Securitisation as a form of funding (raising money by selling future revenue streams) is widely prevalent in western countries. These bonds are commonly traded in the secondary debt market as bearer bonds. The popularity of securitised bonds is on account of distinct advantages it provides to the different parties associated with it. From the perspective of the company that securitises its cash flows, the major benefits are in terms of getting immediate cash and passing the risk to the investors. Besides, for finance companies, securitisation would take the loan assets off the balance sheet, thereby relieving pressures of capital adequacy. For the investor it is a tradable security favourably rated by a Credit Rating Agency. Further, the company that wants to securitise can ask for a particular rating from a rating company and get it, by a mechanism called `credit enhancement'. This refers to shoring up investors' confidence by offering cash collateral to the SPV (Special Purpose Vehicle i.e. the agency that attends to securitisation of assets)

One major advantage of securitisation is its flexibility. A pool of receivables could be split into different `strips' and sold to different types of investors. For example, a money market mutual fund might be interested in a short-term paper (pass through certificate), whereas a pension fund might want to invest in a long-term paper. The SPV can have something to offer to both.

"Asset Reconstruction" is defined as acquisition by Company of any right or interest of a bank or financial institution in respect of a financial assistance for the purpose of realisation of such financial assistance. In other words the company handles debt collection on behalf the banks and financial institutions. Two of the East Asian Countries, i.e. Malaysia and Thailand set up ARCs to tackle problem of NPA in their respective countries. In Thailand, the government created a Financial Institutions' Development Fund (FIDF) by issuing bonds worth Baht 500 billion to cover its liabilities. The government pays the interest on these bonds from its budget, while the Bank of Thailand repays from its profits the principal of these bonds on maturity. The TAMC (Thailand Asset Management Company) acts as the bidder of the last resort at the auctions of NPAs conducted by the FRA and manages the assets thus acquired for up to five years. TAMC finances its operations through the issue of 10 year bonds guaranteed by the FIDF.

In Malaysia, Danaharta, established in June 1998 as a wholly owned government company, was provided, by the government with, Ringgit 1.5 billion in capital. It raised Ringgit 5 billion by the issue of zero-coupon bonds. Danaharta purchased NPAs worth Ringgit 30 billion from banks and swapped them for five year zero-coupon government-guaranteed bonds with an option to roll over for another five years.

By way of summarising the international experience, it is observed that barring a very recent case of Xinda asset Management Corporation in China - which has barely begun its operations - every instance of setting up an ARC has been preceded by massive and systemic banking collapse. This was true of the Resolution Test Corporation (RTC) in the US, which came into being in 1989 after the failure of the savings-and-loan industry; of four ARCs in Scandinavia in the early 1990's; of Danaharta in Malaysia in 1998; of the Financial Restructuring Authority in Thailand in 1997; of Korea Asset Management Corporation; and of FOBAPROA after the December 1994 peso crisis in Mexico, `Although the financial system in India suffers from a large burden of NPAs, there has been no systemic banking crisis that automatically warrants an ARC-type bailout. Moreover, only two countries have had successful ARCs : the US and Scandinavia. Most others have been either abject failures or shown no sign of success.

Handling recoveries is the core function for these companies and they are adequately geared and equipped for this job. In this respect the ARCs handle the function of recycling to productive and beneficial use of assets that threaten to turn as scrap or waste. Banks & FIs assign or transfer all their rights with reference to specific debts including their security rights on the collateral held by them as cover for their lending. The ARC thus steps into the shoes of the banker and attends to recovery of the outstanding through manifold methods and devices.

The financial and banking sector in India during the past three decades is continuously witnessing burden of sick industries, failed credit and bulging non-performing assets. This posed recurring problems leading to poor capital adequacy and turning several banks weak and loss incurring. The Government of India consequently had to rush to their aid on several occasions during the past decade with doles of recapitalisation support to restore the sustainability of the ailing banking and financial institutions. This environment then should provide vast scope for ARCs to thrive with unlimited potential for roaring of business.

Despite this ARCs have not come through in large numbers and a few in the field have shown lackluster performance. The reason for this is not hard to find. The legal and economic environment in the country was not conducive for the growth and success of ARCs all these years.

In place of ARCs professionals have come forward to offer consultancy services for the revival of sick industries for the benefit of the existing owners. Banks too, on their part attempted for several years to "nurse" and revive such "sick" enterprises, without much concrete results. The reason for the poor growth of ARCs in India is discussed in another article contributed by Shri Gaurav Kohli, a student of management from Goa Institute of Management.

The potential market in India for securitisation business is estimated at over a trillion of rupees. However the concept has not taken a wider application so far for various reasons.

Recent trends indicate that securitisation in India is picking up as a source of funding, but experts say it still has a long way to go to catch up with the potential. Figures made available by Crisil show that securitisation of rated transactions increased from less than Rs 1,000 crore in the calendar year 1998, to over Rs 7,000 crore in 2001, and the trend is continuing in the current year too. (Deals, in which Crisil is involved as the rating agency, are estimated to be around 75 per cent of the total rated securitisation deals made in the country).

The first securitisation deal happened way back in 1991 - when the Citibank raised Rs 16 crore from GIC Mutual Fund by securitising some of its auto loans. But over 50 per cent of the deals that have happened so far have happened in the last about 18 months, which Crisil says, "indicates an upsurge in this activity".

However, notwithstanding this sharp rise in volumes, securitisation is yet to happen in the country on a scale consistent with the potential. This was considered on account of lack of legal and market infrastructure to promote and popularise such debt instruments.

A legal framework for securitisation and Asset Reconstruction is now enacted by the passing of the "The Securitisation and Reconstruction of Financial Assets And Enforcement of Security Interest Ordinance, 2002". The main purpose of the Ordinance is to promote the setting up of asset reconstruction/securitisation companies to take over and liquidate the 70000 Crores of NPA accumulated with the commercial banks and public financial institutions. The Ordinance envisages Asset Reconstruction-cum-Securitisation companies to undertake Asset Reconstruction function. The ordinance therefore deals in detail with three distinct legal provisions for handling of dormant financial assets held by banks and FIs, namely,setting up of asset reconstruction companies to take over such assets, by exercising the powers for enforcement of security interest as vested with them in terms of the Ordinance, and later attending to securitisation of such financial assets

The comprehensive Ordinance covers securitisation and asset reconstruction exclusively in respect of defaulted loans (NPAs) of Banks and Financial Institutions. It demonstrates the concern of the Government of India on the growing menace of carried forward NPAs distressing the Public Financial Institutions and Banks in the country by the provision of a comprehensive package. The Ordinance, as a result, has brought to limelight the process of quick liquidation of accumulated overdue NPAs. Banks and Financial Institutions have already served bunches of legal notices to the defaulters under Sec.13(2) of the Ordinance. It has awakened both lenders and borrowers to remind them of their rights and obligations.

The core issues with reference to asset reconstruction and securitisation are discussed and analysed in the series articles that follows this narrative.

The ordinance defines securitisation as the acquisition of financial assets by such a company from any originator, i.e., owner, of the asset for the purpose of securitisation or reconstruction as the case may be. More specifically stated securitisation is a method of funding receivables of whatever kind (mortgage debts, leases, loans, credit card balances etc...), provided they are secured defaulted "financial assets" transferred to NPA and not exempted under the Ordinance. It involves producing asset-backed securities, which can be selectively traded to qualified institutional buyers (QIBs) secured on a portfolio of receivables.

Asset reconstruction has been defined to mean acquisition by the companies of the rights and interests of any bank or FI for realisation of the financial assistance rendered by them. The companies are really debt collectors, given sweeping powers which were so far exercised by debt recovery tribunals and civil courts and were not available to the debt recovery department of the lenders themselves.

While asset reconstruction may be deemed as the main objective or function of these bodies, securitisation and provision for enforcement of security interest are intended to enable the process of recovery of the securitised debts easier and quicker. The powers for enforcement of security enables smooth take over of the assets, and the sale proceeds of securitisation bonds will be available to take make payment for the originator for acquisition of the secured assets. They are to act as in-built facilitators for the process of Asset Reconstruction. Securitisation serves as a means of self-financing the activities of ARCs without the Government or PSBs or the Private Sector obliged to contribute huge initial equity to incorporate the Company. As per the Ordinance ARC/SC Companies are oblige to provide for initial equity of Rs.2 Crores. Subsequently the owned capital need not exceed15% of the value of the assets acquisitioned. It is possible to conduct this business with the limited owned capital in proportion to the turnover contemplated only because the concepts of securitisation and asset reconstruction are combined.