Non-Performing Assets (NPAs)

Context: Probing the links between twin balance sheet crisis and external commodity shocks could lead to a better understanding of the problem of resolving Non Performing Assets.

Definition of NPAs:

• Non-Performing Assets: In most cases, debt is classified as non-performing, when the loan payments have not been made for a minimum period of 90 days.
• Twin balance sheet crisis: A twin balance sheet is a scenario where banks are under severe stress and the corporates are overleveraged to the extent that they cannot repay their loans.

Categories of Non-Performing Assets (NPAs)

Based upon the period to which a loan has remained as NPA, it is classified into 3 types:

Substandard Assets: An asset which remains as NPAs for less than or equal to 12 months.

Doubtful Assets: An asset which remained in the above category for 12 months.

Loss Assets: Asset where loss has been identified by the bank or the RBI, however, there may be some value remaining in it. Therefore, loan has not been not completely written off.

Reasons for rise in NPAs:

• Governance issues: Poor management in public sector banks stemming from government ownership has been cited as the major causes of the NPA crisis.
• Wrong narrative: The government ownership does not explain the improvement in performance that public sector banks saw throughout the 2000s.It is improbable that governance improved suddenly (late 2000s) and dwindled subsequently (2011-18).
• Distinct business models: A careful examination of the data gives overwhelming evidence that a large fraction of the difference between NPAs in the public and private sector banks arose due to differences in their business models.
• Price decline: The rise in NPAs from 2011 onwards coincides with the fall in international commodity prices.
• No NPA stress despite pandemic: It is because of the commodity price boom in the last two years that despite the worst kind of economic crisis due to Covid-19, hardly any stress in the banking sector during the pandemic is heard.
• Statistics: According to the Reserve Bank of India’s latest financial stability report, gross non-performing loans (GNPAs) of the banking system have declined from 7.4 per cent in March 2021 to a six-year low of 5.9 per cent in March 2022.

Impacts of rise in NPAs:

• Lenders suffer a lowering of profit margins.
• Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy.
• Higher interest rates by the banks to maintain the profit margin.
• Redirecting funds from the good projects to the bad ones.
• As investments got stuck, it may result in it may result in unemployment.
• Investors do not get rightful returns.
• Balance sheet syndrome of Indian characteristics that is both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process.
• NPAs related cases add more pressure to already pending cases with the judiciary.

Government’s Initiatives to tackle NPAs:

Lok Adalats – 2001

• They are helpful in tackling and recovery of small loans however they are limited up to 5 lakh rupees loans only by the RBI guidelines issued in 2001. They are positive in the sense that they avoid more cases into the legal system.

Compromise Settlement – 2001

• It provides a simple mechanism for recovery of NPA for the advances below Rs. 10 Crores. It covers lawsuits with courts and DRTs (Debt Recovery Tribunals) however wilful default and fraud cases are excluded.

SARFAESI Act – 2002

• The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 – 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.

Mission Indradhanush – 2015

• The Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their overall performance.

Insolvency and Bankruptcy code Act-2016

• It has been formulated to tackle the Chakravyuaha Challenge (Economic Survey) of the exit problem in India.
• The aim of this law is 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 and for maximization of value of assets of such persons and matters connected therewith or incidental thereto.

Bad Banks – 2017

• A bad bank is a corporate structure that isolates illiquid and high-risk assets or non-performing loans held by a bank or a financial organisation. It is also referred to as Asset Management Company (AMC).
• The concept of a bad bank originated at the Pittsburgh headquartered Mellon Bank in 1988. The idea and discussions over bad bank have been in place since 2015 when former RBI Governor Raghuram Rajan started a debate on bad bank as a possible solution to the problem of NPAs.
• Afterwards, former Interim Finance Minister put forth the idea of National ARC on a recommendation of the Committee headed by Sunil Mehta. The Economic Survey 2017 also propounded to create a Public Sector Asset Rehabilitation Agency (PARA).

National Asset Reconstruction Company Ltd:

• National Asset Reconstruction Company Ltd.(NARCL), India’s first-ever Bad Bank, was set up in 2021, and RBI has recently granted the same under the SARFAESI Act 2002.
• If the bad bank is unable to sell the bad loan or has to sell it at a loss, then the government guarantee will be invoked.
• To manage assets with the help of market professionals and turnaround experts, the Government will also set up India Debt Resolution Company Ltd. (IDRCL) along with NARCL. The IDRCL is a service company or an operational entity wherein public sector banks (PSBs) and PFIs will hold a maximum of 49% stake and the rest will be with private-sector lenders. When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest.

Way Forward:

• There must be a sunset clause to the resolution process through Bad Banks. It is quintessential to develop time-bound strategies for the resolution of assets, or else the bad bank will be reduced to a mere parking space of bad loans.
• Bad Banks should have a suitable mechanism in place that can facilitate funding for maintaining the quality of assets till their resolution.
• Banks have to accept losses on loans (or ‘haircuts’). They should be able to do so without any fear of harassment by the investigative agencies.
• The Indian Banks’ Association has set up a six-member panel to oversee resolution plans of lead lenders. To expedite resolution, more such panels are required.
• An alternative is to set up a Loan Resolution Authority, if necessary, through an Act of Parliament. Also, the government must infuse at one go whatever additional capital is needed to recapitalise banks — providing such capital in multiple instalments is not helpful.
• The pandemic has hit the economy hard and has exposed the vulnerabilities of our banking system.

Source:  Indian Express