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Insights into Issues: Non Performing Assets



Insights into Issues: Non Performing Assets


What are NPAs 

A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.

1. Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.

2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.

3. Loss assets: As per RBI, “Loss 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.” 


Status of NPA:


NPA problem is one of the most severe plaguing the Indian Banking sector posing questions over the stability of Indian Banking System. Raghuram Rajan, the ex Governor of RBI has identified the NPA problem as a major challenge facing the Indian Banking Sector. The problem which was largely hidden earlier as Banks used to do window dressing of their account statement has now come to the forefront after Rajan exhorted the banks to clean up their asset books by March 2017. Resultantly this led to 29 public sector banks writing off Rs1.14 Lakh Crore of bad debts between 2013 -2015, much more than what they had done in the preceding 9 years.


  • The gross bad loans of 39 listed Indian banks, in absolute term, rose 92% in fiscal year 2016 to Rs.5.79 trillion even as after provisioning, the net bad loans more than doubled to Rs.3.38 trillion.
  • In percentage terms, the average gross non-performing assets (NPAs) of this group of banks rose from 4.41% of loans in 2015 to 7.91% in 2016; net NPAs in the past one year rose from 2.45% to 4.63%.
  • Public sector banks, which have close to 70% market share of loans, are more affected than their private sector peers. Two of them have over 15% gross NPAs and an additional eight close to 10% and more.
  • If we include restructured loans as well as those loans that have been written off, the total stressed assets could be as much as one-fourth of loans, at least for some of the government-owned banks.


Impact of NPAs on Banks:


  1. Banks have to adhere to the provisioning norms set by RBI for the bad loans which eats into their profitability. This leads to banks having lesser capital to deploy, shareholders losing money and banks finding it tough to survive in the market
  2. If banks do not classify an asset as NPA, they naturally have more money to advance to earn interest income on. If large NPAs goes unreported, the bank could reach a situation, where it has advanced more money than it has available leading to a situation of technical bankcruptcy.
  3. In light of attaining the Bessel norms, the burden on maintaining Capital Adequacy Ratio increases
  4. It also affects the competitive position of banks
  5. For economy, it is disadvantageous as banks become more circumspect in giving loans which affect the credit offtake in economy. India is still an economy which is largely dependent on banks to raise capital as the bond market is not that well developed. This leads to declining Gross Capital Formation affecting economic growth.
  6. Rising of NPAs will lead to a crisis of confidence in the market. The price of loans, i.e. the interest rates will shoot up. Shooting of interest rates will directly impact the investors who wish to take loans for setting up infrastructural, industrial projects etc. 
  7. It will also impact the retail consumers like us, who will have to shell out a higher interest rate for a loan. 
  8. This will hurt the overall demand in the Indian economy which will lead to lower growth rates and of course higher inflation because of the higher cost of capital.
  9. The trend may continue in a vicious circle and deepen the crisis.


Reasons for growth


  • Governance Issues


  1. Diversion of funds by companies for purposes other than for which loans were taken
  2. Due diligence not done in initial disbursement of loans. Eg: loans given to road sector even before acquisition of land by the contractors. Agreed to TPCs (Total project costs) much higher than assessed by NHAI.
  3. Inefficiencies in post disbursement monitoring of the problem
  4. Restructuring of loans done by banks earlier to avoid provisioning. Post crackdown by RBI, banks are forced to clear their asset books  which has led to sudden spurt in NPAs
  5. During the time of economic boom, overt optimism shown by corporates was taken on face value by banks and adequate background check was not done in advancing loans
  6. In the absence of adequate governance mechanism, double leveraging by corporates, as pointed out by RBI’s Financial Stability Report, is also a reason for increasing bad loans
  7. RBI Governor Rajan has pointed to the prevalence of “riskless capitalism” wherein time of economic swing, the corporate make hay, but when they face problems, resort to legal route, leveraging etc leading to problems galore for the banks


  • Economic Reasons


  1. Economic downturn seen since 2008 has been a reason for increasing bad loans
  2. Global demand is still low due to which exports across all sector has shown a declining trend for a long while now
  3. In the case of sectors like electricity, the poor financial condition of most SEBs is the problem; in areas like steel, the collapse in global prices suggests that a lot more loans will get stressed in the months ahead. Other stressed sectors include infrastructure, textiles and mining
  4. Other stressed sectors include infrastructure, textiles and mining
  5. Economic Survey 2015 mentioned over leveraging by corporate as one of the reasons behind rising bad loans


  • Political reasons


  1. Policy Paralysis seen during UPA 2 regime affected several PPP projects and key economic decisions were delayed which affected the macroeconomic stability leading to poorer corporate performance
  2. Crony capitalism is also to be blamed. Under political pressure banks are compelled to provide loans for certain sectors which are mostly stressed


  • Resolution issues


  1. In the absence of a proper bankruptcy law, corporate faced exit barriers which led to piling up of bad loans
  2. Corporates often take the legal route which is time consuming leading to problems for the banks


Traditional solution

  1. Appointment of nodal officers in banks for recovery at their head office, zonal office
  2. Thrust on recovery of loss assets by banks
  3. Close watch on NPA by picking up early warning signals and ensuring corrective action
  4. Directing state level bankers to be more proactive in resolving issues with state govt
  5. Designating ARC as resolution agent of banks



Laws relating to NPA and Bankcruptcy

  • SARFAESI – The Act empowers Banks/ Financial Institutions to recover their NPAs without the intervention of the court, through acquiring and disposing secured assets without the intervention of the court in case of outstanding amounts greater than 1 lakh. SARFAESI, it is accused, has been used only against the small borrowers primarily from MSME sector
  • Recovery of Debts Due to Banks and Financial Institutions (DRT) Act: The Act provides setting up of Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs) for expeditious and exclusive disposal of suits filed by banks / FIs for recovery of their dues in NPA accounts with outstanding amount of Rs. 10 lac and above. DRTs are overburdened leading to slow disposal of cases  
  • Lok Adalats:  Section 89 of the Civil Procedure Code provides resolution of disputes through ADR methods such as Arbitration, Conciliation, Lok Adalats and Mediation. Lok Adalat mechanism offers expeditious, in-expensive and mutually acceptable way of settlement of dispute
  • Under banking regulation act 1949, RBI is empowered to monitor the asset quality of banks by inspecting record books


Solutions proposed by RBI:


  • Restructured standard account provisioning has been increased to 5% making it easier for banks to go for restructuring. On the flip side, this has the potential to enhance tendency of evergreening of loans
  • RBI has directed banks to give loans by looking at CIBIL score and is encouraging banks to start sharing information amongst themselves. This is to deal with cases of information asymmetry. RBI has directed banks to report to Central Repository of Information on Large Credit (CRILC) when principle/interest payment not paid between 61-90 days
  • RBI has asked banks to conduct sector wise/activity wise analysis of NPA
  • SEBI has eased norms for banks to convert debt of distressed borrowers into equity
  • 5/25 scheme
    • For existing and new projects greater than 500 crores and also for existing projects which have been classified as bad debt or stressed asset, bank can provide longer amortization periods of 25 years with the option of restructuring loans every 5 or 7 years
    • The advantage of this scheme is that it provides for longer lending period with inbuilt flexibility. Shorter lending periods leads to companies stretching their balance sheet to pay back loans
    • From bank’s point of view it is helpful as freshly restructured asset is considered as bad debt and requires 15% provisioning by banks against such loans leading to erosion of profitability for banks
  • Strategic Debt Restructuring Scheme
    • This scheme provides for an alternative to restructuring. Wherever restructuring has not helped, banks can convert existing loans into equity. The scheme provides for creation of Joint Lenders Forum which is to be given additional powers with respect to
      • Management change in company getting restructured
      • Sale of non core assets in case company has diversified into sectors other than for which loans were guaranteed
      • Decision by JLF on debt restructuring by a majority of 75% by value and 60% by number
    • On the positive side, willful defaulters are dissuaded as they fear the loss of their company
    • However there are several issues with the scheme
      • Banks do not have expertise of managing companies
      • The Joint Lenders Forum mechanism has an inherent conflict between large banks and small lenders. The large banks have huge exposure and thus they want to restructure the loans so as to avoid provisioning. The smaller lenders fear arm twisting by large banks. Since they have less exposure they are unwilling to throw good money after bad and prefer to sell their exposure to ARCs as HDFC did in case of Essar Steel
    • Assessment of SDR
      • SDR is not performing too well. Of the 21 cases in which SDR has been invoked, only 4 have been closed. The problems are:
        • Difficulty in finding buyers
          • Buyers demanding prices that are unacceptable 
          • Creditor’s concern over their source of funding and credibility 
          • In the absence of potential buyers, bank wouldn’t want to hold onto these assets indefinitely. Unless and until a mechanism is devised which charts out a course of what to do thereafter, it doesn’t make much sense to do this conversion 
        • Disagreement over valuations 
          • Banks not willing to take severe haircuts 
          • Problem particularly acute in the infra sector where the valuations have drastically declined over the past 2-3 years 
        • Choice of merchant bankers used in SDR Process has a huge impact on the pace of the process. Quick resolution is necessary as otherwise provisioning for bad loans eats a major chunk of the bank’s profit
  • Scheme for sustainable structuring of stressed assets – This allows banks to split the stressed account into two heads – a sustainable portion that the bank deems that the borrower can pay on existing terms and the remaining portion that the borrower is unable to pay(unsustainable). The latter can be converted into equity or convertible debt giving lenders a chance to eventually recover funds if the borrower is unable to pay. The Scheme will help those projects which have started commercial operations and have outstanding loan of over Rs 500crore. Banks will also need to set aside higher provisions if they choose to follow this route.
    • Advantages of new scheme
      • To help restore credit flow to stressed sectors such as steel etc as credit lending condition have been eased in the scheme 
      • Banks can rework their stressed accounts under the oversight of an external agency. This means greater transparency in functioning of banks. This is a provision of the scheme itself. Banks had earlier complained of activism by investigative agencies in probing bad debt which made it difficult for them to go for restructuring in even genuine cases 
      • This scheme would not only strengthen the lenders’ ability to deal with stressed assets, but would also put real assets back on track, benefitting both banks and the promoters of troubled entities.
    • Challenges
      • Evergreening of loans by banks  
      • Distinction between sustainable and unsustainable debt might lead to problems later on 
      • In its current form, S4A favours promoters more than banks as banks have to provide for the loss of interest from their profit, while promoters get away with lower interest payment
      • The scheme can only be used for operational projects. Banks cannot reschedule or reprice the debt that is remaining after converting part of it into equity. Also, they have to assess the sustainable portion of the debt based on current cash flows rather than any future projection of cash flows. Due to this, many firms would not be able to do much for some power projects which are still under implementation.
      • It also does not allow for banks to change the terms and conditions of the loan. This would mean that not too much support to the sustainable part of the debt can be extended.
      • Another concern could be the high level of equity dilution that may result from a scheme of this nature. This could be negative for shareholders and may also reduce the incentive for promoters to actually turn around the company.


Measures announced by government

  • Government has announced recapitalization of the bank to the tune of 70000crore. However, given the situation, this amount is grossly inadequate. Government will have to find a way to increase the capital it provides to state-owned banks. An upfront capital infusion, along with reforms to ensure its proper usage, is the best way to reduce the pain of the bad loan clean-up.
  • Finance Minister has recently mentioned setting up of stressed asset fund in association with banks that can provide equity or debt capital
    • It  is different from an ARC as the assets would remain on the books of the banks whereas ARC transfer the acquired assets to one or more trusts at the price at which financial assets were acquired from the originator
    • A different mechanism from ARC has been proposed as experiences so far say that setting up yet another ARC is pointless. There are a number of existing ARCs in the market, and many large global funds are planning to enter the segment. Among these, many are bank-sponsored ARCs. They have done little good because the banks and the ARCs have failed to agree on the price at which assets are to be sold. Besides, the recovery track record of ARCs has been modest at best.