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Securitisation Act: Tone down expectations - Views on News from Equitymaster
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  • Apr 20, 2004

    Securitisation Act: Tone down expectations

    In the last week, there came a news that brought cheer to many a investors in banking sector stocks, especially banks that are ridden with a large quantum of NPAs. We are referring to the Supreme Court's verdict upholding the constitutional validity of the Securitisation Act.

    For the readers who do not know much about this Act, this new Act gave sweeping powers to the lenders to attach the properties of defaulting borrowers and sell them to realise at least some part of the bad debts. In fact, the Act went so far as to enable the lenders to attach the personal properties of the defaulting borrowers and sell them.

    The recent Supreme Court (SC) judgment had a lot of importance in this regard as this case involved one of the largest corporate defaulters (Mardia Chemicals) in the country and one of the largest lenders (ICICI Bank). The fate of the case filed by Mardia Chemicals against its lenders was to decide the fate of the whole Act itself. But while the court upheld the validity of the Act, one needs to examine the fine print in order to understand who is likely to actually benefit more, the lender or the borrower.

    The SC while upholding the provisions of the Act has quashed section 17(2) of the Act as unconstitutional. The Act earlier stipulated that the borrower had to deposit at least 75% of the default amount in order to move the Debt Recovery Tribunal (DRT) against the seizure and sale of its assets. The SC's ruling has significantly simplified the process of litigation as far as the defaulters are concerned.

    This means that while the bank may be able to attach and seize the properties of the defaulter, selling it may not be as simple. Now since the 75% clause has been removed, the defaulters can go ahead and file an appeal with the DRT to stop the sale of its assets. While the verdict of the DRT will be final for all the cases as stipulated by the Act, one needs to understand that the whole process of seizure and sale would be stalled if the matter goes into litigation. In fact, experts fear that the DRT may not be in a position to handle a deluge of such cases that are likely to be filed post the SC ruling. Historical facts suggest that the DRT has not been too successful in clearing off the default cases due to a large backlog and a slow judicial process.

    As far as investors in the banking sector are concerned, they need to understand that the benefits of the Securitisation Act may not be apparent immediately due to this new ruling from the SC. There are still legal hurdles that the financial sector needs to cross in order to succeed in its objective of successful recovery of bad loans. However, there is a positive. Banks and financial institutions have been able to force defaulters to the negotiating table and in some cases litigation too has been avoided. Also, new lenders will not be in a position to take advantage of the loopholes in the system. At this stage, if one is looking for a miraculous recovery in bad debts for banks due to this Act, one needs to tone down expectations. Again the key here is long-term.



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