Non-Performing Assets (NPAs)
The loans disbursed by the bank are its assets and timely return of these loans is vital for the continued healthy performance of the banks. However, in practice, banks do not get timely return of its loans even from credit-worthy customers. Technically, “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)”. In this situation, such an asset stops giving returns to its investors for a stipulated period of time turning into a Non-Performing Asset (NPA).
Generally, that stipulated period of time is 90 days in most of the countries and across the various lending institutions. However, it is not a hard and fast rule. There can be contextual variations depending upon the terms and conditions agreed upon by the financial institution and the borrower.
The Definition of NPA given by the Reserve Bank of India (RBI)
The asset is categorised as non-performing asset when it stops generating income for the bank. As per the RBI, “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”. Categories of Non-Performing Assets (NPAs) Depending upon the period up to which a loan has remained as NPA, it is classified into three types:
Substandard Assets: An asset which remains as NPA for less than or equal to 12 months.
Doubtful Assets: An asset which remained in the above category for 12 months.
Loss Assets: These are assets where loss has been identified by the bank or the RBI. However, there may be some value remaining in it and hence the loan has not been not completely written off.
An example of NPA: Suppose State Bank of India (SBI) gives a loan of Rs. 5 crore to a company. They agreed upon for an interest rate of say 5 percent per annum. Now suppose that initially everything was good and the market forces were working in support of the company. In this scenario, the company was able to service the interest amount. Later, due to administrative, technical, legal, environmental, corporate reasons etc. suppose the company is not able to pay the interest rates for 90 days. In that case, a loan given to the company is a good case for the consideration as NPA.
Magnitude of India’s NPA Problem
There are about 7 lakh crore worth loans which have been classified as Non-Performing Asset in India. This is a massive amount showing the gravity of the NPA problem in India. This figure is actually around 10 percent of all loans disbursed by the bank. This exposes the fact that about 10 percent of loans are not paid back translating into huge loss of money to the banks. This NPA problem has corroded the health of the banking system in India.
The enormity of the problem is further exposed by the fact that when restructured and unrecognised assets are added into the NPAs then the total stressed asset zooms upto about 15-20 percent of total loans disbursed by the bank. There are various factors which have added to the NPA crisis in India which is set to magnify further in future. The NPA problem in India is also very serious when compared to other emerging economies in BRICS.
To tide over the NPA problem, there are various norms for restructuring loans and stressed assets. But these restructuring norms are being misused further amplifying the woes of the banking system. The perpetual stressed performance of key banks is not a healthy sign. It can catalyse crashing of banks as happened in the sub-prime crisis of 2008 in the United States of America. The NPA problem in India is adversely affecting the lending capacity of banks hindering the growth potential of the economy. The situation regarding the NPAs is alarming for Indian economy as its “corporate bond markets are shallow and underdeveloped and therefore incapable of sharing the banking system’s burden of lending”.
Reasons for prevalence of Non-Performing Assets (NPAs)
- There are serious inefficiencies related to monitoring of loans in the post- disbursement phase.
- Earlier the banks had done restructuring of loans to artificially show that they had a healthy balance sheet. After the crackdown by the RBI, banks were forced to clear their asset books which led to a quick ascent in NPAs.
- There is subdued global demand and India’s exports across various sectors have shown a downward trend leading to losses for companies. This means that these companies are unable to pay back the loans from banks leading to a spurt in NPAs.
- As far as the sectors like electricity are concerned, the miserable financial condition of most state electricity boards (SEBs) is the problem contributing to NPAs.
- There is constant rotation of duties among bank officers and hence the loan officers attain diminished level of expertise in lending principles and end up lending to doubtful customers.
- Crony capitalism is also a factor contributing to the NPAs. Banks provide loans for certain stressed sectors under political pressure.
- Earlier a proper bankruptcy law was missing. Hence, sick companies faced seemingly insurmountable exit barriers leading to accumulation of bad loans.
- The banks have been diversifying its disbursal of funds to unrelated businesses.
- There have been lapses due to lack of diligence and at times they have led to fraudulent transactions.
- The companies have suffered serious losses due to changes in business/regulatory environment.
- Some experts also point out the factor of lack of morale amongst banking staff (especially after government schemes which had written off loans).
- Other factors attributed are global, regional or national financial crisis. Such crisis results in deterioration of margins and profits of companies. In this scenario, the balance sheets of companies are stressed out leading to non-servicing of interest and loan payments. For example, the 2008 global financial crisis catalysed the stressing out of balance sheet of various companies and they were unable to pay back loans.
- There were many scams which were unearthed after 2011 which led to anti-corruption agitations. That was also the period of policy paralysis leading to general slowdown of entire economy which resulted into losses for various companies catalysing the rapid growth of the NPAs. There were problems related to land acquisition, environmental regulations etc. due to which many infrastructure projects started languishing resulting into losses. The slowdown in industrial activity also paralysed the loan repayment ability of various companies contributing to overall NPA problem.
- The NPA problem also resulted because of unplanned expansion of corporate houses during boom period of the economy. These corporate houses got loan at low rates which were later serviced at high rates contributing to NPAs.
- Lack of Corporate Governance: Corporate houses also undertake unethical business practices which is exemplified by the phenomenon of wilful defaulters who run away from India after not paying crores of rupees taken as loan amount earlier.
- There are serious issues related to mis-governance and policy paralysis which hinder the timely completion of projects especially in the infrastructure sector. In this scenario loans become NPAs. The NPAs have also resulted out of intense competition in particular market segments like the telecom sector in India.
- Delays in land acquisition have also contributed to the NPA problem.
- There have been some bad lending practices lacking in transparency adopted by the banks which have contributed to their rising share of NPAs.
- Some companies have also been facing losses due to dumping by foreign nations. For example, the steel sector in India has been faced with losses due to cheap imports as a result of dumping leading to business losses for domestic companies magnifying their stressed assets leading to NPA problem.
Impact of NPAs
- Banks suffer from reduction in their profit margins which corrodes the health of banking system.
- If the banking sector is stressed out then less money is available to fund other projects leading to a larger negative impact on the larger national economy.
- Banks resort to charging higher interest rates to maintain their profit margin. This leads to losses for corporate houses.
- The NPA problem also results in channelling of funds from the good projects to the bad ones. This adversely impacts upon the interests of the economy. Various attractive investment proposals face roadblocks in this scenario leading to substantial unemployment.
- The NPA problem is particularly bad in the case of public sector banks. If these banks are afflicted with the serious NPA problem then there is a loss for shareholders. It means that the Government of India gets less money as dividend. Hence, in the larger frame of things it may adversely impact redirection of public money for socio-economic purposes and infrastructure development. Various other investors/shareholders also do not get rightful returns on their investment.
- Twin Balance Sheet challenge: It refers to balance sheet syndrome with Indian characteristics that is both the banks and the corporate sector have stressed balance sheet. This leads to various roadblocks in the path of investment-led development process.
- The dispute resolution of NPA-related cases magnifies pressure on the judiciary which is already over-burdened with pending cases.
- The NPAs create scarcity of funds in the markets adversely affecting the overall growth performance of the economy.
- The price of loans, interest rates etc. zoom up badly. As interest rates magnify, it impacts upon the investors as they face obstacles in taking loans for various industrial projects.
- It also adversely affects the retail consumers who get loans at higher interest rates.
- All these factors have a damaging impact on the overall demand in the Indian economy leading to subdued growth and higher inflation because of the higher cost of capital.
Steps to deal with the NPA problem
NPAs are a serious problem in India. Hence, there have been several steps taken by the Government of India on legal, financial, policy level reforms concerning the NPA problem. Earlier in the year 1991, the Narsimhan committee recommended many reforms to tackle NPAs. Some of them were implemented. Following are the list of various steps taken so far for dealing with the NPAs:-
The Debt Recovery Tribunals (DRTs) – 1993
The Debt Recovery Tribunals are meant to reduce 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, there are various problems associated with them as their numbers are not adequate in proportion to the case load. Hence, there is also the problem of time lag and cases are pending for many years in some areas.
Credit Information Bureau – 2000
A sound information system is needed to prevent loan falling into bad hands. Hence, it is vital for subsequent prevention of NPAs. It assists banks by the “maintaining and sharing data of individual defaulters and willful defaulters”.
Lok Adalats – 2001
They are beneficial in tackling and recovery of small loans (limited up to 5 lakh rupees loans). They act as per the RBI guidelines issued in 2001. They are advantageous in the sense that they prevent the cases from going into the legal system.
Compromise Settlement – 2001
It stipulates a simple mechanism for recovery of NPAs for loans below Rs. 10 crores. This mechanism is inclusive of cases in courts and DRTs (Debt Recovery Tribunals). However, the fraud cases and cases involving wilful defaulters are excluded from the purview of Compromise Settlement.
SARFAESI Act – 2002
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 is an important mechanism of dealing with the NPA problem. As per its mechanism, “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”. Under this mechanism the banks have to first issue a notice and then after the borrower’s failure to repay, they can:
- Take ownership of security and/or
- Control over the management of the borrowing concern.
- Appoint a person to manage the concern.
In the year 2016, this SARFAESI Act was amended to further fortify its enforcement capacity.
ARC (Asset Reconstruction Companies)
The Reserve Bank of India (RBI) allotted license to 14 new ARCs in 2016 after the amendment of the SARFAESI Act of 2002. These companies are created to uncover value from stressed loans. This provision of ARCs is very important for tackling the NPA problem as earlier lenders could enforce their security interests only through courts, which was a time-consuming process but now they can utilize this ARC mechanism.
Corporate Debt Restructuring – 2005
It is meant 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
This 5:25 rule is Flexible Structuring of Long Term Project Loans to Infrastructure and Core Industries. It was put forward to maintain the cash flow of such companies since the project timeline is lengthy. These companies do not get the money back into their books for a long time during the period of the completion of the project. Hence, there is a need of loans at every 5-7 years for refinancing of projects with long gestation period viz. projects in the infrastructure sector.
Joint Lenders Forum – 2014
The Joint Lenders Forum (JLF) was formed by including all public sector banks (PSBs) whose loans have become stressed. It is a mechanism meant to prevent the possibility of giving loan to 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 revamping the public sector banks (PSBs) is a very comprehensive reform undertaken since banking nationalization in the year 1970. It is meant to bolster the performance of the Public Sector Banks (PSBs) by various means represented by the term “ABCDEFG”.
A-Appointments :This framework is meant to follow best global procedures in the appointment of Chairman and Managing Director of the public Sector Banks in the larger interest of transparency and accountability. It is also based on the robust guidelines in the Companies act. So, it ensures that 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 is another key mechanism. It is supposed to be a body of eminent professionals and officials. It is supposed to replace the Appointments Board for appointment of Whole-time Directors as well as non-Executive Chairman of PSBs. It is expected to promote transparency in banking appointments for the sake of the overall health of the banking system.
C-Capitalization: As per finance ministry, the capital requirement of extra capital will be given by the government. Plus, the PSBs will also have to raise capital from the market because capital requirements are huge.
D-Destressing: This requires de-stressing of the PSBs and fortifying risk control measures viz. measures of NPAs disclosure.
E-Employment: The Government declared its intentions that there will be no arbitrary interference from its side. It is meant to incentivize the banks to take fair, independent and objective decisions keeping in mind its interests.
F-Framework of Accountability: It tries to focus on new key performance indicators which are linked with the overall performance and robust management of the PSBs.
G-Governance Reforms: This part shows the noble intention of the government to promote efficiency in the banking sector through comprehensive reforms. For example, the Gyan Sangam (a conclave of PSBs and financial institutions) also tried to develop sound ideas for revamping the banking sector and the discussions for it were held within a participatory framework giving due space to different stakeholders. Likewise, the Bank board Bureau is meant for promoting merit-based transparent appointments in PSBs.
Strategic debt restructuring (SDR) – 2015
This is again a very important scheme meant for dealing with the NPA problem. Under the framework of 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”. The fundamental purpose is to ensure a greater level of stake of promoters in revitalizing stressed accounts. Further, it is meant to provide banks with greater capabilities for initiating a change of ownership in appropriate cases.
This scheme gives an alternative to restructuring. If restructuring does not help, banks can convert existing loans into equity. The scheme seeks formation of Joint Lenders Forum which is given additional powers regarding “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” among other things. This has positive implications as it deters wilful defaulters who fear the loss of their company.
However, there are certain issues with the scheme. Banks actually lack expertise regarding management of companies. There are certain inherent structural issues with Joint Lenders Forum (JLF) mechanism. It has an inherent conflict between large banks and small lenders. The large banks have huge exposure and thus they want to restructure the loans. The smaller lenders are afraid of being coerced into siding with certain decisions taken by large banks. As smaller banks have less exposure they do not want to throw good money after bad and prefer to sell their exposure to ARCs.
It has been found that the SDR is not performing too well. In October 2017, it was reported that of the 21 cases in which SDR has been invoked, only 4 have been closed. The scheme has been facing problems related to issues like trouble in finding buyers, the demand of unacceptable prices by buyers, inability of banks to hold such stressed assets for a long time, conflict and disagreement over valuations, decrease of valuations particularly in the infrastructure sector.
Asset Quality Review – 2015
It ensures classification of stressed assets. It helps in the timely identification of assets ensuring that they do not become stressed assets through prompt action beforehand.
Sustainable structuring of stressed assets (S4A) – 2016
It is meant for the resolution of largely stressed accounts. It includes various steps like the determination of sustainable debt level for a stressed borrower. After that it divides the outstanding debt into sustainable debt and equity/quasi-equity instruments. It is expected to give advantage to the lenders when the borrower turns around.
Insolvency and Bankruptcy code Act-2016
The Economic Survey 2015-16 argued that the Indian Economy was facing the Chakravyuha Challenge as the sick/non-performing companies were unable to exit. The Survey argued that Indian economy has moved from “socialism with restricted entry to marketism without exit”. This had enormous fiscal, legal and socio-economic costs. Hence, the Insolvency and Bankruptcy Code was devised by the government in the larger interest of the economy. This code seeks 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”. In the larger framework, it seeks to maximize the value of assets concerned and connected with such persons and firms.
Pubic ARC vs. Private ARC – 2017
There has been an animated debate about the pros and cons of public and private Asset Reconstruction Companies. Some economic experts have batted for the private ARC. However, the Economic Survey 2016-17 had mooted the idea of the centralised Public Asset Reconstruction Companies (ARC) fully funded and administered by the government. This public ARC is supposed to deal with “the largest, most difficult Cases, and make politically tough decisions to reduce debt” in order to restore the health of economy in the larger framework. It has been our endeavour to resolve “Twin Balance Sheet (TBS) problem – overleveraged companies and bad-loan-encumbered banks” of our economy. This has been largely a legacy of the boom years around the Global Financial Crisis.
The magnitude of the problem of overleveraged companies means that it has continued to fester. It has catalysed another problem i.e Non-Performing Assets (NPAs) especially of the public sector banks which has kept on magnifying. Seeing the enormity of the problem, the Public Sector Asset Rehabilitation Agency (PARA) has been favoured and the Economic Survey 2016-17 outlines following arguments in favour of the PARA:
- Public discussion of the bad loan problem has focused on bank capital. But far more problematic is finding a way to resolve the bad debts in the first place.
- Some debt repayment problems have been caused by diversion of funds. But the vast majority has been caused by unexpected changes in the economic environment after the Global Financial Crisis, which caused timetables, exchange rates, and growth rate assumptions to go seriously wrong.
- This concentration creates a challenge since large cases are difficult to resolve, but also an opportunity since Twin Balance Sheet (TBS) problem could be overcome by solving a relatively small number of cases.
- Restoring the stressed companies to financial health will require large write-downs which are beyond the capacity of the private ARCs.
- The private ARCs face severe coordination problems, since large debtors have many creditors, with different interests. And they find it hard –financially and politically—to grant them sizeable debt reductions, or to take them over and sell them.
- The private ARC increases the costs to the government since bad debts of the state banks keep rising, and increases the costs to the economy, by hindering credit, investment, and therefore growth.
- Since, private run Asset Reconstruction Companies (ARCs) have not been successful either in resolving bad debts, though international experience (especially that of East Asian economies) shows that a professionally run central agency with the government backing could overcome the coordination and political issues that have impeded progress.
- It has been argued that the formation of PARA will deal with stressed loans through flexible rules and mechanism. It will reduce the overload on the balance sheet of PSBs creating space for them to fund new projects and continue the funding of development projects.
Recapitalisation of PSBs
In 2017, the government came up with a very dynamic and spirited plan to infuse Rs. 2.11 lakh crore capital over the next two years into public sector banks (PSBs) afflicted with magnified levels of non-performing assets (NPAs).
This move is quite significant for the as private investments remain highly subdued because of the problem of “twin-balance sheet problem” troubling corporate India and public sector banks amply reflected in slow bank credit growth. The government has taken this massive step to capitalise PSBs to support credit growth and job creation in an efficient manner. This step has been widely acclaimed as the capital-starved public sector banks badly needed this capital infusion and the government has taken the right step in this regard.
Amendment in Banking Regulation Act, 1949 in 2017
The government passed an ordinance in 2017 to amend certain sections of the Banking Regulation Act, 1949. This gives much-needed freedom to the banking companies to resolve the issues related to stressed assets by initiating the insolvency proceedings whenever required. This amendment in conjunction with the Insolvency and Bankruptcy Code, 2016 is expected to provide for prompt and judicious resolutions of stressed assets. The Banking Amendment, 2017 is supposed to deal with stressed assets, particularly those in consortium or multiple banking arrangements. Under the changed arrangement, the RBI can direct banking companies to resolve the issue related to specific stressed assets, by initiating insolvency resolution process wherever required. Experts on the issues of banking and finance say that this amendment and the Bankruptcy code has to be judiciously and effectively used for efficient resolution of stressed assets. They can go a long way in resolving the NPA problem.
- Banks need to adopt a more conventional approach in giving loans to sectors that have a history of being found as contributors in NPAs.
- The process to sanction loan by banks needs to be very strict. Such a robust process should go beyond the traditional analysis of financial statements and past records of loan applicants.
- An appropriate agenda needs to be formed to incentivize quality professionals to join the discipline of insolvency professionals.
- Greater efficiency must be promoted in Debt recovery tribunals with renewed enthusiasm in order to reduce the burden on National Company Law Tribunal (NCLT).
- Banks should be armed with latest credit risk management techniques to secure bank funds and reduce insolvency issues.
- Banks should analytically consider the feasibility to develop credit derivative market to avoid these risks.
- Various issues like finding of right trust-worthy borrowers, operationally feasible economic activity, time-bound disbursement of funds, proper end-use of funds, judicious and prompt recovery of loans etc. should be prioritized to reduce the incidences of fresh NPAs.
Learning from South Korean Experience
The countries like South Korea and Malaysia have developed bodies like National Asset Management Agency in order to deal with NPAs in an efficient and holistic way. There are companies like South Korea’s Kamco (Korea Asset Management Corp.) or Malaysia’s Danaharta which have played a seminal role in curbing the stressed assets of troubled banks within specified time frames in the aftermath of the Asian financial crisis. They had a role in minimizing imperfections in the market for stressed assets leading to the creation of liquidity and nurturing competition. Experts have opined that “besides being highly illiquid, the market for stressed assets is also characterized by large information asymmetries—sellers possess more information about soured assets than the buyers” creating roadblocks in the path of clearance of stressed assets. India has an opportunity along similar lines in resolution of NPAs. Hence, it can learn from global best practices as far as the institutional designs and sound regulatory framework for resolution of NPAs are concerned. However, such a national asset management agency should be backed by a strong political will on the part of the government in the larger public interest.
In the year 2017, India was ranked fifth on the list of countries with the highest Non-Performing Assets (NPAs) globally. Undoubtedly, the NPA issue has been tormenting the banking system in India and its impact gets magnified given the giant size of the banking industry. By the same logic the NPA issue needs to be handled properly as it involves multi-layered complexity presenting a danger to the macro-economic stability of the Indian economy. The NPA problem is multi-dimensional and is deeply rooted in subdued business environment in India, slowdown in economic activity, loopholes in the legal system and the deficiencies in the operational procedures of the banks.
The Reserve Bank of India (RBI) in its latest Financial Stability Report in June 2018 warned that the gross NPAs of banks are likely to increase further in the current macro-economic scenario. There is a crying need to deal with the problem of NPAs through urgent remedial measures like:
- Technology and data analytics can be utilized to recognize the early warning signals.
- A suitable mechanism should be created to identify the hidden NPAs.
- Advancement of internal skills for credit assessment.
- Forensic audits can also be pressed into service to understand the intent of the borrower.
There has to be pragmatism and clear economic logic in the resolution process of NPAs. There are chances that stressed assets recur. In order to pre-empt such a possibility there should be reforms not just in governance but in regulatory oversight. Besides, there have been certain failures of banking regulations which need to be curbed for a sustainable resolution of the NPAs. The 4R formula (Recognition, Recapitalisation, Resolution, Reform) given by the Economic Survey 2015-16 must be followed in the right earnest. This comprises of the following steps in that order:
- ‘Recognition’ of assets close to their true value,
- ‘Recapitalisation’ or infusion of equity for banks to protect their capital,
- ‘Resolution’ in the form of selling underlying stressed assets,
- ‘Reform’, through the right future incentives for the private sector and corporates to ensure there is no repeat of the twin balance sheet syndrome.
The NPA problem in our public sector banks has been particularly acute. The enormity of the NPA problem means that flow of funds to capital intensive infrastructure projects gets adversely affected. This has impacted upon the highways construction, power sector and the telecom sector. There is a crying need for the revitalization of investment momentum but it cannot happen without bank’s lending and so it logically means that the NPA issue needs to be resolved.
There are problems related to the Asset Quality Review. There has been a very quick-paced Asset Quality Review (AQR) to clean up balance sheet of banks in order to recognize the NPAs in advance. However, there is a flip side to this way of doing AQR as it has magnified the magnitude of NPAs several times and the RBI has also shifted large borrowers to the bond market. These developments have led to the weakening of the PSBs as shifting of large borrowers to bond market is hard hitting the income of these banks.
The P.J. Nayak committee report and Indradhanush plan have batted for Banking Board Bureau and governance reforms. These are measures meant to strengthen the banking system but they are lagging behind which is causing lack of clarity of direction. It has been argued that write-off of debt is not a sustainable option. Additionally the NCLT should not be misused as a mechanism for promoters to recycle their own companies. The promoters tend to get their own company back minus the debt and that’s certainly not a good sign as it amounts to “public funding of private profiteering”. Hence, there is a need to bar original promoters of the company from bidding for that asset again.
The Economic Survey 2016-17 says that NPAs are “an economic problem, not a morality play”. Hence, pragmatism has to be the hallmark of dealing with the vexed issue of the NPAs. The Survey had actually acknowledged that the RBI and government are running out of options and thus mooted a novel idea of a ‘bad bank’. The bad bank will be a Public Sector Asset Rehabilitation Agency (PARA), with 49% government ownership. The bad bank shall take over the bad loans and administer/sell them into the private markets. The RBI is also of the view that a bad bank just by itself will not necessarily work but it has to be ‘designed right’ instead. The fundamental premise of the bad bank is “getting right the price at which the bank can sell off the assets to private investors”. The bad bank idea can work properly if it is designed properly helping to mitigate the complex NPA problem.