SC Asks Banks to Identify MSME Stress Before Accounts Turn to NPA

SC Asks Banks to Identify MSME Stress Before Accounts Turn to NPA

Sub: Eco

Sec : Monetary policy

Supreme Court’s Mandate:

• The Supreme Court has mandated that banks and creditors must identify incipient stress in the accounts of Micro, Small, and Medium Enterprises (MSMEs) before these accounts turn into non-performing assets (NPAs).

Judgment Details:

• The appeals focused on a notification titled “Instructions for the Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises”, issued on May 29, 2015, under Section 9 of the MSMED Act.
• This notification was revised by the Reserve Bank of India (RBI) in March 2016, under Section 21 and 35 (A) of the Banking Regulation Act.
• The court held that the May 2015 notification has “statutory force binding to all Scheduled commercial banks, licensed to operate in India by the RBI.”
• The exercise as contained in the “Framework for Revival and Rehabilitation of MSMEs” must be carried out by banking companies before MSME accounts turn into NPAs.
• MSMEs are required to produce authenticated and verifiable documents/materials to substantiate their claim of being an MSME before their account is classified as an NPA. SARFAESI Act Recourse:
• If MSMEs fail to provide the necessary documentation and their account is classified as an NPA, banks (secured creditors) are entitled to take recourse to Chapter III of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) for the enforcement of the security interest.

High Court Challenge:

• The MSMEs had challenged a Bombay High Court decision dated January 11, which dismissed their writ petitions.
• The High Court had held that banks and Non-Banking Financial Companies were not obliged to adopt the restructuring process as contemplated in the May 2015 notification without specific applications from MSMEs.

SARFAESI Act

The SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest) Act, 2002, was designed to tackle the issue of NPAs (Non-Performing Assets) or bad assets. This legislation grants banks and other financial institutions the authority to recover loans by auctioning residential or commercial properties. Banks are enabled to confiscate collateral/securities (excluding agricultural property) without the participation of a court in case of a loan default.

Features

• Secured creditors (banks or financial institutions) possess significant rights for the enforcement of security interest under Section 13 of this Act.
• If the borrower of financial assistance defaults in repayment of a loan or any instalment and his account is classified as a Non-performing Asset by the secured creditor, the creditor may, before the expiry of the period of limitation, issue a written notice to the borrower for repayment of dues in full within 60 days, clearly stating the amount due and the intention for enforcement.
• The SARFAESI Act empowers financial institutions to ‘seize and desist’. They should give a notice to the defaulting borrower asking to repay the amount within 60 days.
• If the debtor doesn’t comply, the bank can resort to one of the three following measures:

1. Take possession of the loan security.
2. Sell or lease or assign the right over the security.
3. Manage the asset or appoint someone to manage the same.

• The Act provides for the establishment of Asset Reconstruction Companies (ARCs) to acquire assets from banks and other financial institutions. ARCs are regulated by the RBI.
• The law does not apply to:

1. Unsecured loans.
2. Loans below ₹100,000.
3. Where the remaining debt is below 20% of the original principal.

• The SARFAESI Act provides for the establishment of Asset Reconstruction Companies (ARCs) which are regulated by the RBI. Asset Reconstruction Companies can buy securities from banks and financial institutions.
• The government amended the SARFAESI Act in 2016 to empower the Asset Reconstruction Companies (ARC). ARCs purchase non-performing assets (NPAs) from financial institutions and banks to help them clean up their balance sheets.
• The RBI registers ARCs, and the SARFAESI Act of 2002 regulates them