When the borrower stops paying interest or principal on a loan, the lender will lose money.

Such
a loan is known as Non-Performing Asset (NPA). Indian Banking industry is seriously affected
by Non-Performing Assets.

In the best interest of our readers, we have come up with a comprehensive post on NPAs, in
which analyze the entire issue in detail. We will also list out the entire steps taken by
Government and RBI to counter the situation.

What is a Non-Performing Asset (NPA)?

 You may note that for a bank, the loans given by the bank is considered as its assets. So if
the principle or the interest or both the components of a loan is not being serviced to the
lender (bank), then it would be considered as a Non-Performing Asset (NPA).
 Any asset which stops giving returns to its investors for a specified period of time is
known as Non-Performing Asset (NPA).
 Generally, that specified period of time is 90 days in most of the countries and across the
various lending institutions. However, it is not a thumb rule and it may vary with the
terms and conditions agreed upon by the financial institution and the borrower.

An example of NPA:
Suppose the State Bank of India (SBI) gives a loan of Rs. 10 crores to a company (Eg:
Kingfisher Airlines). Consider that they agreed upon for an interest rate of say 10% per annum.
Now suppose that initially everything was good and the market forces were working in support
to the airline industry, therefore, Kingfisher was able to service the interest amount. Later, due to
administrative, technical or corporate reasons suppose the company is not able to pay the interest
rates for 90 days. In that case, a loan given to the Kingfisher Airlines is a good case for the
consideration as NPA.

NPAs definition by Reserve Bank of India (RBI)

 An asset, including a leased asset, becomes nonperforming when it ceases to generate
income for the bank.

Technical definition by RBI on NPA on different cases

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.
  The instalment of principal or interest thereon remains overdue for two crop seasons for
short duration crops.
 The instalment of principal or interest thereon remains overdue for one crop season for
long duration crops.
 The amount of liquidity facility remains outstanding for more than 90 days, in respect of
a securitisation transaction undertaken in terms of guidelines on securitisation dated
February 1, 2006.
 In respect of derivative transactions, the overdue receivables representing positive mark-
to-market value of a derivative contract, if these remain unpaid for a period of 90 days
from the specified due date for payment.

Categories of Non-Performing Assets (NPAs)

Based upon the period to which a loan has remained as NPA, it is classified into 3 types:

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Categories of NPAs Criteria
An asset which remains as NPAs for less than or equal to 12
Substandard Assets
months.
An asset which remained in the above category for 12
Doubtful Assets
months.
Asset where loss has been identified by the bank or the RBI,
Loss Assets however, there may be some value remaining in it. Therefore
loan has not been not completely written off.
How serious is India’s NPA issue?

 More than Rs. 7 lakh crore worth loans are classified as Non-Performing Loans in India.
This is a huge amount.
 The figure roughly translates to near 10% of all loans given.
 This means that about 10% of loans are never paid back, resulting in substantial loss of
money to the banks.
 When restructured and unrecognised assets are added the total stress would be 15-20% of
total loans.
 NPA crisis in India is set to worsen.
 Restructuring norms are being misused.
 This bad performance is not a good sign and can result in crashing of banks as happened
in the sub-prime crisis of 2008 in the United States of America.
  Also, the NPA problem in India is worst when comparing other emerging economies in
BRICS.

What can be the possible reasons for NPAs?

 Diversification of funds to unrelated business/fraud.
 Lapses due to diligence.
 Busines losses due to changes in business/regulatory environment.
 Lack of morale, particularly after government schemes which had written off loans.
 Global, regional or national financial crisis which results in erosion of margins and
profits of companies, therefore, stressing their balance sheet which finally results into
non-servicing of interest and loan payments. (For example, the 2008 global financial
crisis).
 The general slowdown of entire economy for example after 2011 there was a slowdown
in the Indian economy which resulted in the faster growth of NPAs.
 The slowdown in a specific industrial segment, therefore, companies in that area bear
the heat and some may become NPAs.
  Unplanned expansion of corporate houses during the boom period and loan taken at low
rates later being serviced at high rates, therefore, resulting in NPAs.
 Due to mal-administration by the corporates, for example, willful defaulters.
 Due to misgovernance and policy paralysis which hampers the timeline and speed of
projects, therefore, loans become NPAs. For example the Infrastructure Sector.
 Severe competition in any particular market segment. For example the Telecom sector in
India.
 Delay in land acquisition due to social, political, cultural and environmental reasons.
 A bad lending practice which is a non-transparent way of giving loans.
 Due to natural reasons such as floods, droughts, disease outbreak, earthquakes, tsunami
etc.
 Cheap import due to dumping leads to business loss of domestic companies. For example
the Steel sector in India.

What is the impact of NPAs?

 Lenders suffer a lowering of profit margins.
 Stress in banking sector causes less money available to fund other projects, therefore,
negative impact on the larger national economy.
 Higher interest rates by the banks to maintain the profit margin.
 Redirecting funds from the good projects to the bad ones.
 As investments got stuck, it may result in it may result in unemployment.
 In the case of public sector banks, the bad health of banks means a bad return for a
shareholder which means that the government of India gets less money as a dividend.
Therefore it may impact easy deployment of money for social and infrastructure
development and results in social and political cost.
 Investors do not get rightful returns.
 Balance sheet syndrome of Indian characteristics that is both the banks and the
corporate sector have stressed balance sheet and causes halting of the investment-led
development process.
 NPAs related cases add more pressure to already pending cases with the judiciary.

What are the various steps taken to tackle NPAs?

NPAs story is not new in India and there have been several steps taken by the GOI on legal,
financial, policy level reforms. In the year 1991, Narsimham committee recommended many
reforms to tackle NPAs. Some of them were implemented.

The Debt Recovery Tribunals (DRTs) – 1993

To decrease the time required for settling cases. They are governed by the provisions of the
Recovery of Debt Due to Banks and Financial Institutions Act, 1993. However, their number is
not sufficient therefore they also suffer from time lag and cases are pending for more than 2-3
years in many areas.
Credit Information Bureau – 2000

A good information system is required to prevent loan falling into bad hands and therefore
prevention of NPAs. It helps banks by maintaining and sharing data of individual defaulters and
willful defaulters.

Lok Adalats – 2001

They are helpful in tackling and recovery of small loans however they are limited up to 5 lakh
rupees loans only by the RBI guidelines issued in 2001. They are positive in the sense that they
avoid more cases into the legal system.

Compromise Settlement – 2001

It provides a simple mechanism for recovery of NPA for the advances below Rs. 10 Crores. It
covers lawsuits with courts and DRTs (Debt Recovery Tribunals) however willful default and
fraud cases are excluded.

SARFAESI Act – 2002

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAESI) Act, 2002 – The Act permits Banks / Financial Institutions to recover their NPAs
without the involvement of the Court, through acquiring and disposing of the secured assets in
NPA accounts with an outstanding amount of Rs. 1 lakh and above. The banks have to first issue
a notice. Then, on the borrower’s failure to repay, they can:

1. Take ownership of security and/or

2. Control over the management of the borrowing concern.
3. Appoint a person to manage the concern.

Further, this act has been amended last year to make its enforcement faster.

ARC (Asset Reconstruction Companies)

The RBI gave license to 14 new ARCs recently after the amendment of the SARFAESI Act of
2002. These companies are created to unlock value from stressed loans. Before this law came,
lenders could enforce their security interests only through courts, which was a time-consuming
process.

Corporate Debt Restructuring – 2005

It is for reducing the burden of the debts on the company by decreasing the rates paid and
increasing the time the company has to pay the obligation back.

5:25 rule – 2014

Also known as, Flexible Structuring of Long Term Project Loans to Infrastructure and
Core Industries. It was proposed to maintain the cash flow of such companies since the project
timeline is long and they do not get the money back into their books for a long time, therefore,
the requirement of loans at every 5-7 years and thus refinancing for long term projects.

Joint Lenders Forum – 2014

It was created by the inclusion of all PSBs whose loans have become stressed. It is present so as
to avoid loan to the same individual or company from different banks. It is formulated to prevent
the instances where one person takes a loan from one bank to give a loan of the other bank.

Mission Indradhanush – 2015

The Indradhanush framework for transforming the PSBs represents the most comprehensive
reform effort undertaken since banking nationalization in the year 1970 to revamp the Public
Sector Banks (PSBs) and improve their overall performance by ABCDEFG.
A-Appointments: Based upon global best practices and as per the guidelines in the companies
act, separate post of Chairman and Managing Director and the CEO will get the designation of
MD & CEO and there would be another person who would be appointed as non-Executive
Chairman of PSBs.

B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials, which
will replace the Appointments Board for the appointment of Whole-time Directors as well as
non-Executive Chairman of PSBs

C-Capitalization: As per finance ministry, the capital requirement of extra capital for the next
four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000 crores will
be provided by the GOI and the rest PSBs will have to raise from the market.

Financial Year Total Amount

FY15-16 25,000 Crore
FY16-17 25,000 Crore
FY17-18 10,000 Crore
FY18-19 10,000 Crore
Total 70,000 Crore

D-DEstressing: PSBs and strengthening risk control measures and NPAs disclosure.

E-Employment: GOI has said there will be no interference from Government and Banks are
encouraged to take independent decisions keeping in mind the commercial the organizational
interests.

F-Framework of Accountability: New KPI(key performance indicators) which would be linked

with performance and also the consideration of ESOPs for top management PSBs.

G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial
institutions. Bank board Bureau for transparent and meritorious appointments in PSBs.

Strategic debt restructuring (SDR) – 2015

Under this scheme banks who have given loans to a corporate borrower gets the right to convert
the complete or part of their loans into equity shares in the loan taken company. Its basic purpose
is to ensure that more stake of promoters in reviving stressed accounts and providing banks with
enhanced capabilities for initiating a change of ownership in appropriate cases.

Asset Quality Review – 2015

Classify stressed assets and provisioning for them so as the secure the future of the banks and
further early identification of the assets and prevent them from becoming stressed by appropriate
action.

Sustainable structuring of stressed assets (S4A) – 2016

It has been formulated as an optional framework for the resolution of largely stressed accounts.
It involves the determination of sustainable debt level for a stressed borrower and bifurcation of
the outstanding debt into sustainable debt and equity/quasi-equity instruments which are
expected to provide upside to the lenders when the borrower turns around.

Insolvency and Bankruptcy code Act-2016

It has been formulated to tackle the Chakravyuaha Challenge (Economic Survey) of the exit
problem in India. The aim of this law is to promote entrepreneurship, availability of credit, and
balance the interests of all stakeholders by consolidating and amending the laws relating to
reorganization and insolvency resolution of corporate persons, partnership firms and individuals
in a time-bound manner and for maximization of value of assets of such persons and matters
connected therewith or incidental thereto.

Pubic ARC vs. Private ARC – 2017

This debate is recently in the news which is about the idea of a Public Asset Reconstruction
Companies (ARC) fully funded and administered by the government as mooted by this year’s
Economic Survey Vs. the private ARC as advocated by the deputy governor of RBI Mr. Viral
Acharya. Economic survey calls it as PARA (Public Asset Rehabilitation Agency) and the
recommendation is based on a similar agency being used during the East Asian crisis of 1997
which was a success.

Bad Banks – 2017

Economic survey 16-17, also talks about the formation of a bad bank which will take all the
stressed loans and it will tackle it according to flexible rules and mechanism. It will ease the
balance sheet of PSBs giving them the space to fund new projects and continue the funding of
development projects.

Summary
The need of the hour to tackle NPAs is some urgent remedial measures. This should include:

 Technology and data analytics to identify the early warning signals.

 Mechanism to identify the hidden NPAs.
 Development of internal skills for credit assessment.
 Forensic audits to understand the intent of the borrower

NPA in Banking Sector

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Search 6th March, 2018 Spotlight here:

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TOPIC:

 General Studies 2: Government policies and interventions for development in various sectors
and issues arising out of their design and implementation; Important aspects of governance,
transparency and accountability
 General Studies 3: Indian Economy and issues relating to mobilization of resources, growth,
development

In News: The non-performing assets (NPAs) in the Indian banking system have become a big
concern – posing a threat to the stability of the country’s financial system and the economy.
India has been ranked fifth on the list of countries with the highest Non-Performing Assets
(NPAs), by CARE Ratings.

What is NPA?
NPA in terms of RBI regulations result out of non-payment of interest for a period of 90 days or
non-payment of principle amount for 90 days or more. So beyond that point, it is called Non-
Performing Asset. The loan is taken by the company on its assets from the bank. When the asset
is not performing because they become doubtful and NPAs from doubtful become bad loans.

A glimpse into the history:

The problem name NPA is not of recent origin. Few years back, India suffered from a huge
infrastructuregap and the banking sector was encouraged to get themselves into a lending spree
for companies willing to undertake various projects. Public Sector Banks were actually pushed to
provide loans for projects that were floated largely by the private sector.

The following have caused distress in the banks’ assets and have played part in the mounting
NPAs –

 Prolonged downturn in the world economy,

 Falling commodity prices,
 Lack of due diligence and adherence to rules (inadequate and poor risk assessment of the
proposals by the banks)
 Complex workings of the bureaucracy,
 Typical bureaucratic red tape,
 Long delays and gestation periods of several infrastructure projects,
 Delays in land acquisition and
 Politically inspired agitations

The NPA “SAMADHAN” Project

 Resolution process must move on smoothly – and not be stalled by long drawn legal wrangling’s.
Longer the delay, the resolution of assets will be postponed further. The capital that is blocked
in the NPA would not yield anything and will continue remaining stressed.
 It is important to recognize that even if we could resolve quickly, no matter the amount of
“haircut” there exists a major upside for both the economy and the bank:
o Economy: 1000 of stalled projects will come back contributing to the growth and
positive GDP evaluation
o Bank: As they have been provided for 100% for the stressed assets, at leasttheir
financialhealthwould turn better.
 Issues causing moral hazard: Do we allow promoters who have made these assets stressed, to
bid directly or indirectly for the same projects?
o Government has taken a decision that promoters who have stressed assets to their book
of accounts should not be allowed to bid for any further stressed asset.
o Resolution process must be pragmatic –Rules must be clear upfront. Tricky questions
should not be allowed to clout and delay the process of resolution. Correct procedures
should be followed.

The Way Forward:

  Post resolving stressed assets, there is no guarantee that it will not come up again.To prevent a
recurrence of such failure, it is important to reform not just governance, but also regulatory
oversight. The failures of banking regulation must be addressed and checks and balances
created.
 Consolidation could be the first step for stringer balance sheet but the next step should be to
reduce government’s stake to below 49% so that the banks can work without any political
influence.
 Need to be mindful of the 4 Rs —
o ‘Recognition’ of assets close to their true value
o ‘Recapitalisation’ or infusion of equity for banks to protect their capital
o ‘Resolution’ in the form of selling underlying stressed assets
o ‘Reform’, through the right future incentives for the private sector and corporates to
ensure there is no repeat of the twin balance sheet syndrome.

Connecting the Dots:

1. What is Non-Performing Assets (NPA)? Why are they detrimental for the economy? Examine.
2. NPAs or stressed assets have adversely affected the banking system in India. In this light,
identify the factors that have led to this status and also examine the steps taken by the
Government and the RBI to address the same.
3. Which major sectors contribute the maximum to bad loans or NPAs in India? What is the way
out? Analyse.

3 April 2019

Title 6. RBI circular to banks on loan defaulters quashed (The Hindu Page 1)
Syllabus Prelims: Economy
Mains: GS III – Economy
Theme RBI circular struck down by Supreme Court
Highlights In order to strengthen the framework for the resolution of stressed assets, the RBI had issued a
circular on Feb 12, 2018. However, the Supreme Court has recently stuck down this circular.

What was the RBI's February Circular?

 It introduced a new framework to deal with the problem of NPAs. Under the new framework,
the RBI discontinued programmes for banks to restructure their defaulted loans such as
corporate debt restructuring (CDR), sustainable structuring of stressed assets (S4A), strategic
debt restructuring (SDR) and made the Insolvency and Bankruptcy Code as the main tool to
deal with defaulters.
 The framework made it mandatory for banks to identify signs of incipient stress in loan
accounts and classify stressed assets as Special Mention Account (SMA), immediately on
default. Even a single day's default would require reporting to the RBI and implementation of
Resolution Plan.
 Furthermore, lenders were asked to finalise a resolution plan in case of a default on large
accounts of Rs 2,000 crore and above within 180 days, failing which insolvency proceedings
would be invoked against the defaulter under the Insolvency and Bankruptcy Board.
 Rationale for Introducing February Circular
 Earlier the Banks had resorted to “ever greening” of bad loans in order to keep their NPAs at
the lower level.
 Further, the schemes introduced by RBI such as corporate debt restructuring (CDR),
sustainable structuring of stressed assets (S4A) etc were quite lenient and most of the times,
the resolution plans were not finalised on time leading to undue delays in recovering bad
loans.
 The circular was intended to identify the stress levels in the banks at an earlier stage and
immediately take necessary steps for their resolution.

Why was the circular challenged before the Supreme Court?

 Several companies from the power sector and shipping sector had argued that the RBI's
circular was based on "One-Size-fits-all" approach.
 These companies were facing problems that were beyond their control and hence it was
extremely difficult for them to implement the resolution plan .For example, the power
producers had argued that they faced shortage of fuel and delays in regulatory clearances
which were beyond their control.
 In this regard, even the Indian Banks Association (IBA) had sought relaxation in the RBI's
norms for infrastructure and power companies.

Why did the SC declare the circular as ultra-vires?

 The Supreme Court took recourse to two sections of the Banking Regulation Act, 1949 to
declare the circular as ultra-vires. The Section 35A talks about general powers of RBI to issue
directions to banking companies, Section 35AA gives power to the Central Government to
authorize RBI to direct any bank to initiate insolvency process in respect of a default.
 The RBI sought to sustain the circular by tracing its source to the general powers under
Section 35A, instead of Section 35AA, which is inserted as per 2017 amendment. The RBI
had argued that since no authorization from Central Government is needed to exercise powers
under Section 35A, the circular was valid, argued the RBI.
 On the other hand, the SC ruled that after the insertion of Section 35AA in 2017 with a
specific condition of authorization from central government, recourse cannot be made to
general powers under Section 35A for issuing directions to take insolvency action in respect of
bad debts.
 Apart from that, the general application of Circular to all debts above Rs. 2000 crores was
challenged by petitioners as it failed to draw a distinction between various forms of "stressed
assets" from different industrial sectors.
 They further contended that the circular failed to distinguish between genuine and wilful
defaulters. The Court held that reference to IBC under Section 35AA can be made only on a
case to case basis, and that there cannot be a blanket direction to that effect.

Likely impact of the SC Judgment

  Delay in the process of resolution of stressed assets
 No likely impact on the resolution that have already been completed or under the due process
 Relief to the stressed power sector companies
Personal
Notes