in the case of Solid Containers Ltd. (supra)
does not apply to the facts of the case and
moreover similar to the decision of
the Hon’ble Bombay High Court
in the case of Mahindra and Mahindra Ltd. vs. CIT 261 ITR 501.


The loans availed for acquiring the capital asset,
i.e. shares, when waived cannot be treated as assessable
income for invoking the provisions of section 28.
Since the original receipt was undoubtedly on account
of capital nature, its waiver does not have the quality
of changing the same into a revenue receipt.


In view of these facts and also the various
principles laid down in the case law relied
upon by the learned counsel, we are of the
opinion that the learned CIT(A) erred in treating
the amount as taxable income in the hands of the
assessee under section 28 of the Act. On the facts
of the case, we are of the opinion that the provisions
of section 28 does not apply and the amount is not taxable
under the provisions of the Act. Accordingly the assessee’s
grounds are allowed.

Assessing Officer is directed to deleted the amount.

Fast-track restructuring is even in lenders' interest

Like an animate person, the health of a corporate is also subject to innumerable bacteria and viruses. However, the Sick Industrial Companies (Special Provisions) Act 1985 (SICA) which provides for revival and rehabilitation of sick companies, have been quite ineffective. The BIFR setup under SICA has virtually become a boon for defaulting borrowers.

The SICA has in fact been misused by the defaulting borrowers to get immunity from legal action. The liquidation procedure under the Companies Act, 1956 also has not helped in expediting the process of quick death and release of national resources getting blocked in liquidation.

Debt Recovery Tribunals also could not expedite the process.

The Securitisation and Reconstruction of Financial Assets
and Enforcement of Securities Act, 2002 (SRFESI)was
a bold step and it addressed the problem of banks
and financial institutions in recovering their debts
but could not deal with issue of reviving the health
of the corporate affected by bacteria or virus.

I think the new modern bankruptcy code being contemplated
by the government of India is a step in the right direction.
This bankruptcy law proposes to provide for a mechanism
of diagnosis and treatment. Obviously, a time period has to
be provided for during which such exercise would be carried out.
During this period, the right of the lenders under the SRFESI
Act to take possession of the assets of a defaulting borrower
has to be suspended.

The objective of bankruptcy law is to revive the health
of the corporate and during this treatment everyone
concerned including the lenders have to co-operate.
If during this process of revival, the secured lenders
take away the secured assets, the treatment in the
form of restructuring can’t continue. Suspension of this
right of the secured lenders is not going to adversely
the lenders. In any case, even if restructuring is not found feasible,
fast-track liquidation under the proposed bankruptcy law will
ensure that the secured lenders get hold of the assets secured to them.

The new bankruptcy law should be structured in a manner
so that it is litigation free. Further, as the trigger of the
bankruptcy code is pressed, the entire assets and management
of the corporate should vest in a trust. The process of diagnosis
and treatment should be managed through professionals.

Vesting of entire assets and the management in the hands
of a trust comprising of professionals will ensure avoidance of
any misuse of the provisions of bankruptcy law or diversion of
any asset to the detriment of the lenders. Such bankruptcy law
will go a long way in ensuring that the national resources do
not get unnecessarily locked up and are put back in use at the
earliest. To safeguard the interest of the secured lenders and to
ensure efficiency of the new set-up, a period of not more
than a year be allowed for restructuring or revival and in case
of failure, the secured lenders should get back the right to take
possession of assets secured to it.

Satyam and Maytas Infra are two live examples
that demonstrate how quick diagnosis can help in
reviving the health of corporates infected by deadly
viruses. A strong, effective and efficient bankruptcy law
is vital to the growth of the economy.

*(Institute of Chartered Accountants of India)