NON-PERFORMING ASSETS & ITS EFFECTS ON INDIAN BANKING SECTOR
Authored by: Supriya Rani
The Non-performing Asset has been one of the widespread problems of the financial system and economy. The number of NPAs acts as an indicator of soundness of the banking system of any country. The problem of NPAs is faced globally but when it comes to developing countries like India, the magnitude is undoubtedly very high. The Government of India has initiated economic reforms to cope up the speed of the global economy but it is impossible to achieve unless the Indian banking and financial system will be at a complete overhaul. The paper aims to explain the concept of non-performing assets and the magnitude of their impact on the banking sector.. The author will try to throw light on the reasons for its growth and changes that came after RBI guidelines. At lastwhile suggesting measures and drawing inferences from past, the paper will suggest measures that can help in preventing the growth of NPAs focussing on the Indian economy set up.
The banking sector is the keystone to any financial system and it is important to ensure the smooth working of the banking system to ensure healthy functioning of any country’s economy. Banks create credits in the process of accepting deposit and lending loans and the funds received by the banks from borrowers in the form of interest on loan and repayment of principal are recycled for fundraising. This is the cycle of our banking system which gets disrupted by non-performing assets (NPAs) as it hampers the credit growth by affecting the profitability of banks. NPAs works as an indicator to judge banks performance and failures which has the potential to not only affect the financial health but also to paralysed the economy[i]. The number of NPAs reflects the number of credit defaults of the bank which erodes the assets’ value by affecting profitability and net worth of the bank. The spiralling of NPAs has become one of the most calamitous problems for a commercial bank in all over the world. In India, with the nationalization of banks in 1969, there has been a considerable rise in the geographical presence of banks but at the same time, the profitability and economic stability of various banks have been negatively impacted due to increased cost of maintenance and the lending of money to masses at a reasonable cost to fulfil the social objective of banks[ii].
What are Non-performing Assets?
In 1991, the Narasimhan Committee (Committee on financial system reforms, 1991) introduced the concept of non-performing asset[iii]. As per the circular of RBI dated 01-07-2005, NPA is an asset or account of the borrower which has been classified sub-standard, doubtful or loss asset by any bank or financial institution[iv]. In simple terms, a non-performing asset is a loan or advance for which the principal amount has not been paid for a period of 90 days. An amount which has not been paid within 30 days from the due date is treated as ‘past due’. A loan amount which has not been paid by the borrower is classified as a non-performing asset which becomes an asset that no longer generates income for the bank as the borrower is not paying the interest. In such situation, the loan is classified as arrears.
The Reserve Bank of India which is Central Bank of India has defined the non-performing asset as:
An asset which includes leased asset when it stops generating income for the banks or financial institutions, it is termed as NPA. An NPA is a loan or advance in which:
- Any interest or instalment for which the principal amount is overdue more than 90 days from the due date.
instalment of principal or interest remains due:
- Two crop seasons in case of short duration crops
- One crop season in case of long duration crops
- In the case of securitisation transaction, the liquidity amount remains overdue for more than 90 days as per the guidelines of securitisation[v].
- For derivative transactions in which the due receivables representing positive mark-to-market value remains unpaid for 90 days from due date in case of derivative contracts[vi].
Kinds of NPA
- Gross NPA
The overall amount of all the loans that have gone as bad loan is known as Gross NPA. It is a kind of advance which is written off, for banks which have made provisions and are in the book of account of the bank.
- Net NPA
Gross NPA-Provisions= Net NPA
Lenders generally provide a grace period for payment of arrears and afterwards it is considered as NPA. NPAs has been classified into sub-categories as:
- Standard Assets: NPAs which has been due for 90 days to 12 months with a normal risk are classified as a standard asset.
- Sub-Standard Assets: Sub-standard Assets are NPAs that have been due for 12 months and the risk level is higher and combined with the less credibility of the borrower. For these kinds of NPAs, banks usually assign a haircut (reduction in market value) because the chances of getting the repayment are slightly less[vii].
- Doubtful Debts: The NPAs which have been due for 28 months and there is serious doubt that the borrower will repay the full loan ever, can be called as doubtful debts.
- Loss Assets: These NPAs are for an extended period of non-payment and it is presumed that the loan will not be paid. The entire amount of loan must be written off on balance sheet of lending bank.
Reasons for growing NPAs
It is important for the banking sector to flourish to maintain a healthy financial system of any country as banking sector indirectly or directly affects every other sector and the increasing NPAs acts as a hindrance in the same. There are various reasons responsible for the growing NPA and some of them are:
- Earlier, the Indian banking sector has been operating in close markets but now they have to operate in an open economy which leads to various challenges such as an increase in the cost of banking services. The increasing NPAs are result of a prescribed percentage of credit of the banking sector to priority sector and the percentage is too high i.e. 40 percent.
- The problem of NPA is not new, it has been existing for decades but loan waiver of Rs. 15,000 crores to rural loan account by Prime Minister VP Singh in the year 1989-1990 has worsened the situation by leaving a negative impact on payer-borrower relationship. As a result of which the payer didn’t feel much responsibility in paying off their debts which has negatively affected the Indian Banking Sector[viii].
There are two types of factors that makes a loan amount, a non-performing asset:
- Defective Lending: The commercial banks have been following three principals of lending
- Principal of safety
- Principal of liquidity
- Principal of profitability
In many cases, banks gave the loan to many companies without analysing the asset and financial situation just based on their popular names. For example, Kingfisher Corporation.
- Inappropriate Technology: Some decisions which are required for the market on a real-time basis due to lack of technology and management information system. Due to the non-implementation of Proper MIS and financial accounting system by the banks, poor credit collection rise resulting in increasing NPAs.
- Managerial deficiencies: To safeguard its interests, the banker needs to select borrowers wisely and take tangible assets as security. While accepting securities, the banks should consider Marketability, Acceptability, Safety and Transferability of the asset.
- Poor Credit Appraisal: The bank gives advances to those who are not able to return there loan back. Banks should use good credit appraisal to decrease NPAs.
- Absence of Regular Industrial Visit: The absence in visiting of the banks’ officials to the customers decreases the chances of collection of interests and principals on the loan on timely basis which leads to increasing NPAs by the wilful defaulters.
- Ineffective Recovery: The ineffectiveness and negligence of recovery tribunals set up by the Government have resulted in banks suffering from the consequences of non-recovery that lead to reduced profitability and liquidity.
- Wilful Defaults: Some borrowers intentionally refrain themselves from paying back the loan. These groups of people should be identified and proper measures should be taken to get back the money.
- Natural Calamities: This has been one of the major reasons adding to NPAs as it makes the borrower unable to pay their debts and thus, the bank has to make provisions for a large amount to compensate those loans, hence ends up the fiscal with a reduced profit.
- Industrial sickness: Industrial sickness comes into picture because of lack of resources, ineffective management, lack of advanced technology and changing policies of thegovernment. If the banks give loans to these industries, having industry sickness, it ends up in low recovery of their loans.
- Lack of demand: Entrepreneur who lacks in predicting the demands of the market for their products ends up piling up their products by producing it in large quantity which eventually resulted in making them unable to repay the loan that they have borrowed. The banks sell their assets to recover their debts which covers a minimum label[ix].
The state governments in India have given loan waiver to small farmers a number which has also added to rise in the non-performing assets.
|State||Year||Amount (in crores)|
Impact of Non-Performing Assets
The efficiency of banks is not only measured by the size of its balance sheet but the level of return of its asset also adds to its reputation[x]. The increasing NPAs not only reduces the profitability but also impacts negatively on the credibility of banks in Indian Banking Sector.
These increasing NPAs in commercial banks erode away the maximum amount of capital of public sector banks resulting in destabilising the confidence of depositors to the banks. When the depositors lose their confidence in banks, they start withdrawing their money from the bank leading to the collapsing of the banking system. This is how non-performing assets attacks the sustainability and stability of the banks.
With the increase in NPAs, the banks are forced to decrease their interest rate in order to margin the profitability of the banks. The shortage of funds due to NPAs prompted the banks to invest less in the industrial sector which affects the growth of the industrial sector and economy of the country.
The increase in NPA leads to shrink in availability of credit for the public at large, mainly priority sectors which in turn affects the overall economy of a country. For new entrepreneurs to establish and generate employment, it is important that banks should have excess credit to provide the public[xi].
The increase in Non-performing Assets have harmful impact on the return on assets in many ways such as:
- Return on investments is reduced.
- Limits recycling of funds
- Profitability of banks is adversely affected because of providing of doubtful debts and consequent to writing it off as bad debts
- The income of bank i.e. interest on loans will fall and is accounted on receipt basis
- Mismatch of assets and liabilities
- Adequate ratio of capital gets disturbed as NPAs are added into calculation
- Rise in cost of capital[xii]
- EVA (Economic Value additions) by banks get upset as EVA is equal to net operating profit minus cost of capital
- NPA leads to decrease in value of share, which can be even lesser than book value in capital market.
- The risk facing ability of banks get affected by NPA[xiii]
Because of these above-mentioned effects of NPAs, Public Sector Banks (PSBs) lose their income and there are high chances of debts going unpaid which further reduces the profit margin.
Changes after RBI Guidelines
The Reserve Bank of India (RBI) has issued various guidelines to provide solution to the stressed assets of banks including introduction of various schemes such as (a) Strategic Debt Restructuring which allows banks to change the management of defaulting company (b) Joint Lenders’ Forum under which lenders evolve a resolution plan and voted on its implementation; and many more. With the enactment of Insolvency & Bankruptcy Code, the RBI substituted some specific pre-existing guidelines through a circular in February 2018 with a simplified, generic, time-bound framework for resolution of stressed assets[xiv].
The RBI revised its framework by replacing the earlier scheme and putting a strict deadline of 180 days within a resolution plan must be implemented. If the resolution plan fails, the stress must be referred to NCLT within 15 days under IBC. The same framework also introduced a provision of monitoring of one-day defaults in which stress that can emerge is identified and flagged, if repayment remains unpaid for one day.
Some borrowers appealed in various High Courts against the RBI guideline whose deadline of 180 days just crossed without repayment of loan and who were tagged as NPAs for internal resolution of banks. In case of Independent Power Producers Association of India vs Union of India[xv], the Allahabad High Court ruled in favour of RBI and refused to grant interim relief to producers from being taken to NCLT for bankruptcy. All lawsuits relating to the matter were transferred to Supreme Court of India which has passed an order to maintain status quo, meaning these cases cannot be referred to NCLT until Supreme Court take some decision on the circular, however 180 days deadline has already passed. The order of the Supreme Court has provided interim relief to borrowers. The Supreme Court in its judgement quashed the RBI 12 February circular[xvi].
Measures taken to recover NPAs
- The measures taken to prevent and resolve NPAs are classified into two kinds: (a) regulatory meaning resolving NPAs on basis various laws such as IBC, SARFAESI, DRT, etc. and (b) remedial measures provided by RBI restructuring of measures for stressed assets.
- With the enactment of Insolvency and Bankruptcy Code (IBC) in 2016, a time bound 180 days deadline was initiated for the insolvent accounts (where borrowers are unable to repay their debts)
- Banking Regulation Act, 1949: The Banking Regulation Act was amended so that the RBI will be vested with the right to issue directions for banks to initiate insolvency resolution process under IBC.
- NCLT: As on December 2017, the NCLT was given the right to give orders on insolvency matters as per IBC
- DRT Act: The DRT Act provides for setting of Debt Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT) for expedition and speedy disposal suits filed by banks or financial institutions for recovery of debts in NPAs account having outstanding amount of Rs. 10 Lakh or more.
- SARFAESI Act: This Act allows banks and financial institutions to recover their Non-Performing Assets by acquiring and disposing of secured assets in NPA accounts having outstanding amounts of One Lakh or more.
- Lok Adalat: Lok Adalat provides a solution that is mutually acceptable by way of settlement of dispute. As per government advice, the PSBs are advised to utilize the mechanism to fullest for recovery of their stressed assets[xvii].
- Measures taken by Government of India
In order to tackle the issue of rising NPA, the Government taken certain initiatives such as:
- In each DRT, at every bank (head offices/zonal offices) a Nodal officer has been appointed to recover debts.
- The state-level bankers’ committees were directed to be proactive with state governments in resolving issues.
- The banks are being pushed to recover loan assets and the Asset Reconstruction Companies (ARC) were designated as agent banks.
- Sanctioning of fresh loan on the basis of information shared by the lending bank.[xviii]
- Measures by Reserve Bank of India (RBI)
For making the banks able to deal with the problem of rising NPA, the RBI has taken some measures which are:
- When the principal amount or the interest has not been paid within 61 to 90 days, the banks were directed by RBI to report it to the Central Repository of Information on Large Credit (CRILC).
- SEBI norms has been eased to convert loans of defaulters into equity.
- In cases where restrictions imposed have not helped, banks were given the power to convert the loans into equity in Strategic Debt Restructuring Scheme (SDRS).
- The sale for non-core assets in case of a company has been diversified except for guaranteed loans[xix].
- RBI has issued Prompt Corrective Action (PCA) to maintain financial health of banks[xx].
Significance of NPA
Both borrower and lender should have the knowledge of not only performing assets but also non-performing assets and the ratio amongst them.
- For Borrower, if the asset is non-performing and the interest for the same are not paid on time, it can affect their credit and possibilities of growth negatively which will further hamper their chances of future borrowing.
- For banks (lender) interests earned on loan is the main source of income and NPAs affects their ability to generate satisfactory income negatively which further affect the overall profitability. It is important for banking sectors to keep a track of non-performing assets which can affect the liquidity and growth abilities of banks.
The non-performing assets can be managed but it should be not very high in number and not long due otherwise it will negatively affect the financial health and future of the lender[xxi].
Conclusion & Suggestion
The problem of increasing NPA is posing serious threat to not only banking sector but also to the financial health of country. It is high time that the banks and financial institutions should become cautious towards the factors which are affecting the repayment ability of borrowers, usefulness of the project for which the bank is providing loan and probable profitability in the near future[xxii]. The money that got stuck in the NPA has a direct impact on the profitability of the banks and mostly Public Sectors Banks are being affected from the problem of NPA. Although Indian Government has taken various initiatives to tackle to problem of NPA but still the NPA level of Indian banks is much higher than that of foreign banks. At the same it is also important to keep in mind that the NPAs cannot never be zero but it is also important for banks to speed up their recovery process to maintain low level NPAs. The recovery problem is not only associated with small borrowers but also with large borrowers and thus it is important to impose strict policies to curb this problem. The problem of NPA needs serious attention and efforts otherwise it will keep on rising and killing the credibility and profitability of banks which in return will affect the growth of Indian economy.
This disclaimer informs readers that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author’s employer, organization, committee or other group or individual.
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