Monday, November 2, 2009
Sunday, November 1, 2009
Get your FREE BOOK on the Impact of Debt Recovery Tribunals in India
The Microeconomic
Impact of Debt Recovery Tribunals in India
by wulan
In many developing countries and transition economies,
the quality of formal judicial institutions is poor.
Cases in court are subject to long delays.
As a result, economic agents cannot depend on courts
for the protection of their property rights,
leading to high transactions costs and other contracting
problems (Williamson 1985).
A large and growing body of theory suggests
that in such situations some welfare-improving transactions
will not be undertaken (Mookherjee 1999).
Improving the quality of formal judicial institutions
and more generally “getting the institutions right” (North 1990)
may thus allow the achievement of superior economic outcomes.
For instance, it has been shown that entrepreneurs’
confidence in a country’s institutions, including the judicial system,
predicts levels of investment and
rates of economic growth (Knack & Keefer 1995, Mauro 1995),
and that the nature of a country’s laws and the efficiency
of its judiciary can explain the concentration of share-holding
and the extent of external long-term financing
that firms receive
(Demirgüç-Kunt & Maksimovic 1998, La Porta et al. 1998).
However the literature provides very little evidence of
the micro-level mechanisms through which judicial
quality influences economic development.
This paper seeks to contribute in filling that void.
This paper investigates the effects of a
particular improvement
in the judicial institutions that process
debt recovery cases in India.
In 1993 the Indian government passed
a national act that allowed
for the establishment of Debt Recovery Tribunals
(DRTs) across India.
These tribunals are a new quasi-legal
institution set up to process
legal suits filed by banks against
defaulting borrowers.
They follow a streamlined legal procedure
that emphasizes speedy
adjudication of cases and swift
execution of the verdict.
By March 31st 2003 they had disposed claims
worth Rupees 314 billion (roughly 4 percent
of total bank credit
to the commercial sector in 2002-03) and recovered
Rupees 79 billion (Government of India 2003).
Two aspects of this reform are particularly relevant.
One, the monetary threshold for claims to be filed in a DRT
is Rupees 1 million (approximately US$ 20,000).
Two, there is variation in the
timing of tribunal establishment
in different states. Neither the monetary threshold nor
the timing of DRT placement appears to be correlated
with other factors which may influence the ability or
willingness of borrowers to repay their loans.
Therefore these two features allow a differences
in differences strategy to identify the effects of the DRTs.
The data used to implement this strategy consist of loan
level records that I collected from a large private sector
bank with a national presence.
I observe detailed information about the
contractual terms of the loans, their repaymen
schedule and actual repayment in each quarter
when an installment becomes due.
I utilize the two sources of variation described
above to examine the effect of DRTs on borrowers’
repayment behavior.
Loans that are late on repayment of more than
Rupees 1 million at the time of the legal
reform are potentially treated by DRTs.
Therefore I compare the change in the
repayment behavior of these loans after
DRTs are established, to the change in the
repayment behavior of other loans
(those with less than Rupees 1 million overdue).
The difference can be attributed to the DRTs.
To address possible concerns that other factors
may be driving these results, I conduct several
robustness checks. I control for state-level time-varying
unobservable factors
(by including state × quarter fixed effects),
and allow different time-varying unobservables
for loans above and
below the Rupees 1 million threshold.
I find robust evidence that for loans with more
than Rupees 1 million overdue, the establishment
of a tribunal increases the likelihood that an installment
is paid on time. Furthermore, this effect holds
within loans as well: for the same loan, installments
that become due after a tribunal is established are
more likely to be paid up on time than installments
that become due before.
As evidence of the economic impact of this reform,
I find further that the establishment of a DRT
leads to a change in the contractual terms of
new loans given out subsequently.
While the size of an average loan does not
change significantly, the interest rate on new
loans tends to be lower than that on comparable
older loans by 1 to 2 percentage points.
This suggests that improved repayment behavior
lowers the risk of default and allows the bank
to provide cheaper credit.
The paper is organized as follows.
Section 2 provides some background on
the factors leading to the DRT Act, and
details of the act and its implementation.
Section 3 presents a theoretical framework
to explain the phenomenon studied here.
Section 4 describes the data.
Section 5 presents the empirical strategy.
Sections 6, 7 and 8 present the empirical results.
Section 9 concludes the paper.
Please send a mail
to Get Free copy of the
book on Legal Reform and Loan Repayment:
The Microeconomic Impact of Debt Recovery Tribunals in India
Saturday, October 31, 2009
Friday, October 30, 2009
Wednesday, October 28, 2009
Debt Collection In India
Until the emergence of the debt collection,the recovery of debts was never treated as a specialized job and was always treated as one of the jobs that legal departments of the banks and financial institutions were required to undertake.
A typical legal department of an organization would approach the collection job strictly as a legal issue rather than as a revenue collection measure. Litigation would be the only tool used for recoveries and no other tool was either known or used by the industry.
Litigation as a recovery measure always had its own limitations due to long and winding court procedures the Indian legal system is always criticized for. On the other hand, foreign banking firms introduced the concept of specialized debt collection services.
Debt collection services became one of the many services that began to be outsourced to specialized agencies. The collection business had a very humble beginning and it barely qualified as a specialized service.
However over a period of time with the emergence of India as a global outsourcing destination the domestic businesses also adopted the outsourcing as an efficient business tool. With the result today, the third-party debt collection industry plays an important role in the Indian economy.
The industry employs hundreds of thousands of Indians as collection professionals, who are servicing several industries ranging from banks, to telecom service providers to insurance companies. Typically, only small recoveries arising from periodic billing defaults by the customers are outsourced to the collection agencies. Not only the collection business has become a direct source of employment to thousands but its contribution to the economy is more pronounced because it helps infuse money back in the economy that otherwise would have remained uncollected.
The economic benefits of third-party debt collection are significant. Citibank is the pioneer in introducing third party collection techniques in India.
The debt collection industry in India also has grown sharply this year as higher borrowing costs; rising inflation and the general slowdown in the economy force more companies and individuals into difficulties.
Underlying debt has gone through the roof and lenders and organizations increasingly want to move any bad debt off their books. Whether it is a high street bank, a credit card lender or a mobile phone company, growing numbers are turning to professional debt collectors in a more difficult environment.
The Debt collection industry in India is growing at a faster pace and is surely poised for growth. The credit card outstanding have shot up by a whopping 87% at US D 6114 Million during this year, from US D 2844 Million in the period year ago.
The Reserve Bank of India (RBI) which regulates the banking industry in the country encourages banks to shift bad loans off their books more quickly because they will be required to hold more capital against risky assets that may default.
COLLECTION INDUSTRY - UNREGULATED SCENARIO
The collection business has its own inherent shortcomings due to unregulated and primitive nature of this business in this country. The persons employed in the industry are untrained both in soft skills and legal skills. Being unregulated, the procedures are not standardized and there are no industry specific checks and balances. Still litigation is used as the last resort tool for recoveries.
However the industry has been accused of manipulating the legal system to their advantage by using courts as their agents of recovery. It is seen that big corporations with large volumes of recoveries have unwritten understanding with the local courts at the lowest level. With the patronage of minuscule minority of pliable judges simple civil defaults are registered as criminal cases thus pressurizing the debtors into paying the dues.
Slow and long civil recovery court process has no takers in this age of instant results where revenue targets are the most sacrosanct. Under such strict and cut throat environment, there is pressure on the banks to keep their account books healthy therefore such aggressive and extra-legal methods are employed for quick recoveries.
GOVERNMENT / RBI INTERVENTION
Debt collectors in the past had a lot of leeway and it wasn't uncommon for collectors to embarrass, harass or humiliate debtors by adopting extra-legal measures. In the absence of any regulatory regime the courts had to step in by laying down guidelines for the industry to follow. After the intervention of judiciary, the RBI woke up to the need of regulating the unruly collection agencies and laid down its own guidelines for the banking industry to follow.
The guidelines prescribed by RBI are enforced against the banks that have contractually employed collection agencies. The banks in turn via their contracts with the collection agencies ensure that the RBI guidelines are followed.
Now, under the RBI guidelines it is illegal to threaten violence or cause harm to debtor, use obscene language, or repeatedly use the phone to harass debtors. In addition, collection agents cannot seize or garnish a consumer's property or wages without recourse to court procedure.
The following are few of the core underpinnings of the collection process:
These are the norms formalized by the top bank in India - RBI.
1. DSAs/DMAs/Recovery agents to get minimum 100 hours of training.
2. Recovery agents should call borrowers only from telephone numbers notified to the borrower.
3. Each bank should have a mechanism whereby borrowers' grievances with regard to the recovery process can be addressed.
4. Banks are advised to ensure that contracts with recovery agents do not
induce adoption of uncivilized, unlawful and questionable behavior or recovery process.
5. Banks are required to strictly abide by the codes pertaining to collection of dues.
RBI in the draft guidelines issued for banks engaging recovery agents,
has asked banks to inform borrowers the details of recovery agents engaged for the purpose while forwarding default cases to the recovery agents.
The Reserve Bank of India has also considered imposing a temporary ban (or even a permanent ban in case of persistent abusive practices) for engaging recovery agents on those banks where penalties have been imposed by a High Court/Supreme Court or against its directors/officers with regard to the abusive practices followed by their recovery agents.
An operational circular in this regard has been issued in November 15, 2007.
Other Laws
Still the non banking debts collection business is outside the purview of any regulator. There are no licenses or registrations to be obtained from any regulator to pursue collection business in India. The extant guidelines applicable to banking industry are found inadequate as they address only the problem of debtors' harassment and the guidelines do not regulate the industry as such. The Government is well aware of the need of having a specialized legal mechanism for recovery of institutional debts which has become a huge problem for the entire banking industry.
Every bank is grappling with the non-paying accounts, known as Non Performing Accounts (NPA) in the Indian banking parlance. The problem has taken enormous proportion and threatened the economy. Creation of Debt Recovery Tribunals in the year 1993 was a step in the direction of facilitating fast recoveries by the banks .
The intention behind creation of such Tribunal was to ensure that banking industry was provided with its own recovery mechanism that was part of the legal system but at the same time exclusive to the banking industry. Bank debts above USD 22,727 could be recovered through the Tribunals.
However, over a period of time it was realized that this new mechanism did not yield the desired result since the recoveries were still slow and due to shear volume of work, the Tribunal became like any other court.
The whole objective of having a fast track and efficient recovery mechanism was therefore defeated. Bank debts still remained a major problem to be solved since it affected the entire economy of the country. The Government felt the need of having a mechanism that was minimally dependent on the courts for effecting recoveries since the legal system could not be reformed overnight.
Therefore instead of reforming the court procedure the government did some clever thinking and came up with a legislation that minimized the intervention of court and empowered the banks with special powers using which the recoveries could be affected.
The government thus came up with a new law Scrutinization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) where under the banks are allowed to liquidate security given by the borrower for recovery of their dues. This law also paved the way for creation of asset reconstruction companies that take over the security interest of the debtors. These agencies are thus another form of debt collection agencies that have been institutionalized.
The need to share credit information among the banking industry was also felt in order for the industry to benefit from each other. Thus Credit Information Companies (Regulation) Act was enacted in the year 2005.
INDIAN LEGAL SYSTEM AND COLLECTION PROCESSES
The Indian legal system is absolutely fair and assures justice to the party involved. There are remedies available under the law to collect the debt, if the debtor does not agree to pay under normal circumstances. The creditor may file a suit for his recovery. Debts based on written contracts could be recovered by following fast track procedure.
If the debtor is a company, creditor / his lawyers may apply in the 'Company Court' for winding up of the company due to non-payment of substantial amount of debt. Summary trial is another way.
The process may take time-1 to 2 years. Evidences are recorded appropriately and produced in the court of law, whenever required. There is also the arrangement of appeal to be filed at later stage.
US OUTSOURCING SCENARIO
India has attracted many technology jobs in recent years from Western nations, particularly the United States. Now, it is on its way to becoming a hub in another offshore outsourcing area - debt collection. According to the industry report, units of General Electric, Citigroup, HSBC Holdings and American Express have used their India-based staff to pursue credit card debt and mortgage payment by calling defaulters.
US debt collection agencies are the newest to start outsourcing their work to India and are satisfied with the results produced by the polite but persistent Indian experts. After insurance claims and credit card sales, debt collection is a growing business for outsourcing companies at a time of downturn in the US economy when consumers struggle to pay for their purchases.
Debt collection is a vital and growing component of US economy. There is more than $2.5 trillion in outstanding consumer debt. As a result, the third-party collection industry makes more than one billion contacts with consumers each year. Recently this year, more than $39.3 billion in debt was returned to creditors.
Indians have the advantage of lower salaries and other expenses, which cut drastically costs of collecting debts. Debt collectors in India cost as little as one-quarter the price of their US and European counterparts and are often better at the job. Many such Indian firms run 24-hour services. Indian debt-collection companies comply with strict regulations on operations in the American and / or European markets.
SUMMARY
India has a long way to go in establishing a mature collection services industry. The collection business needs to be regulated and empowered with legal powers to become an effective tool.
Already, there is a realization in the country that court dependant recovery is an inefficient way of way of debt collection.
Creation of Assets Reconstruction and Securitization Companies under the SARFARESI Act is a step in the right direction of recognizing debt collection as an independent and specialized business function.
While some progress is made for the bank debts but still for a large volume of unrealized non bank debt there are no professionally managed and regulated third party collection service providers. Non bank debts are largely unsecured that makes it even more difficult to realize. No big corporations and business houses are interested in acting as collection agents without there being an attraction of valuable security asset.
Lawyers can fill this gap by providing collection services for non bank debts. Indian law does not permit contingency fee that makes the business less lucrative. India is therefore ready to benefit from foreign experience, expertise and ideas to create an efficient debt collection industry of its own at par with global status.
This need is more felt now by India due to its global ambitions wherein India must adopt globally recognized practices and models. Transnational businesses need a uniform operating system for seamless transactions.
Efficient debt collection industry will only instill confidence in companies doing business with Indian companies. Collection professionals have this challenge facing them of creating an efficient system that reduces people's dependence on court supported recoveries.
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