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Home / IAS Preparation / Sarfaesi Act

SARFAESI Act, 2002 - Objectives, Provisions & Working for UPSC

Last Updated on Dec 01, 2024
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SARFAESI Act stands for the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002. It is a legislative act passed by the parliament of India in the year 2002. It empowers lenders, which includes banks and other financial institutions, to recover bad loans efficiently. 

Bad loans and NPAs are seen in the news regularly. It becomes important to understand the concepts and legislations related to NPAs and bad loans from the perspective of UPSC Prelims, General Studies Mains, and Interviews. Time and again, factual and conceptual questions have been asked from this section in the UPSC IAS exam. The Topic of the SARFAESI Act is equally important for the State PSC exams.

This article will discuss the SARFAESI Act 2002 objective, advantages, applicability, and associated challenges in detail.

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What is SARFAESI Act, 2002?

The SARFAESI Act stands for the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. It is a legal framework enacted by the Indian government to tackle non-performing assets (NPAs) and facilitate asset reconstruction. The act empowers banks and financial institutions to take action against defaulting borrowers and recover their dues. Under the SARFAESI Act, banks can enforce their security interests by seizing and selling the collateral without court intervention. The act provides a quicker and more efficient process for resolving bad loans and reducing the burden on the banking system. It has played a significant role in strengthening the financial sector and improving debt recovery in India.

History of SARFAESI Act, 2002

  • In 1991, Narasimham Committee – I (Committee on the Financial System) observed that borrowers obtain stay orders from ordinary courts, so banks and financial institutions face difficulty while recovering Non-Performing Assets(NPAs). Hence, to strengthen this process, Debt Recovery Tribunals were set up in 1993, and the loan recovery process was made beyond the jurisdiction of ordinary courts.
  • In 1998, Narasimham Committee – II (Committee on Banking Sector Reforms) observed that Debt Recovery Tribunals (DRTs) need to be strengthened with a law, So, Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act enacted in the 2002.

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Objectives of SARFAESI Act, 2002

Some of the major objectives of the SARFAESI Act are as follows:

  • To provide a mechanism for banks and other financial institutions to recover secured assets. This is done in a more efficient and effective manner.
  • To reduce the time and cost of recovery of secured assets.
  • To protect the interests of borrowers and depositors.
  • To promote financial stability.

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Important Provisions of the SARFAESI Act 2002
  • The first Asset Reconstruction Company (ARC) of India, ARCIL, was set up under this act in 2002 by four banks: SBI, ICICI Bank, PNB and IDBI Bank.
  • Under this act, secured creditors (banks or financial institutions) have the right to enforce security interest under section 13 of the SARFAESI Act, 2002.
  • Type of lenders covered under the SARFAESI Act :
    • All types of Banks (Public Sector Banks, Private Banks, Foreign Banks, Co-operative Banks, etc.)
    • Housing Finance Companies (Ex. – Dewan Housing Finance Corporation Ltd.)

If an NBFC fulfills two conditions simultaneously: The NBFC has an asset size of ₹100 cr or more. The loan given is at least ₹20 lakhs.

For example, Bajaj Finserv, Reliance Capital, etc

  • When a borrower defaults on a loan or an installment, a creditor categorizes his account as a non-performing asset (NPA). The SARFAESI Act provides alternative methods for the recovery of non-performing assets, which include:
    • Change the board of directors/Management in such companies.
    • Can auction such assets
    • Can also sell such assets to Asset Reconstruction Companies(ARCs).
  • Sudarshan Sen Committee [2021]: The Reserve Bank of India set up this committee to study the country's Asset Reconstruction Companies (ARC). And to evaluate the role of ARCs in debt resolution.
  • If a loan defaulter seeks a stay order, he cannot do so through ordinary courts. To obtain the stay order, defaulters have to approach DRT. If DRT doesn’t help, then a higher appeal can be filed in Debt Recovery Appellate Tribunal(DRAT), but DRAT will first ask him to deposit a minimum of 50% of the loan dues to prevent frivolous appeals.

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Working Mechanism of SARFAESI Act, 2002

The SARFAESI Act of 2002 grants banks and financial institutions authority to take possession of a defaulting borrower's property. According to the procedures outlined in the SARFAESI Act, banks issue notices to defaulting borrowers. It provides them with 60 days to fulfill their obligations. In cases where the borrower fails to comply with the notice, the SARFAESI Act enables the bank to pursue the following actions:

  • Take possession of the collateral provided for the loan.
  • Lease, sell, or assign the rights to the collateral.
  • Manage the collateral directly or appoint a designated person for its management.

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Borrower's Right under SARFAESI Act, 2002
  • The borrower has the right to receive a notice from the bank or financial institution before any action is taken under the SARFAESI Act.
  • The borrower has the right to object to the proposed action and to have the matter heard by a tribunal.
  • The borrower has the right to redeem the secured asset by paying the loan amount and other dues before it is sold or leased.
  • The borrower has the right to seek compensation from the bank or financial institution. This is, if any loss is caused due to wrongful action under the SARFAESI Act.

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Applicability of SARFAESI Act, 2002 

The Act addresses the following aspects:

  • Registration and regulation of Asset Reconstruction Companies (ARCs) by the Reserve Bank of India.
  • Facilitation of securitization of financial assets of banks and financial institutions, with or without underlying securities.
  • Promotion of seamless transferability of financial assets through ARCs via debentures, bonds, or other securities issuance.
  • Authorization for Asset Reconstruction Companies to raise funds by issuing security receipts to qualified buyers.
  • Facilitation the reconstruction of financial assets acquired through enforcement of securities, change of management, or other powers conferred on banks and financial institutions.
  • Recognition of registered securitization and asset reconstruction companies as public financial institutions.
  • The definition of 'security interest' includes various types of securities, such as mortgages, given for repayment of financial assistance.
  • Classification of borrower's accounts as non-performing assets based on the Reserve Bank of India guidelines.
  • Granting authorized officers the rights of a secured creditor, as per rules established by the Central Government.
  • Provision for appeal against actions of banks or financial institutions to the Debts Recovery Tribunal, with a second appeal to the Appellate Debts Recovery Tribunal.
  • Provision for establishing a Central Registry by the Central Government for registration of transactions related to securitization, asset reconstruction, and security interest creation.
  • Initial application of the legislation to banks and financial institutions, with the Central Government empowered to extend its application to non-banking financial companies and other entities.
  • Exclusion of security interests in agricultural lands, loans below one lakh rupees, and cases where the borrower has repaid eighty percent of the loan amount.

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Recovery Methods under SARFAESI Act 2002

The SARFAESI Act offers the following three methods for recovering Non-Performing Assets (NPAs):

  • Securitization: Securitisation involves converting existing assets, such as home or auto loans, into marketable securities. These securities can be sold to raise funds. Qualified Institutional Buyers (QIBs) can participate in schemes formed by securitization or asset reconstruction companies to acquire financial assets.
  • Asset Reconstruction: Asset reconstruction allows companies to manage a borrower's business, sell or acquire it, or reschedule debt payments by the Act's provisions.
  • Enforcement of security without court intervention: Banks and financial institutions are empowered to issue notices to individuals who have obtained a secured asset from the borrower, demanding payment of the outstanding amount. They can also claim payment from the borrower's debtor on behalf of the borrower without involving the court.

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Sarfaesi act, 2002 with latest amendments
  •  2013 The Central Government passed a law bringing cooperative banks under the SARFAESI Act of 2002. But, The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016, changed the statute again.
  • Enforcement of Security Interest and Recovery of Debts Laws Amendment Bill, 2016-
  •  It empowers the RBI with the authority to audit and inspect Asset Reconstruction Companies (ARCs) and to penalize them if they do not follow the RBI’s directions.
  • It authorizes the District Magistrate (DM) to seize collateral within 30 days to protect creditors. It allows DM to assist banks in taking over a firm’s management if the company cannot repay loans.
  • In May 2020, A five-judge bench of the Supreme Court held that Co-operative banks established under State law and multi-State level co-operative societies come within the ambit of the SARFAESI Act of 2002.

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Limitations of the SARFAESI Act, 2002
  • The Debt Recovery Tribunals (DRTs) & Debt Recovery Appellate Tribunals (DRATs) must be more staffed. More than 1 lakh cases are pending, so the matter would drag on for years, and the debtor will keep the asset. This leads to depreciation of asset value (machinery, vehicles, etc. ) even when DRT permits auction at a later time.
  • Auction or liquidation may not be the best option always for some enterprises, such as a hotel resort in a distant location where no other hoteliers are interested in investing.
  • In some specific cases, banks could salvage more value if the loans were restructured (i.e., reducing the percentage of interest rate, extending tenure, finding new partners, etc.). But, the SARFAESI act doesn’t facilitate such arbitration.

Facts about Sarfaesi Act, 2002
  • The act applies to all of India, including the states of Jammu and Kashmir.
  • SARFAESI Act does not apply to farm/agricultural loans.
  • Committees related to Sarfaesi Act – Narasimham Committee I(1991) and Narasimham Committee – II (1998) and Andhyarujina Committee(1998)
  • ARCIL is India's first Asset Reconstruction Company(ARC), which was set up under this act.

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Conclusion

The entire goal of the SARFAESI Act was to eliminate the time delay banks faced in recovering loans and NPAs. Despite the strict provisions, the legislation still needs an effective solution. So, to resolve all the limitations of the SARFAESI Act, the Government of India came up with Insolvency And Bankruptcy (I&B) Code in 2016.

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SARFAESI Act - FAQs

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) allows banks and other financial institutions to auction residential or commercial properties for the purpose of recovering their loan.

Any movable or immovable asset which was given as security except those excluded under Section 31 of the act comes under the SARFAESI Act.

The SARFAESI Act is applicable in case of Non-Performing Asset (NPA) loans with outstanding above Rs. 1 lakh by banks , Housing Finance companies , NBFC.

Non-Banking Financial Companies(NBFCs) are also allowed to use powers of SARFAESI law with some conditions.

The Asset Reconstruction Company (ARC) is a dedicated financial company that purchases non-performing assets (NPAs) from banks and other financial institutions. It assists banks in de-risking their balance sheets by purchasing bad loans.
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