In India, it seems easy to lend money, but it is difficult to get it back. Just ask our banks. New law, and associated institutional infrastructure, for bankruptcy is in the pipeline, with the draft Insolvency and Bankruptcy Code by the T. K. Vishwanathan Committee. Will it work? What can the impediments be that could limit its effectiveness?
One of the key weapons in a lender's armoury is the collateral (or security) from the borrower. The quality of the collateral - how easy it is to collect, store, value and dispose of - determines the type and extent of credit that a lender is willing to provide. Land and associated real estate constitute a large part of collateral in India. More than 50 percent of corporate loans and 60 percent of retail loans have land and real estate as collateral. It is hence important to understand the complex nature of land markets to determine whether they would facilitate or undermine the effectiveness of these new laws. We examine this issue in a recent paper titled Distortions in Land Markets and Their Implications to Credit Generation in India.
The land market in India is not a homogenous national market but a heterogeneous collection of various State markets with variation in laws and regulations. This is because land related issues fall under the State and Concurrent List under our Constitution. This poses the first big problem: it is not easy to provide credit across state boundaries unless lenders have local presence or partners to count on. Even when land is accepted as collateral, several factors exist that could raise costs and risks for lenders. Let's run through the list of challenges faced by the lender.
Challenge 1: Does the land belong to the borrower?
It is hard to say because titles are not guaranteed by the State (like the Torrens system used in countries like Australia). Hence, all evidence of title is merely presumptive and can be challenged at any point by a person claiming to have better title to the land.
To mitigate the risk of future challenges to title, lenders spend considerable resources, including legal help, to conduct title searches, to protect themselves. A title search can be a fairly complex and expensive exercise in the Indian setting. This is because:
- Indian law does not mandate the registration of every single transaction that affects rights in or the enjoyment of, property. Hence, records of some transactions that affect title or enjoyment of property will not be found in any public office.
- Land records in India are spread across three offices - the Sub-Registrar's office, the revenue offices and the offices of the survey department. Time lags between these offices in updation of land records, often lead to inconsistencies in information obtained from these three offices.
- Title related disputes in courts require a search process in the courts, as the status of the dispute may not be reflected in the records in the Sub-Registrar's office or the revenue offices.
- A title search is necessarily a local exercise, as land records are maintained in local offices in local languages. The contents of land records across States are not standardised. Several State laws have restrictions on the transferability of land, depending on the land classification. For instance, in most States, agricultural land cannot be transferred to a non-agriculturist. The localisation of the title investigation process adds to transaction costs.
Challenge 2: Has the land been already pledged with other lenders?
There is no single point of information on all the processes and transactions that can encumber land. Again, some transactions which create encumbrances on land (such as the mortgage by deposit of title deeds) are not required to be registered. Consequently, the records of such mortgages cannot be found in any public office.
The Central Registry of Securitisation Asset Reconstruction and Security Interest of India, or CERSAI, was set up to consolidate information about mortgages against property. However, its scope is limited: it does not include reconstruction loans outside the purview of the SARFAESI Act or loans given out by entities other than banks. Nor does it have information about all loans issued prior to 2011 when CERSAI was set up. Further, since the registry requires identification of land clearly, the importance of accurately mapping land boundaries becomes critical for its success. Accurate mapping of land boundaries has its own set of problems as described next.
Challenge 3: Is the land properly identifiable in classified records?
Land parcel identification is a challenge since cadastral maps are outdated and rarely reflect the reality on the ground. As mentioned above, record-keeping of various related aspects of land - titles and registrations, encumbrances, geographic information sources, revenue and taxation - is done in silos by various departments, often leading to conflicting information on the same land parcel. The problem is more acute in rural areas, where use of technology is still limited. The use of different units (acres, hectares etc.), terms (like Khata in Karnataka and Patta in Tamil Nadu) and bookkeeping standards across states present their own set of difficulties in identifying land across States, thus hampering the economies of scale of running a nationwide lending business.
Challenge 4: Do the constructions/settlements on the land adhere to local laws, and have all dues been properly paid?
Important attributes such as flood plain, seismic zone, lake encroachments, easements and rights of way etc. also cannot be conclusively established given the siloed nature of record keeping. If not properly accounted for through pricing, these attributes could pose significant risk to lenders. The recent announcement in Bengaluru that several lake beds have been encroached by entities including the Bangalore Development Authority - the agency obligated to protect lake beds - shows the extent of risk to lenders who have financed development activity on such land.
The problem is exacerbated where the collateral is built-up property. In the case of built-up collateral, the lender is also required to verify whether the building complies with city-level zoning regulations and has the requisite building permissions. This is to avoid the possibility of the future demolition of the collateralised property which is not compliant with the local laws. The value of the collateral may also change depending on issues such as the area on the land, if any, earmarked for municipal road widening, changes in town planning norms, etc. This requires searches in the local municipal offices.
Challenge 5: Is the value of land sufficient enough to cover the loan in case of distress?
Land valuation is done by lenders at the time of loan origination, and after the borrower has exhibited distress. Empanelled valuers use a combination of recent transactions and government estimates (called guidance values or circle rates) to derive land values that are used by lenders. Given the significant presence of black money in land transactions, getting true market values is more an art than science. Issues such as defective land title and illegal developments, mentioned above, impede land values but are hard to account for at the time of origination of the loan.
Challenge 6: If there is default, can the land be sold to recover dues owed easily?
The battle to recover the collateral really begins after default. The SARFAESI Act has shortened the recovery process for banks and financial institutions. However, it leaves out creditors who are not banks and financial institutions such as creditors of firms which have borrowed through secured bond issuances. For such creditors, a mortgage foreclosure suit will, under current law, have to go through the delays associated with civil courts. Moreover, the implementation and interpretation of the SARFAESI Act has not been free of problems. For instance, proceedings under the SARFAESI Act are often delayed through writ petitions or simultaneous proceedings which are pending in other fora (Ravi, 2015). Similarly, the SARFAESI Act does not resolve the problems of already encumbered collateral or collateral with no marketable title. For example, a bank or a financial institution cannot evict tenants of collateralised property under SARFAESI. This proposition was recently upheld by the Supreme Court in Vishal Kalsaria v. Bank of India and Others, January 2016.
Bankruptcy reform is important and valuable in and of itself. Land market reform is important and valuable in and of itself. Given the prominence of land as collateral in the working of the Indian credit market, improved working of the land market is an important enabler of a better functioning credit market and improved working of the bankruptcy code. Parallel and simultaneous progress on both fronts will yield a magnified impact upon the economy.
While the Bankruptcy Code is expected to improve recovery proceedings, it will not help where the title to the collateral itself is challenged at the time of recovery. Unlike movable collateral, the ability of a creditor to monetise immovable collateral quickly is fettered. Indian lenders have, so far, rationally responded to these issues by protecting themselves through credit rationing and through solutions like personal guarantees. Also, due to the difficult process of establishing title and related encumbrances, urban lands - where recovery time and cost are high - are subject to higher loan to value ratios.
One part of the reforms agenda is structural, and involves significant fiscal outlays, for cleaning up land titles, improving the quality of land registry through digitisation, overhauling the land litigation system and creating efficient stamp duty and registration processes. In addition, in the paper, we propose many modest, feasible and less expensive reforms. To begin with, we must standardise land-related data capture across states and create a repository of valuers' data that can be shared across lenders. Similarly, States need to focus their energies on building capacity in land record offices to enable smooth and efficient updation of land records. While creating conclusive titles with state guarantees is a laudable and ultimate goal, there are numerous opportunities for front-loading gains by streamlining existing land records using modern technology, and facilitating private title insurance to mitigate risk from lending against land.
Most of the challenges described above relate to the structure of information. Modern technology -- computers, telecom networks, GPS, Aadhaar, ubiquitous digital cameras -- has created a new opportunity to build improved institutional infrastructure for creating, storing and disseminating information that would transform the land market.
Aparna Ravi, The Indian insolvency regime in practice -- an analysis of insolvency and debt recovery proceedings, Economic and Political Weekly, 2015.
J. Zasloff, India's Land Title Crisis: The Unanswered Questions, Jindal Global Law Review, 2011.
K. P. Krishnan is at the Department of Land Resources, Government of India. Venkatesh Panchapagesan and Madalasa Venkataraman are researchers at the Indian Institute of Management, Bangalore.