Recovery of Retail Loans : CAIIB Retail banking (Module D),Unit 1

Recovery of Retail Loans : CAIIB Retail banking (Module D),Unit 1

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We all know that CAIIB exams are conducted by the Indian Institute of Banking and Finance (IIBF).  CAIIB is said to be one of the difficult courses to be cleared for the bankers. But we assure you that with the help of our “CAIIB study material”, you will definitely clear the CAIIB exam.
CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 1: Recovery of Retail Loans of “Module D: Other Issue Related to Retail Banking” from “Optional Paper: Retail Banking”.

The Article is CAIIB Unit 1: Recovery of Retail Loans

Repayment In Retail Loans

The success of any banking initiative is judged only by the profit generated from that business segment. Banks aggressively build up their retail asset portfolios to expand business as retail assets are one of the best revenue drivers in banking.

Holiday Period/ Moratorium Period

A Moratorium period/holiday period is a time allowed for the borrowers, during the loan term, when they are not required to make any principal repayment. It is a waiting before which repayment by way of EMIs begins.

Generally;

  • The repayment begins only after disbursement of entire loan. Term loan may be disbursed either in single debit or in multiple debits, as per the requirements.
  • Holiday period interest needs to be serviced. But it educational loans, this is not insisted upon.
  • In respect of housing loans, a holidays period upto 18 months is allowed in case of construction and 3 months in case of purchases.
  • The Holiday period is allowed with an intention to allow the borrowers to get themselves equipped for repayments. In the initial stages of availing the loan, there may be some miscellaneous expenses which they need to meet.
Types of Monthly Installments

Borrowers can choose among three types

  • Monthly instalment to repay their loan.
  • Repayment includes the principal loan amount and
  • Interest accrued on it.
Bullet Payment
  • In this case, the loan amount with interest is paid in a single payment at the end of the loan period. Small value gold loans are paid in this way.
Fixed Instalment loan
  • This payment is in equal monthly instalments. The loan amount is divided into equal monthly instalments. In this method, the interest servicing burden is more in initial stages. The borrower has to pay the loan instalment along with the entire interest accrued in the account during that period.
Equated Monthly Installments (EMI)
  • An equated monthly installment (EMI) is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. Equated monthly installments are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full.

Formula for calculation of EMIs

The mathematical formula for calculating EMIs is: EMI = [P x R x (1+R)^N]/[(1+R)^N-1]

Defaults and Rescheduling In Retail Loans

What is default?
  •  Default is the occurrence of an event which happens due to non payment of agreed installments. If the repayment schedule is not adhered to as per the commitments made, then it translates into default. The strength of the default grades it according to the period of default from a simple overdue to the stage of NPA. What are the reasons for default in retail loans? Let us take the case of Home Loans.
  • Home Loans are offered in two price formats. One is fixed pricing and the second is variable pricing or floating pricing. The irony is that even fixed pricing takes the character of a floating pricing as interest is reset as per the reset clause agreed between the lender and borrower.

Rescheduling happens in Credit Cards and Personal Loan segments also where the interest rates are quite high and unsecured in nature. Here default happens mainly due to the following reasons;

  • Genuine defaults due to reasons beyond the borrowers’ control and
  • Willful defaults where the borrowers deliberately default with malafide intention.

Genuine Defaults: In genuine defaults, the customers fail to repay the EMIs due to personal set backs, job losses, unforeseen medical expenses etc., that tilt the balance of their monthly pay outs and results in non payment of banks’ dues. Here the intention to pay is intact but the ability to pay is affected and results in defaults. The approach of the banks for recovery will be one of care and concern and will be a customer oriented approach because the chances of recovery are bright.

Willful Defaults: In willful defaults, the customers deliberately fail to pay the EMIs and the attitude is negative. The intentions of the borrowers are malafide and there is no attempt from the borrowers’ side to service the loans as per the committed repayments. The objective is to delay the EMIs and put the banks into difficulties. In willful defaults the approach of the banks will be on a recovery basis as the chances of recovery are not so bright. So banks take a systematic and firm approach for recovery of these loans.

Penal Measures against Wilful Defaulters
  • No additional facilities should be granted by any bank/FI to the listed willful defaulters.
  • In addition, such companies (including their entrepreneurs/promoters) where banks have identified siphoning/diversion of funds, misrepresentation, falsification of accounts and fraudulent transaction should be debarred from institutional finance from the scheduled commercial banks.
  • The legal process, wherever warranted against the borrowers/guarantors and foreclosure for recovery of dues should be initiated expeditiously.
  • The lenders may initiate criminal proceedings against willful defaulters, wherever necessary.
  • Wherever possible, the banks and FIs should adopt a proactive approach for a change of management of the willfully defaulting borrower unit.
  • The bank can proceed against the guarantor, if any, along with the principal debtor also by virtue of the Contract Act.
Diversion of funds

The term ‘diversion of funds’ should be construed to include any one of the undernoted occurrences.

  • Utilization of short-term working capital funds for long-term purposes not in conformity with the terms of sanction.
  • Deploying borrowed funds for purposes/activities or creation of assets other than those for which the loan was sanctioned.
  • Transferring borrowed funds to the subsidiaries/Group companies or other corporates by whatever modalities.
  • Routing of funds through any bank other than the lender bank or members of consortium without prior permission of the lender.
  • Investment in other companies by way of acquiring equities/debt instruments without approval of lenders.
  • Shortfall in deployment of funds vis-à-vis the amounts disbursed/drawn and the difference not being accounted for.

Siphoning of funds: The siphoning of funds refers to the occurrence of a situation that the unit has failed in meeting its payment/repayment commitments to the lender bank and also the funds borrowed from the bank was not utilized for the specific purpose for which the credit was released.

Monitoring of loan Accounts

Monitoring process is a scientific as well as an essential tool for maintaining the quality of retail assets. As discussed above it has to de designed in such a way that it addresses both genuine defaulters as well as willful defaulters. While genuine defaulters are to be handled very sensitively as they are otherwise good customers and default have happened due to circumstances beyond their control.

Irregularities in Loan Accounts – Special Mention Accounts

To have more control over monitoring of accounts, the loan accounts are grouped us under:

SMA sub categories Basis for classification

Principal or interest payment or any other amount wholly or partly overdue between

SMA -0 1 to 30 days
SMA -1 31 to 60 days
SMA -2 61 to 90 days

 

Classification of Irregular loan Account

International practices and as per the recommendations made by the Committee on the Financial System (Chairman Shri M. Narasimham), The RBI has introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the banks.

Income Recognition

The policy of income recognition should be objective and based on record of recovery rather than on any subjective considerations.

A retail asset becomes non-performing when it ceases to generate income for the bank. A non-performing asset (NPA) is a loan or an advance where:

  • Interest and/or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan,
  • The account remains ‘out of order’, in respect of an Overdraft/Cash Credit (OD/CC).
  • The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
 Asset Classification

Banks are required to classify non-performing assets further into the following three categories based the period for which the asset has remained non-performing and the realisability of the dues

  • Substandard Assets
  • Doubtful Assets
  • Loss Assets

Substandard asset: A sub-standard asset is one, which has remained NPA for a period less then to 12 months. Such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

Doubtful Assets: An asset is required to be classified as doubtful, if it has remained NPA for more than 12 months.

Loss Assets: An asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

Recovery Policy of Banks

The recovery policy clauses are clearly spelt out in the recovery policy of the bank. The fundamental assumptions and approaches to recovery are clearly communicated to the customers. Let us see the different clauses of the recovery policy.

Preamble
  • The debt collection policy of the bank is built around dignity and respect to customers.
  • The Bank will not follow policies that are unduly coercive in collection of dues.
  • The policy is built on courtesy, fair treatment and persuasion.
  • The bank believes in following fair practices with regard to collection of dues and repossession of security and thereby fostering customer confidence and long-term relationship.
  • The repayment schedule for any loan sanctioned by the Bank will be fixed taking into account paying capacity and cash flow pattern of the borrower.
  • The Bank will explain to the customer upfront the method of calculation of interest and how the Equated Monthly Installments (EMI) or payments through any other mode of repayment will be appropriated against interest and principal due from the customers.
  • The Bank would expect the customers to adhere to the repayment schedule agreed to.
  • The Bank Security Repossession Policy aims at recovery of dues in the event of default and is not aimed at whimsical deprivation of the property.
  • The policy recognizes fairness and transparency in repossession, valuation and realization of security. All the practices adopted by the Bank for follow up and recovery of dues and repossession of security will be inconsonancc with the law.
General Guidelines

All the members of the staff or any person authorized to represent the Bank in collection or/and security repossession would follow the guidelines set out below:

  • The customer would be contacted ordinarily at the place of his/her choice and in the absence of any specified place, at the place of his/her residence and if unavailable at his/her residence, at the place of business/occupation.
  • Identity and authority of persons authorized to represent the Bank for follow up and recovery of dues would be made known to the borrowers at the first instance. Bank staff or any person authorized to represent the Bank in collection of dues or/and security repossession will identify himself/herself and display the authority letter issued by the Bank upon request.
  • Bank would respect privacy of its borrowers.
  • Bank is committed to ensure that all written and verbal communication with its borrowers will be in simple business language and Bank will adopt civil manners for interaction with borrowers.
  • Normally Bank’s representatives will contact the borrower between 0700 hrs and 1900 hrs, unless the special circumstance of his/her business or occupation requires the Bank to contact at a different time.
  • Borrower’s requests to avoid calls at a particular time or at a particular place would be honored as far as possible.
  • Bank will document the efforts made for the recovery of dues and the copies of communication set to customers, if any, will be kept on record.
  • All assistance will be given to resolve disputes or differences regarding dues in a mutually acceptable and in an orderly manner.
  • Inappropriate occasions such as bereavement in the family or such other calamitous occasions will be avoided for making calls/visits to collect dues.
Giving Notice to Borrowers

While written communications, telephonic reminders or visits by the Bank’s representatives to the borrowers place or residence will be used as loan follow up measures, Bank will not initiate any legal or other recovery measures including repossession of the security without giving due notice in writing. Bank will follow all such procedures as required under law for recovery/repossession of security.

SARFAESI ACT 2002

SARFAESI provide a structured platform to the banking sector for managing its mounting NPA stocks and keep peace with international financial institutions, the Securitisation and reconstruction of financial Assets and Enforcement of Security Interest (SARFAESI) Act was put in place to allow banks and FIs to take possession of securities and sell them.

Provision of the SARFAESI Act

The SARFAESI Act introduced major changes in the legal framework for the recovery of dues by banks/FIs by giving those powers to realize the securities without the need to approach courts.

  • Securitization of financial assets.
  • Reconstruction of financial Assets.
  • Recognition of any ‘interest’ created in the security for due repayment of a loan as a ‘security interest’ irrespective of its form and nature but when it is not in the possession of the creditor.

The provisions of the SARFAESI Act, relating to enforcement of the security interest, applies only to cases in which the security interests are created for due repayment of financial assistance. As per

SARFAESI Act, financial asset means debt or receivables and includes:

  • A claim to any debt or receivables or part thereof whether secured or unsecured, or
  • Any debt or receivable secured by mortgage of or charge in immoveable property, or
  • A mortgage charge, hypothecation of moveable property, or
  • Any right or interest in the security, whether full or part, securing debt, or
  • Any beneficial interest in any moveable or immoveable property or in debt, receivables, whether such an interest is existing, future, accruing, conditional or contingent, or
  • Beneficial right, title or interest in any tangible property given on hire/conditional sale/contract which secures the obligation to pay any unpaid portion of purchase price.
  • Any right title or interest on any intangible asset or license or assignment of such intangible asset, which secures the obligations to pay any unpaid portions of purchase.
  • Any financial assistance.
Enforcement of security interest

SARFAESI Act can be initiated only if the loan account satisfies the following conditions:

  • Loan account must have been classified as NPA, backed by security.
  • Outstanding in the account including the interest accrued/applied should be more than Rs. One lakh.
  • Outstanding dues should be 20% or above of the principal and interest.
  • Secured asset should not be an agricultural land.
  • Documents should be enforceable and unexpired period of a minimum of 6 months must be available (not specified in the Act). Action under SARFAESI Act 2002 will not extend limitation period of documents.
  • In case of multiple lenders/consortium advances, ensure lenders having a minimum of 60% of dues outstanding are agreeable for initiating action under SARFAESI Act 2002.

Demand Notice under section 13(2) can be issued by any one or more of the following modes:

  • By Registered Post with Acknowledgement Due, or
  • By Speed Post, or
  • By Courier, or
  • By Fax Message, or
  • By electronic mail service (e-mail),
  • By hand delivery against proper acknowledgment addressed to the borrower at the place where he resides or carries on business or works for gain

On receipt of the notice if the borrower makes any representation or raises any objection, the secured creditor has to communicate his reply to the borrower within 15 days of the receipt of such representation based on factual position and on merits.

Sec 13(13) of the SARFAESI Act: Provides that after receipt of the demand notice, the Borrower/Mortgagor! Guarantor shall not transfer any of the secured assets by way of sale, lease or otherwise without the prior written consent of the Bank. Sec 29 of the Act provides that if any person contravenes or attempts to contravene or abets the contravention of the provisions of the Act or Rules, he shall be punishable with imprisonment for a term which may extend to one year or with fine or both.

Debt Recovery Tribunals (Drts)

Debt Recovery Tribunals are apex bodies to settle recovery issues in case of loans extended by financial institutions. Debt Recovery Tribunals (DRTs) are constituted for helping financial institutions recover their bad debts quickly and efficiently. DRTs are governed by provisions of the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, also popularly called as the RDB Act. Rules have been framed and notified under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993. After the enactment of the Securitisation And Reconstruction of Financial Assets  and Enforcement of Security Interests Act (S ARFAESI Act),borrowers could become first applicants before the Debt Recovery Tribunal. Earlier only lenders could be applicants.

Application for recovery of debts due shall be accompanied with a fee payable as follows:

  • Where amount of debt due is Rs. 10 lacs: Rs. 12000
  • Where the amount of debt due is above Rs. 10 lacs: Rs. 12000/-plus Rs. 1000/-for every one lakh rupee of debt due or part thereof in excess of Rs 10lakhs subject to a maximum of Rs 150000.
  • DRT will issue summons to the defendant requiring him to show cause within 30 days of the services of summons as to why the relief prayed for should not be granted.

Recovery Through LOK ADALAT

Recovery of NPAs through award of Lok Adalat is the easiest and fastest mode. One time Settlement (OTS) can be put through Lok Adalat, so that in case of default in payment as per OTS, the award could be executed by the Court, as in the case of execution of a decree.

Some Suggestive steps are given below for recovery of bank dues:

  • Identify NPAs in the branch with dues upto Rs. 20lacs, irrespective of whether secured or unsecured.
  • The Bank/branch shall prepare a petition, separately for each account, to be submitted before the Hon’ble forum of Legal Services authority.
  • The Identified cases can be referred to the usual Lok Adalat organized by the repective leagal Service Authorities, Periodically.
  • The district or Taluk Legal Services Authority shall also be approached by the bank with the list of accounts where settlement is feasible to conduct exclusive Lok Adalat for the bank’s cases alone, if more number of cases is involved. Banks can organize Lok Adalats in association with other banks also in the locality.
  • With the consent of the respective Legal Service Authority the branch shall file petition, separately for each account, before the Hon’ble forum. The Legal Service Authority fixes the date of Lok Adalat and informs the same to the bank. Lok Adalat can be organized and award can be passed even on a holiday
  • The concerned branch of the bank should personally contact the borrowers, convince them the benefits of settling the matter through Lok Adalat and ensure that all parties be present at Lok Adalat on the fixed date.
  • The branch manager has to take the permission of Regional Office wherever necessary, with regard to proposed terms of settlement in Lok Adalat.
  • The Lok Adalat will be convened on the date fixed and passes the award with the consent of both the parties (Authorised official of the bank and the borrower/guarantor).
  • The Lok Adalat is presided over by a sitting or retired judicial officer as the chairman, with one or two other members, usually a lawyer and a social worker.
  • The settlement may be made prudently under the following terms:
  1. Down Payment of awarded amount at the time of settlement itself.
  2. Full payment of the awarded amount within a short duration
  3. Full payment of the awarded amount in instalments within a short duration, etc.
  • The most important factor to be considered while deciding the cases at the Lok Adalat is the consent of both the parties. It cannot be forced on any party for a settlement in Lok Adalat. No appeal shall lie in any court against the Award.
  • While agreeing for a settlement, branch manager should ensure that a default clause – ‘if not settled fully as per the terms of the award, the bank shall be at liberty to recover the contracted amount’ is incorporated in the award.
  • In the event of failure to honour the Lok Adalat commitments EP proceedings should be initiated immediately. If the case referred is a suit filed one, entire court fee paid for filing suit will be returned back.

Recovery Agents

When we talk about recovery of retail loans, the first thing which flashes in our mind is the most dreaded recovery agents deployed by banks for recovery of loan in which defaults happen. Public Sector Banks’ approach to recovery of loans is different from the strategies adopted by private sector banks and foreign banks.

RBI Guidelines For Recovery Agents

RBI vide their circular DBOD.No.Leg.BC.75/09.07.005/2007-08 dated April 24,2008, issued guidelines for all scheduled commercial banks for Recovery Agents engaged by them for recovery of loans. In view of the rise in the number of disputes and litigations against banks for engaging recovery agents in the recent past, it is felt that the adverse publicity would result in serious reputational risk for the banking sector as a whole. Hence RBI felt that a need has arisen to review the policy, practice, and procedure involved in the engagement of recovery agents by banks in India. Reserve Bank issued draft guidelines which were placed on their web-site for comments of all concerned. Based on the feedback received from a wide spectrum of banks/individuals/organizations, the draft guidelines have been suitably revised and the guidelines finalized and implemented by RBI are as follows:

Engagement of Recovery Agents

Banks are advised to take into account the following specific considerations while engaging recovery agents:

  • ‘Agent’ in these guidelines would include agencies engaged by the bank and the agents/employees of the concerned agencies.
  • Banks should have a due diligence process in place for engagement of recovery agents, which should be so structured to cover, among others, individuals involved in the recovery process. The due diligence process should generally conform to the guidelines issued by RBI on outsourcing of financial services vide circular DBOD.No.BP.40/21.04.158/2006-07 dated November 3, 2006. Further, banks should ensure that the agents engaged by them in the recovery process carry out verification of the antecedents of their employees, which may include pre-employment police verification, as a matter of abundant caution. Banks may decide the periodicity at which reverification of antecedents should be resorted to.
  • To ensure due notice and appropriate authorization, banks should inform the borrower the details of recovery agency firms/companies while forwarding default cases to the recovery agency. Further, since in some of the cases, the borrower might not have received the details about the recovery agency due to refusal/non-availability/avoidance and to ensure identification, it would be appropriate if the agent also carries a copy of the notice and the authorization letter from the bank along with the identity card issued to him by the bank or the agency firm/company. Further, where recovery agency is changed by the bank during the recovery process, in addition to the bank notifying the borrower of the change, the new agent should carry the notice and the authorization letter along with his identity card.
  • The notice and the authorization letter should, among other details, also include the telephone numbers of the relevant recovery agency. Banks should ensure that there is a tape recording of the reasonable precaution such as intimating the customer that the conversation is being recorded, etc.
  • The up to date details of the recovery agency firms/companies engaged by banks may also be posted on the bank’s website.
  • Where a grievance/complaint has been lodged, banks should not forward cases to recovery agencies till they have finally disposed of any grievance/complaint lodged by the concerned borrower:
  • However, where the bank is convinced, with appropriate proof, that the borrower is continuously making frivolous/vexatious complaints, it may continue with the recovery proceedings through the Recovery Agents even if a grievance/complaint is pending with them. In cases where the subject matter of the borrower’s dues might be sub judice, banks should exercise utmost caution, as appropriate, in referring the matter to the recovery agencies, depending on the circumstances.
  • Each bank should have a mechanism whereby the borrowers’ grievances with regard to the recovery process can be addressed. The details of the mechanism should also be furnished to the borrower while advising the details of the recovery agency as at item (iii) above.

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