Non-Performing Assets (NPA) are loans and arrears lent by the banks or financial institutions whose principal and interests are delayed beyond 90 days. The Classification of NPA is based on the number of days the payment of principal and interest is due. It is classified as Substandard assets, Doubtful assets, and Loss assets.

In this article, let us see the meaning of NPA, the classification of NPA and the trends in NPA. Non-Performing Assets topic is very important for UPSC IAS Exam in General Studies Paper 3 and Economy subjects.

What are Non Performing Assets?

• When an asset no longer generates income for the bank, it is considered a non-performing asset.
• Previously, an asset was classified as a non-performing asset (NPA) based on the concept of "Past Due."
• A 'non-performing asset' (NPA) was defined as a credit for which interest and/or principal installments have been 'past due' for a specified period of time.
• To move towards international best practices and ensure greater transparency, '90 days' overdue norms for identifying NPAs were made applicable beginning with the fiscal year ended March 31, 2004.
• Commercial loans that are more than 90 days past due and consumer loans that are more than 180 days past due are typically classified as nonperforming assets by banks.
• In the case of agricultural loans, NPAs have declared if the interest and/or installment of principal remain unpaid for two harvest seasons.
  • However, this period should not be longer than two years. Any unpaid loan/installment will be classified as NPA after two years.

Classification of Non Performing Assets

• Sub-standard: When the NPAs have aged <= 12 months.
• Doubtful: When the NPAs have aged > 12 months.
• Loss assets: When the bank or its auditors have identified the loss, but it has not been written off.

For Example, consider a commercial loan made on January 1st, 2015 with repayment date of interest and principal amount on the 5th of every month. The firm stops its repayment and misses its repayments from January 2016.

• The loan is classified as an NPA if there is no repayment by April 5, 2016.
• If it is not repaid after that it is called a sub-standard asset till April 5, 2017.
• If the repayment due is past April 5, 2017, then it is classified as a doubtful asset.
• When the bank decides it no longer can recover this commercial loan it is classified as loss assets.

Trends of Non Performing Assets

• The NPA was on a declining trend from FY 2018 due to various initiatives by the Reserve Bank of India and the central government such as the Insolvency and Bankruptcy Code, Abolition of previous initiatives like the 5:25 rule, etc.
• Due to the effects of the coronavirus (COVID-19) epidemic and lockdown, the country was expected to see an increase in bad loans.
• The Reserve Bank of India projected three scenarios for the fiscal year 2022 until September 2021 based on the value for September 2020.
• Under the baseline scenario, the GNPA-ratio would reach 13.5 percent, setting a new high.

Reasons for rise of NPAs in India

Historical factors

• Between the early 2000s and 2008, the Indian economy was booming. During this time, banks, particularly public sector banks, lent heavily to businesses.
• However, due to a slowing global economy, a restriction on mining projects, and delays in environmental-related licenses affecting the power, iron, and steel sectors, as well as volatility in raw material prices and a scarcity of, most corporations' profits have declined.
• This has harmed their ability to repay loans and is the primary reason for the rise in nonperforming assets (NPA) at public sector banks.

Relaxed lending norms

• One of the key causes of rising NPA is the loosening of lending standards, particularly for corporate executives whose financial situation and credit rating are not thoroughly examined.
• In addition, in order to compete, banks are aggressively selling unsecured loans, which contributes to the high level of nonperforming assets (NPAs).

Poor Contingency Plan

• Banks did not conduct enough contingency planning, particularly for managing project risk, due to a lack of contingency planning.
• They did not account for contingencies such as the failure of gas projects to ensure gas supply or the collapse of the highway land acquisition procedure.

Poor Restructuring and loan servicing

Restructuring of credit facilities was extended to enterprises with more serious over-leverage and under-profitability issues. This issue was more prevalent in public sector banks.

Unforeseen conditions

Economic shocks such as demonetization and Covid 19 are unforeseeable.

The problem of Wilful Defaulters

• Diversification of finances into unrelated businesses or fraudulent activities.
• Due to a lack of diligence, there are lapses.
• Willful defaulters, for example, are the result of corporate malfeasance.

Poor Governance

• Loans become non-performing assets (NPAs) as a result of mismanagement and policy gridlock, which slows down the timetable and speed of projects. Take, for instance, the Infrastructure Sector.
• Land acquisition is being held up due to social, political, cultural, and environmental factors.
• Changes in the business/regulatory environment have resulted in business losses.
• Morale was low, especially after government loan forgiveness programs.

Unsustainable Competition

Intense competition in a specific market segment. Consider India's telecommunications industry.

Impact of NPAs

• Twin Balance Sheet Syndrome: In which both banks and corporations have strained balance sheets, leads the investment-led growth process to come to a halt.
• Judicial burden: Cases involving NPAs add to the pressure on the judiciary's already overburdened docket.
• Reduced Profits: Profit margins for lenders are shrinking.
• Stress in the banking sector means less money is available to fund other projects, resulting in a negative impact on the overall economy.
• Poor monetary policy transmission: Banks are raising interest rates to retain their profit margins.
• Funds are being diverted from good initiatives to bad ones.
• Unemployment: As a result of the stagnation of investments, it is possible that unemployment will result.
• Reduced revenue for the government: In the case of public sector banks, poor financial health equals poor shareholder returns, which means the government of India receives less money as a dividend. As a result, it may affect the ease with which money is used for social and infrastructure development, resulting in social and political costs.
• Investors do not receive their due returns.

Measures to curb NPAs in India

NPAs are not a new problem in India, and the government has taken many attempts to address them at the legal, financial, and policy levels. The Narasimhan Committee suggested a number of measures to deal with nonperforming assets (NPAs) in 1991. Some of them were put into practice.

Debt Recovery Tribunals (DRTs)

• The Debt Recovery Tribunals (DRTs) were established in 1993.
• To reduce the amount of time it takes to settle matters. The requirements of the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, apply to them. However, because their numbers are insufficient, they face a time lag, with cases in many locations pending for more than two years.

Credit Information Bureau (CIB)

• In the year 2000, the Credit Information Bureau (CIB) was established.
• To avoid loans getting into the wrong hands and, as a result, NPAs, a good information system is essential. Individual defaulters and wilful defaulters are tracked and shared, which aids banks.

Lok Adalats - 2001

They are useful in dealing with and recovering small loans, but the RBI guidelines established in 2001 limit them to loans of up to 5 lakh rupees. They are beneficial in that they prevent more cases from entering the legal system.

Compromise Settlement - 2000

For advances under Rs. 10 crores, it provides a straightforward route for NPA recovery. Willful default and fraud cases are excluded. It covers lawsuits in courts and DRTs (Debt Recovery Tribunals).

SARFAESI Act

• The SARFAESI Act (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) of 2002 - The Act allows banks and financial institutions to recover their nonperforming assets (NPAs) without the participation of a court by acquiring and disposing of secured assets in NPA accounts with an outstanding balance of Rs. 1 lakh or more.
• The banks must first send out a notification. They can then take the following actions if the borrower fails to repay:
  • Assume responsibility for security and/or management of the borrowing concern.
  • Make a decision on who will be in charge of the problem.

Asset Reconstruction Companies (ARC)

Following the modification of the SARFAESI Act of 2002, the RBI has granted licenses to 14 additional ARCs. These businesses were formed in order to extract value from troubled loans. Prior to the passage of this law, lenders could only enforce their security interests through the courts, which was a lengthy procedure.

Restructuring of Corporate Debt – 2005

Its purpose is to reduce the company's debt burden by lowering the interest rates paid and lengthening the time it takes to repay the debt.

5:25 rule

• The 5:25 rule was enacted in 2014.
• Flexible Structuring of Long-Term Project Loans to Infrastructure and Core Industries is another name for it. It was suggested that such organizations maintain their cash flow because project timelines are long and they do not receive money back into their books for a long time, necessitating the need for loans every 5-7 years and therefore refinancing for long-term projects.

Joint Lenders Forum 2014

It came about as a result of the inclusion of all PSBs with stressed loans. It's there to prevent many banks from lending to the same person or firm. It was created to prevent situations in which a person accepts a loan from one bank in order to give a loan from another bank.

Indradhanush Framework – 2015

• Since banking nationalization in 1970, the Indradhanush framework for changing PSBs has been the most comprehensive reform effort undertaken by ABCDEFG to remodel the PSBs and improve their overall performance.
• Appointments: Based on worldwide best practices and guidelines in the Companies Act, a distinct post of Chairman and Managing Director will be created, with the CEO receiving the designation of MD & CEO, and a non-executive Chairman of PSBs would be appointed.
• Bank Board Bureau: will replace the Appointments Board in the selection of Whole-time Directors and non-Executive Chairman of PSBs.
• Capitalization: According to the finance ministry, the capital requirement for the next four years up to FY 2019 is estimated to be around Rs.1,80,000 crore, of which the government will pay 70000 crores and PSBs will have to raise the remainder from the market.
• Destressing: De-stressing entails resolving concerns in the infrastructure sector in order to keep stressed assets out of banks by bolstering asset reconstruction firms. The creation of a thriving debt market for PSBs.
• Empowerment: PSBs should be given more flexibility and autonomy when it comes to employing staff.
• A framework of Accountability: The banks will be evaluated based on a few key performance indicators. It would include everything.
  • Non-performing asset management, growth, diversification, return on capital, financial inclusion, and other quantitative indicators
  • Steps done to improve asset quality, human resource initiatives, and so on are examples of qualitative parameters.
• Governance Reforms: Banker's Retreats or Gyan Sangam talks between bankers and government officials to resolve banking sector concerns and determine the future course of action.

SDR (Strategic Debt Restructuring)

• Under this program, banks that have provided a corporate borrower with a loan have the option to convert all or part of their loan into equity shares in the company that has accepted the loan.
• Its main goal is to give promoters a bigger stake in rescuing stressed accounts and to give banks better tools for initiating a change of ownership in appropriate instances.

Asset Quality Review (2015)

Classify stressed assets and make provisions for them in order to ensure the banks' long-term viability. Identify stressed assets early and take appropriate steps to prevent them from becoming stressed.

Sustainable Asset Structuring (S4A) 2016

• It's been designed as an optional framework for resolving accounts that are heavily pressured.
• It entails determining a stressed borrower's sustainable debt level and bifurcating outstanding debt into sustainable debt and equity/quasi-equity instruments that are projected to deliver upside to lenders if the borrower recovers.

Insolvency and Bankruptcy Code of 2016

• It was created to address the Chakravyuaha Challenge (Economic Survey) of India's exit problem.
• The goal of this law is to promote entrepreneurship, credit availability, and balance the interests of all stakeholders by consolidating and amending the laws governing the timely reorganization and insolvency resolution of corporate persons, partnership firms, and individuals, as well as matters related to or incidental to such reorganization and insolvency resolution.

Public ARC vs. Private ARC 2017

• This dispute, which was recently in the news, is about the idea of a public asset reconstruction company (ARC) that is entirely funded and administered by the government, as suggested by this year's Economic Survey, against a private ARC, as proposed by RBI deputy governor Mr. Viral Acharya.
• PARA (Public Asset Rehabilitation Agency) is the name given to it by an economic survey, and the proposal is based on the performance of a similar agency utilized during the East Asian crisis of 1997.

Bad Banks 2017

• Economic survey 16-17 also mentions the establishment of a bad bank that will take on all stressed loans and deal with them according to flexible regulations and mechanisms.
• It will help PSBs' balance sheets by giving them more room.

Conclusion

NPAs place a financial burden on the lender; a significant number of NPAs over time may indicate to regulators that the bank's financial fitness is jeopardized. Lenders can recover their losses by taking possession of any collateral or selling the loan to a collection agency at a significant discount.