NON PERFORMING ASSETS (NPA)
- Money or Assets provided by banks to companies as loans sometimes remain unpaid by borrowers. A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. It is also called bad assets or bad loans.
- According to RBI, an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
- The Non-performing assets (NPAs) ratio is the ratio of bad loans (or NPAs) to total loan. (NPA ratio = Net non-performing assets / Loans given )
- NPAs are categorized into three:
- 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.
- India has the second highest ratio of NPAs among the major economies of the world.
- The basic metals and cement industries are the most defaulted sectors. The construction, infrastructure and automobile industries also account for a sizeable portion of banks’ NPAs
- Public sector banks accounts for 90% of the total NPA in India, with private sector banks accounting for the remainder.
- State Bank of India (SBI) had the highest amount of NPAs at over Rs 2.23 lakh crore (in March 2018) followed by Punjab National Bank. IDBI Bank has highest proportion of NPA among public sector banks in India.
- Among private sector lenders, ICICI Bank had the highest amount of NPAs.
- The gross NPA ratio of all scheduled commercial banks declined from 11.6% in March to 10.8% in September 2018. The Financial Stability Report published by RBI in December 2018 says that it will further decline to 10.3 % by March 2019.
Reasons for NPA Crisis
- From 2000-2008, the Indian economy was in a boom phase and banks, especially public sector banks, started lending extensively to companies. But after the financial crisis of 2008, corporate profits decreased. A larger number of bad loans were originated in the period 2006-2008.
- The major reason is the relaxed lending norms and non-transparency adapted by banks, especially to the big corporate houses, without considering their credit capacity.
- Some other reasons are:
- delay in land acquisition and environmental permits
- slow down of power, iron, and steel sectors
- maladministration by the corporate
- Severe competition in any particular market segment such as Telecom sector
- Increasing size of frauds in the public sector banking system
Impact of NPA
- 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
- As investments got stuck, it may result in it may result in unemployment.
- In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that the government of India gets less money as a dividend. Government will have to infuse more capital to banking sector to overcome the crisis.
To recover outstanding loans, a slew of legislations including the IBC (Insolvency and Bankruptcy Code), the SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, and the RDDBFI (Recovery of Debts due to Banks and Financial Institutions) were instituted. Debt Recovery Tribunals (DBT) were also set up to fast-track proceedings.
Insolvency and Bankruptcy Code 2016
- The Government of India implemented the Insolvency and Bankruptcy Code (IBC) to consolidate all laws related to insolvency and bankruptcy and to tackle Non-Performing Assets (NPA).
- The Code was passed by parliament in May 2016 and became effective in December 2016
- The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the country and regulate the entities registered under it.
- As per the new law, when a loan default occurs, either the borrower or the lender approaches the NCLT (National Company Law Tribunal) or DRT (Debt Recovery Tribunal) for initiating the resolution process.
- The Code provides two options if a firm files insolvency: first is an Insolvency Resolution Process, during which creditors assess whether the underlying business is viable and if so, they have to search options for the rescue of the firm. The second option is liquidation if it is not financially viable.
- SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act is framed to address the problem of NPAs (Non-Performing Assets) or bad loans through different processes and mechanisms.
- It allows banks and other financial institution to auction residential or commercial properties of defaulters to recover loans.
- Banks are allowed to take possession of the collateral property (except agricultural land) without intervention of the court.
- The SARFAESI Act also provides for the establishment of Asset Reconstruction Companies (ARCs) regulated by RBI. Banks can sell their non-performing assets to ARCs.
Prompt Corrective Action (PCA)
- RBI introduces Prompt Corrective Action when the Bank’s financial conditions worsen below certain limits.
- The PCA framework specifies the trigger points or the level after which the RBI will intervene with corrective action. The trigger points are set by considering three financial indicators of that bank:
- (1) Capital to Risk weighted Asset Ratio (CRAR)
- (2) Net Non-Performing Assets (NPA) and
- (3) Return on Assets (RoA)
- PCA norms allow the regulator to place certain restrictions such as halting branch expansion and stopping dividend payment. It can even cap a bank’s lending limit to one entity or sector. Other corrective actions that can be imposed on banks include special audit, restructuring operations and activation of recovery plan. Banks’ promoters can be asked to bring in new management, too.
- The PCA framework is applicable only to commercial banks and not extended to co-operative banks and non-banking financial companies (NBFCs)