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Contents

• Non-Performing Assets – Basics
• Why had NPAs increased so much in the last decade?
• Impact Of High NPAs
• 4 Key steps in solving the NPA problem
• Steps Taken
• Impact: Current Situation

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Non-Performing Assets – Basics

• Assets in a banking system comprises of loans given and investments (in bonds etc.) made by banks as these earn interest/profit for banks.
• If the interest/ principal instalment of a loan is not paid until due date, it is called bad loan.
• An asset including a leased asset, becomes non-performing when it ceases to generate income for the bank.
• According to RBI A Non-Performing Asset is a loan or advance where instalment/interest is due for more than 90 days in case of a term loan or overdraft account/ credit account. Similarly in case of agriculture loans an account becomes an NPA if the instalment/interest remains overdue for two crop season for a short duration crop, or one crop season for a long duration crop.
• Stressed Assets refers to all NPAs plus restructured assets plus written off assets.

NPAs of Indian Banking System had reached 11.18% in 2018.

Why had NPAs increased so much in the last decade?

I. Credit Boom in mid 2000s and then the global financial crisis: In Mid 2000s large corporates were granted loans based on extrapolation of their recent growth and performance. But with stagnating economic growth due to Global financial crisis, their loan returning capabilities
decreased.

II. Indian creditors used the strategy of “Giving time to time” and hoped that economic revival
will reduce NPAs -> this only led to evergreening of NPAs.

III. Poor Recognition: Banks were initially reluctant to recognize NPAs. The true extent of NPA
problem only started becoming clear once the RBI initiated the Asset Quality Review in 2015.

IV. Poor Governance and Regulation of Banks – Crony Capitalism – Poor Recovery

V. Lack of specialization of banks in recovering bad loans / NPAs

VI. Other Factors which negatively impacted businesses

• Key Judicial Decisions
  • Judicial decisions like abrupt cancellation of coal mines and spectrum allocation led to reallocation through expensive auctioning procedure and thus proved to be a fatal burden on respective business models of power, steel and telecom.
  • Land Acquisition and environmental clearance issues also blocked a number of projects and contributed towards increasing NPAs.

VII. Insolvency and Bankruptcy Procedure has not proved very effective yet.

VIII. Absence of strict action against bank frauds of high magnitude

• This is because of absence of a strong law against wilful defaulters and fraudsters

Impact Of High NPAs

• On Banking Sector
  • Decreasing income/Increasing losses for the banks
  • Reduces effective internal source of increasing capital which is even under a lot of pressure on account of impeding BASEL-3 guidelines.
  • Downgrading of ratings as asset quality deteriorates, this would make international operation and funding difficult.
• Hinders Economic Growth
  • Accumulation of NPAs in the banking system, specifically in the PSBs, had adverse effects on credit disbursement. Reduction in credit available for market and individual
    customers led to slowing down of economy.
  • The Rise in NPAs occurred with the deterioration of the balance sheet of non-financial firms, and this twin balance sheet problem contributed significantly to the deceleration
    of growth in late 2000s.
• On Government
  • Increasing fiscal burden on government as it has to recapitalize these banks to ensure
    their proper functioning.
• On Individuals/ Society
  • Relatively expensive loans and decreased interest on deposits.
    • This means that performing borrowers and depositors were effectively being taxed in order to subsidize the non-performing borrowers.
    • Only after demonetization, the interest rates went down because of the flux of cash with the banks
  • Less budget/credit available for social welfare programs.
  • Eventually its common man’s money in the form of deposits which have been lend by banks and is put at risk in case the bank fails.

Balance Sheet Syndrome with Indian Characteristics: High NPAs (TBS problem) have derailed growth in other countries. But huge NPAs have not had as huge an impact as in case of other countries. This is being considered ‘Balance Sheet Syndrome with Indian Characteristics.’

• This is because the NPA’s are concentrated in public sector banks which not only hold their own capital but are ultimately backed by the government who would eventually come to save these banks in case situation gets out of hand. Therefore, creditors have retained confidence in the banking system and there has been no bank runs, no stress in the inter-bank market etc.
• Mid 2000s boom had created enough infrastructure (in India’s severe supply constraint economy), that there was ample room for the economy to grow after the GFC.

4 Key steps in solving the NPA problem (As suggested by Economic Survey of India 2015-16)

• 4Rs, Recognition, Recapitalization, Resolution, Reform
  • Recognition: Banks must value their assets as far as possible close to true value (recognition) as the RBI has been emphasizing
    • Asset Quality Review by RBI has done this and brought the real numbers forward.
  • Recapitalization: Once the true value of the assets is recognized, the capital position must be safeguarded via infusion of equity (recapitalization).
    • Bank recapitalization has been a regular feature of the Union Budget since 2016-17. Between FY17 and FY21, the centre has infused about 3.31 lakh crore into banks.
  • Resolution: The underlying stressed assets in the corporate sector must be sold or rehabilitated (resolution) as the government has been desiring.
    • IBC has played an important role in increasing recovery.
  • Reform: Future incentives for private sector and corporates must be set-right to avoid repetition of the problem.
    • Reform is one area where least progress has been made.
    • Governance structure of the banks have almost remained the same

Steps Taken:

1. Know your customer (KYC) norms have been strengthened.
2. Early identification and reporting of stress – Special Mention Account (As per revised framework for resolution of stressed assets – Feb 2018)

• Lenders are required to identify incipient stress in loan accounts, immediately on default, by classifying assets as Special Mention Account (SMA) as per the following categories.

SMA Subcategory	Basis for classification – principal or interest payment or any other amount wholly or partly overdue
SMA-0	1-30 days
SMA-1	31-60 days
SMA-2	61-90 days

• This has to be reported to Central Repository of Information on Large Credit (CRILC) on all borrowers’ entities having aggregate exposure of Rs 5 crore and above with them.

3. Asset Quality Review by RBI

• To deal with the cases of divergences in identification of NPAs or addition provisioning across banks at the central office level

4. Indradhanush Scheme

• Improving 7 different areas of banks (including capitalization)

5. Insolvency and Bankruptcy Code (IBC-2016)

• To fast track insolvency resolution process and increase the % recovery. This was a more direct path to handle bad loan.
• It allowed lenders to take defaulting borrowers to NCLT and trigger off bankruptcy proceedings against them.

6. Fugitive Economic Offenders Act, 2018, is also acting as a deterrent and may prevent future offenders from running to other countries.

7. Project Sashakt (July 2018)

• It is a five pronged strategy to resolve bad loans outline – SME resolution approach, bank led resolution approach, AMC/AIF led resolution approach, NCLT/IBC approach and asset trading platform

1. SME Resolution Approach (SRA): Bad loans of upto 50 crore will be resolved at the bank level, with a deadline of 90 days. For this approach, the committee has also suggested setting up of a steering committee by banks for formulating and validating the schemes, with a provisional for additional funds.

2. Bank led resolution approach: For loans between 50-500 crore, banks will enter an inter creditor agreement, authorizing the lead bank to implement a resolution plan in 180 days, or refer the asset to NCLT. Here, an independent steering committee appointed by the Indian Banks Association (IBA) will validate the process. The resolution plan has to be approved by lenders holding at least 66% of the debt.

3. AMC/AIF led resolution approach: For loans above 500 crore, the panel envisages one or more Independent Asset Management Company (AMC), supported by institutional funding through the Alternate Investment Fund (AIF).

• • • The committee suggested that the bidding process should follow a market-led approach, inviting bids from AMCs, ARCs, and AIF.
    • Existing players, such as ARCIL and the national AMC, will be allowed to set the floor price for the bad assets while other players will be asked to either match the price or better it.
    • The AMC has to redeem security issued to banks by ARCs within 60 day

4. Asset trading platform for performing and non-performing loans

5. NCLT/IBC approach

• • If none of the above approaches work, NCLT will take over under the IBC provisions.

8. Prompt Corrective Action (PCA) Framework

What is PCA?

• It is a framework under which banks with weak financial matrices are put under watch by RBI.
• The framework uses three parameters to measure the weakness of a bank:
  • Capital Ratio
  • Asset Quality
  • Profitability
• RBI’s revised PCA framework for banks applicable from 1st Jan 2022.
  • The framework would apply on all banks operating in India, including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.
  • Three parameters to measure the weakness of the bank: Capital, Asset Quality and Leverage Ratio.
  • Indicators to be tracked for capital, asset quality and leverage would be CRAR/Common Equity Tier-1 Ratio, Net NPA Ratio, and Tier 1 Leverage Ratio.
  • Breach of any risk threshold may result in invocation the PCA.
  • Entry: A bank will generally be placed under PCA framework based on the Audited Annual Financial Results and the ongoing Supervisory Assessment made by RBI.

RBI’s corrective action plan based on risk threshold

• RBI can put mandatory restrictions on dividend distribution, branch expansion, and management compensation based on the risk threshold.
  • In an extreme situation, breach of third threshold, would identify bank as likely candidate for resolution through amalgamation, reconstruction or winding up.
  • Further there can be discretional restrictions on bank’s lending limit, special audit etc.
  • RBI can supersede the bank’s board, under the PCA.
• Idea behind PCA:
  • Handle problems before they attain crisis situation.
  • Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore financial health of a bank.

9. UDAY Scheme (for state power discoms)

• As they were one of the largest NPA holders.

10. Governance Reform in banks

• E.g., Separation of the post of CMD and Chairman

Impact: Current Situation:

• Since 2015-16, RBI and the government have made dedicated efforts in terms of calibrated measures like strengthening the regulatory and supervisory framework, implementation of 4R’s approach of Recognition, Resolution, Recapitalization, and Reforms to clean and strengthen the balance sheet of the banking system. These continuous efforts have culminated in the enhancement of risk absorption capacity and a healthier banking system balance sheet in terms of asset quantity and quality over the years.

Indian Banks’ NPA has fallen to a 10-year low and is expected to improve further: RBI

• Gross NPAs of Indian Banks is 3.9% as of March 2023.
• Net NPAs had dropped to a ten year low of 1.3% in Sep 2022.

Why decrease:

• Lower slippages and reduction in outstanding GNPAs through recoveries, upgrades, and write offs led to this decrease.

What more can be done:

• Governance Reform in Banks and exit of poorly performing banks.
  • Financial sector is undergoing structural changes (fintech and other NBFCs) are challenging existing business models.
  • Governance reforms and cost reduction through innovation should be the key to survive in this environment and therefore it is important that inefficient banks should be wind up.
  • Banks have to come up with robust credit worthiness evaluation mechanism.
  • Process of consolidation of banking sector should continue.
• Strengthening Insolvency and Bankruptcy Code as and when loopholes emerge
  • Currently NCLT faces huge work load and hence its resources needs improvement.
• Bring back developmental financial institutions.
• Robust and Transparent Secondary market should be promoted to deal with bad loans.
  • For e.g., in USA, almost a trillion dollar of bad debt is handled every year through an active secondary market which includes ARCs.
• A robust and transparent secondary market, unhindered by excessive regulation, is an essential element in the vital process of transferring risk from the banks to the capital
  markets.
• Strengthening legal system to deal with willful defaulters.
  • Currently, willful defaulters are mostly able to go scot free. This will inculcate discipline among the borrowers.

Conclusion

Though NPA issue has been resolved, but if the core issues of the banking sector like poor
governance, political interference, etc are not resolved, the problem may re-emerge in future.