Non-Performing Assets (NPA) are loans and arrears lent by banks or financial institutions whose principal and interests are delayed beyond 90 days. In simpler terms, any asset that ceases to provide returns to its investors for an extended period of time is referred to as a non-performing asset (NPA). According to the RBI data, nearly over 10% of all loans have become NPAs as of September 2021.

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 instalments have been 'past due' for a specified period of time.
• To move toward 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 are declared if the interest and/or instalment or principal remain unpaid for two harvest seasons.
  • However, this period should not be longer than two years. Any unpaid loan/instalment 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.

*Click here to read more about the classification of NPAs.

NPA Problem of India Banks

• 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 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.

Wilful Defaulter

• Any entity is considered a wilful defaulter when:
  • The unit has failed to make its payment/repayment commitments to the lender, despite having the financial means to do so.
  • The unit has failed to meet its payment/repayment commitments to the lender and has not used the lender's funds for the specific objectives for which they were obtained, instead of diverting the money to other uses.
  • The unit has failed to meet its payment/repayment commitments to the lender and has syphoned off the funds, such that the funds have not been used for the precise purpose for which credit was obtained, nor are the funds available in the form of other assets with the unit.
• The Banks have to submit the names of the Wilful defaulters to the Reserve Bank of India (RBI) with outstanding loans of more than 25 Lakhs.

*Click here to read more about Wilful Defaulter.

SARFAESI Act

• SARFAESI Act of 2002 is ".. an act to regulate securitization and reconstruction of financial assets and enforcement of security interests, and to provide for a central database of security interests created on property rights, and for matters associated with or incidental thereto,".
• SARFAESI is an acronym for Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest.
• It permits banks and other financial institutions to recover loans by auctioning off the defaulter's residential or commercial assets.
• Under this act, India's first Asset Reconstruction Corporation (ARC), ARCIL, was established.
• Secured creditors (banks or financial institutions) have rights to security interest enforcement under section 13 of the SARFAESI Act, 2002.
• The SARFAESI Act of 2002 will now apply to all state and multi-state co-operative banks, according to the Supreme Court of India. Banks can now seize and sell defaulters' properties to recoup their debts, thanks to the Supreme Court's momentous decision.

*Click here to read more about SARFAESI Act.

Insolvency and Bankruptcy Code

• The Insolvency and Bankruptcy Code, 2016 (IBC) is India's bankruptcy law, which aims to unify the existing framework by establishing a single insolvency and bankruptcy law.
• Insolvency is a condition in which a debtor is unable to pay his/her debts.
• Bankruptcy is a legal process that involves an insolvent person or company that is unable to pay its debts.
• It establishes clearer and faster insolvency procedures to assist creditors, such as banks, in recovering debts and avoiding bad loans, which are a major drag on the economy.
• It is an all-encompassing insolvency code that applies to all businesses, partnerships, and individuals (other than financial firms).

*Click here to read more about Insolvency and Bankruptcy Code.

Bad Bank

• A bad bank is a financial institution that was formed to purchase the bad loans and other illiquid assets of another financial institution.
• An organisation with a large number of nonperforming assets will sell them to the bad bank at market value.
• The original institution may be able to clear its balance sheet by transferring such assets to the bad bank, albeit it will still be compelled to take write-downs.
• Instead of a single bank, a bad bank structure may assume the risky assets of a consortium of financial organisations.
• Grant Street National Bank is a well-known example of a bad bank. This entity was founded in 1988 to house Mellon Bank's bad assets.
• Outside of the United States, the Republic of Ireland established the National Asset Management Agency, a bad bank, in 2009 in response to the country's own financial crisis.

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Asset Quality Review

• Inspectors from the Reserve Bank of India (RBI) typically review bank records once a year as part of the Annual Financial Inspection (AFI) process.
• In 2015-16, however, throughout the months of August and November, a special inspection was carried out. Asset Quality Review (AQR) was the name given to this.
• A small sample of loans is evaluated in a routine AFI to see if asset classification matches loan repayment and if banks have made necessary reserves.
• The sample size in the AQR, on the other hand, was substantially larger, and most of the large borrower accounts were investigated to see if categorisation complied with prudential standards.
• According to some reports, a list of over 200 accounts was identified, and banks were instructed to designate them as non-performing.
• Banks were allocated two quarters to complete the asset classification: October-December 2015 and January-March 2016.
• The main aspect of AQR is that it is a random check rather than a periodic check.

*Click here to read more about Asset Quality Review.

Recapitalisation of Banks

• Recapitalisation of Banks is injecting additional capital into state-owned banks to bring them up to capital adequacy standards.
• It entails injecting more capital into state-owned banks in order for them to achieve capital adequacy requirements.
• The requirement for Indian public sector banks to maintain a Capital Adequacy Ratio (CAR) of 12 per cent has been underlined by the Reserve Bank of India in line with BASEL norms.
• The capital-to-risk-weighted-assets-and-current-liabilities ratio (CAR) is the ratio of a bank's capital to its risk-weighted assets and current liabilities.
• The government injects capital into banks that are short on cash using a variety of instruments.
• Because the government is the largest stakeholder in public sector banks, it is the government's responsibility to increase capital reserves.
• The government injects capital into banks by issuing bonds or buying new shares.
• In 2017, the government had announced an Rs. 2.11 Lakh crore recapitalisation package for the Public sector Banks

*Click here to read more about the Recapitalisation of Banks.

Prompt Corrective Action

• The RBI uses the PCA framework to keep track of banks with poor financial performance.
• The PCA framework was introduced by the RBI in 2002 as a structured early-intervention mechanism for banks that have become undercapitalized or fragile due to a loss of profitability.
• Its goal is to address the issue of non-performing assets (NPAs) in India's banking system.
• Based on the recommendations of the Financial Stability and Development Council's working group on Resolution Regimes for Financial Institutions in India and the Financial Sector Legislative Reforms Commission, the framework was reviewed in 2017.
• If a bank is in crisis, PCA is supposed to inform the regulator, as well as investors and depositors.
• The goal is to prevent problems from reaching crisis proportions.
• Essentially, PCA assists RBI in monitoring banks' key performance indicators and taking corrective action to restore a bank's financial health.

*Click here to read more about the Prompt Corrective Action Framework.

Conclusion

Given the enormous size of the banking industry, there is no doubt that the threat of NPAs must be mitigated. It poses a significant threat to the Indian economy's macroeconomic stability. An examination of the current situation reveals that the problem is multifaceted, with roots in the economic slowdown, the deteriorating business climate in India, shortages in the legal system, and the banks' operational shortcomings. The RBI's recommendations are a positive step in this direction.