BANKING AND DEBT RECOVERY: A COMPARATIVE STUDY OF THE LAW AND PRACTICE IN INDIA, SRI LANKA AND MALAYSIA BY SONALI GOTHAMI ABEYRATNE THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY LONDON SCHOOL OF ECONOMICS AND POLITICAL SCIENCE UNIVERSITY OF LONDON 1998 UMI Number: U148667 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Dissertation Publishing UMI U148667 Published by ProQuest LLC 2014. Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 British Library of Political and Economic Science ABSTRACT OF THESIS Current economic development law theories and technical assistance practices of international financial institutions emphasise the critical importance for an emerging or transitioning economy in moving towards a market orientated system, to have in place a modem commercial law infrastructure so that the economy can develop robust credit and other financial markets and can attract internal and external capital investments. One essential element o f this desired commercial law infrastructure is a legal and judicial framework that provides for an efficient and prompt debt recovery process. Unfortunately, recent studies indicate that, in most developing countries debt recovery is in crisis. The subject matter of this volume will be debt recovery in South Asia countries of India, Sri Lanka and Malaysia. These countries have been chosen for different reasons: India because it represents one of the largest emerging economies; Sri Lanka because its relevant legal system is a mix of English Common Law and Roman Dutch Law concepts; and Malaysia because it has achieved significant economic and financial modernisation through a rather special governmental-societal approach. Hopefully such a comparative analysis will shed some light on how to improve debt recovery laws in emerging economies in a manner conducive to sustainable economic and social development. The ultimate thesis o f this manuscript is that a suitable debt recovery system for an emerging economy requires, not simply suitable laws and judicial remedies, but also appropriate financial industry practices as to credit allocation and loan supervision; a broad range of fair and effective enforcement mechanisms; and an independent, commercial trained and responsive judiciary. The conclusion looks at the present state of the development of the banking sector in the selected three countries, with special attention being given to the apparent tensions between the market orientated policies that are being ambitiously pursued and the laws that govern credit, security and debt recovery. 2 Section TABLE OF CONTENTS Page ABSTRACT OF THESIS 2 PREFACE 7 CHAPTER ONE 10 INTRODUCTION 1.1 THE NEW MARKET ECONOMIES 10 1.1.1 Foundations for a Sound Market Economy 12 1.2 MARKET REFORMS AND GOOD GOVERNANCE 13 1.3 THE ABSENCE OF A MARKET FRIENDLY LEGAL ENVIRONMENT 18 1.3.1 Characteristics of a Market Friendly Legal Environment 19 1.4 DEBT RECOVERY: THE PROBLEMS 23 1.4.1 Debt Recovery in India, Sri Lanka and Malaysia 25 1.5 SCOPE OF THE THESIS 28 CHAPTER TWO 31 CREDIT ALLOCATION AND DEBT RECOVERY: THE REFORM CONTEXT 2.1 INTRODUCTION 31 2.2 MAJOR FINANCIAL REFORMS IN INDIA -POST INDEPENDENCE YEARS 35 2.2.1 Social Controls 36 2.2.2 Nationalisation Of Banks - First Banking Revolution 3 7 2.2.2.1 Effects of the Nationalisation Programme 39 2.2.3 Financial Sector Reforms in 1991- Second Banking Revolution 41 2.2.3.1 Narasimham Committee Report on the Financial System 42 2.2.4 Salient Features of Financial Reforms in the Banking Sector - Post 1991 46 2.2.4.1 Interest Rate Policy 4 7 2.2.4.2 Directed Credit 49 2.2.4.3 Institutional Strengthening 50 2.3 ECONOMIC AND FINANCIAL REFORMS IN SRI LANKA 52 2.3.1 An Open Market Economy: 1948-1956 53 2.3.2 Shift Towards a Planned Economy: 1956-1965 54 2.3.3 Semi-Planned Economy: 1965-1970 55 2.3.4 Inward-Looking, Closed, Controlled Economy: 1970- 1977 56 2.3.5 Outward-Looking Economy with a Heavy Market Orientation : 1977- 57 2.3.5.1 Financial Sector Reforms 58 2.3.5.2 Liberalisation of Interest Rates 59 2.3.5.3 Credit Allocation 60 2.3.5.4 Institutional Strengthening 63 2.4 ECONOMIC AND FINANCIAL REFORMS IN MALAYSIA 67 2.4.1 Interest Rate Reforms 70 2.4.2 Credit Controls 71 3 Institutional Strengthening 72 Islamic Banking 74 THE CENTRAL BANKS AND THEIR ROLE 76 Monetary Instruments 77 CONCLUSION 79 CHAPTER THREE 88 CREDIT ALLOCATION AND LOAN SUPERVISION INTRODUCTION 88 CREDIT APPRAISAL 92 ‘Five C ’s in Credit Appraisal 93 Credit Appraisal in India, Sri Lanka and Malaysia 95 CREDIT INFORMATION 97 Information Provided by Banks 98 Information Provided by Credit Reference Agencies 102 LENDING AGREEMENTS 106 Usury and Money Lending Legislation in India 108 Usury and Money Lending Legislation In Sri Lanka 109 Money Lending Legislation In Malaysia 111 Terms of a Loan 112 Documentation 114 LOAN SUPERVISION 119 INFORMAL CREDIT 123 Role of Informal Credit and Institutional Credit 124 Banking for the Poor 127 New Approach To Rural Lending 130 CONCLUSION 133 CHAPTER FOUR 139 ENFORCEMENT OF SECURITY INTRODUCTION 139 RANGE OF AVAILABLE SECURITY IN INDIA 143 Security Over Immovable Property 144 Security Over Movable Property 147 RANGE OF SECURITY AVAILABLE IN SRI LANKA 151 Immovable Property as Security 152 Movable Property as Security 154 RANGE OF AVAILABLE SECURITY IN MALAYSIA 159 Security Over Immovable Property 159 Security Over Movables 163 ENFORCEMENT OF SECURITY IN INDIA 166 Enforcement of Mortgage Security Under the Transfer of Property Act, 1882 167 Enforcement Of Rights Under a Pledge or Hypothecation 171 Receivership Under the Companies Act, 1956 172 4 4.6 ENFORCEMENT OF SECURITY IN SRI LANKA 173 4.6.1 Parate Execution Under the Recovery Of Loans By Banks (Special Provisions) Act, 1990 174 4.62 Enforcement Of Mortgage Security Under The Mortgage Act, 1949 176 4.6.3 Receivership Under The Companies Act, 1982 178 4.7 ENFORCEMENT OF SECURITY IN MALA YSIA 178 4.7.1 Enforcement of Real Property Security Under the National Land Code, 1950 179 4.7.2 Enforcement of a Pledge 182 4.7.3 Appointing a Receiver Under the Companies Act, 1965 182 4.8 PROBLEMS OF ENFORCING SECURITY 183 4.8.1 Industrial Sickness in India 183 4.8.2 Power of Extra Judicial Sale Under The Transfer of Property Act, 1882 186 4.8.3 Enforcing a Hypothecation in India 187 4.8.4 The Sri Lankan Recovery of Loans by Banks (Special Provisions) Act of 1990 189 4.8.5 Restriction on Receiver’s Powers in Malaysia 192 4.8.5.1 The Kimlin Decision 192 4.8.6 Muslim Culture in Malaysia 194 4.9 CONCLUSION 195 CHAPTER FIVE 199 RECOVERY THROUGH THE COURTS 5.1 INTRODUCTION 199 5.2 ORDINARY ACTIONS IN INDIA AND SRI LANKA 201 5.3 ORDINARY ACTIONS IN MALAYSIA 204 5.4 SUMMARY PROCEDURE 209 5.4.1 Objective 209 5.4.2 Summary Procedure in India and Sri Lanka 210 5.4.3 Summary Procedure in Malaysia 213 5.5 DEBT RECOVERY SUITS FILED UNDER SPECIAL LEGISLATION 215 5.5.1 The Indian Recovery of Debts Due To Banks & Financial Institutions Act, 1993 215 5.5.2 The Sri Lankan Debt Recovery (Special Provisions) Act of 1990 221 5.6 WINDING UP IN INDIA, SRI LANKA AND MALAYSIA 224 5.7 RECEIVERSHIP IN INDIA, SRI LANKA AND MALAYSIA 230 5.8 DELA YS IN THE COURTS 233 5.8.1 Causes of Delay and Backlog of Cases 234 5.9 CONCLUSION 244 CHAPTER SIX 250 FINAL OBSERVATIONS AND RECOMMENDATIONS 6.1 TENSIONS BETWEEN MARKET REFORMS AND THE LAW 250 6.1.1 Greater Access to Foreign Lenders 251 6.1.2 Protecting the Rights of Creditors 253 6.1.3 A Modern Insolvency Law 254 6.1.4 Lending and Security 259 5 6.2 LA WAND PRACTICE OF CREDIT ALLOCATION AND DEBT RECOVERY 261 6.2.1 Credit Allocation and Debt Recovery: The Reform Context 261 6.2.2 Credit Allocation and Loan Supervision 262 6.2.3 Enforcement of Security 265 6.2.4 Debt Recovery Through The Courts 270 6.3 CONCLUSIONS 275 BIBLIOGRAPHY 278 INTERVIEWS 292 6 PREFACE On 12 February 1996 the London School of Economics conducted a seminar for its new research students on “How to do your PhD.” We were told: "...you are required to write a thesis on a chosen topic to a maximum of 100,000 words, not a Royal Charter! ” Described in this manner, the task ahead appeared to be less daunting. Nevertheless, it was not an easy one, and I could not have accomplished it without the assistance and support of many. I am however, solely responsible for what is written in this thesis. I have been very fortunate to have my research supervised by Professor Ross Cranston, Cassel Professor of Commercial Law at the London School of Economics, (as he then was) one of the foremost authorities in Banking Law in the United Kingdom. I am indebted to him for his guidance and support throughout my research. He has always been available to discuss problems of an academic nature and been understanding and sympathetic where it has been more personal.