Banking sector reform was done on the expectation of allocation of more commercial banks’ credit to the existing real sectors vis-à-vis reducing operating costs of banks and statutory reserve and cash reserve ratios. Special attention was put upon reduction of a large fund in the head of bad debt which is popularly known as the non-performing assets (NPA) so that the productive real sectors are entitled to get more bank credit in one hand and profitability of banks rises on other. Assumptions were made that, it will improve the health of the banking institutions, it will also lead to influence the real sectors’ output growth through channelization of savings money into investment money as there is linkage between financial sector and real sector.
To avert the credit risk, there are rising trends of commercial banks’ intention of making their funds to be invested in the government and other approved securities other than investing in the real sectors in spite of significant margin of fall in the non-performing assets (NPA) of the banks. Moral suasion, Capital Infusion and other incentives have been used by Government of India and Reserve Bank of India to motivates the Banks for lending to real sector specially the Priority Sector as classified by Reserve Bank of India. Before discussing, how the PSU Banks in India have play upon the craving of Government of India, first let discuss what is NPA and how the loan in India classified as NPA.
Non-Performing Assets (NPA):
As per RBI Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances No. RBI/2023-24/06 DOR.STR.REC.3/21.04.048/2023-24 dated 01-04.2023 an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
A non-performing asset (NPA) is a loan or an advance where;
- Interest and/ or installment of principal remains overdue for a period of more than 90 days in respect of a term loan,
- The account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC)
- The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted
- The installment of principal or interest thereon remains overdue for two crop seasons for short duration crops
- The installment of principal or interest thereon remains overdue for one crop season for long duration crops
- The amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of the Reserve Bank of India(Securitisation of Standard Assets) Directions, 2021 as amended from time to time
- In respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
‘Out of Order’ status:
A CC/OD account shall be treated as ‘out of order’ if:
- The outstanding balance in the CC/OD account remains continuously in excess of the sanctioned limit/drawing power for 90 days, or
- The outstanding balance in the CC/OD account is less than the sanctioned limit/drawing power but there are no credits continuously for 90 days, or the outstanding balance in the CC/OD account is less than the sanctioned limit/drawing power but credits are not enough to cover the interest debited during the previous 90 days period.
Types of NPA
- Sub Standard:A sub-standard asset was first defined as one which was classified as NPA for a period not exceeding two years. However, on 31 March 2005 the RBI changed the duration to 12 months and therefore a sub-standard asset now was that which has remained an NPA for a period less than or equal to 12 months. In such cases, an asset will have well defined credit weaknesses which means that the borrower is unable to cover his total liabilities/exposure which will jeopardize the liquidation of the debt and there is a distinct possibility that the banks will sustain some loss if the shortcomings are not corrected.
- Doubtful:A doubtful asset was first defined as one which remained as an NPA for a period exceeding two years. However, on 31 March 2005 the RBI changed the duration to 12 months and therefore a doubtful asset was that which an NPA remained for a period exceeding 12 months. When a loan is classified as doubtful, the assets have all the same weaknesses that were found in assets classified as sub-standard but also with the added aspect that the weaknesses make collection or liquidation in full of the borrower on the basis of the existing facts, conditions and values highly uncertain and improbable.
- Loss:A loss asset is one where a loss has been identified by the bank or by the internal or external auditors or by the RBI inspection but the amount has not been written off completely. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
These are the three categories in which NPAs are classified as. The RBI has provided guidelines to banks to efficiently and fairly classify assets as non-performing. These guidelines in a nut shell state that classification of assets into above categories should be done by considering the degree of well-defined credit weaknesses and the extent of dependence on collateral security (for example promoter guarantee, shares, real estate etc.) for realization of dues.
Reasons for High NPA in India:
- Stalled Judiciary & Legislative Procedures: The courts in India gave judgements that were not in favour of businesses. The judgements negatively affected businesses, specifically the mining, power and steel divisions. Furthermore, the businesses had to face problems regarding the acquisition of land because of which many projects got stalled due to which the repayments have been not done by many current NPA defaulters.
- Intentional Defaults: It is also observed that many borrowers are totally competent to pay the loan, but they are deliberately not paying. Such people must be identified, and appropriate measures should be taken to recover the money lent to them.
- Poor Credit Appraisal System: The lack of proper credit appraisal is another factor for the rise in NPAs. Because of poor credit appraisal, sometimes the bank gives loans to those who cannot pay back the loan.
- Natural Calamities: Natural calamities are also a factor creating an alarming rise in NPAs in public sector banks. India is hit by one or the other major natural calamity very often that causes failure of repayment of loans by the borrowers. Generally, the farmers are dependent on rainfall for their crops. However, the irregularity in rainfall reduces the production level of the farmer, and as a result, he is unable to repay the loan.
- Credit cycle effects: At the time of the credit boom in the year 2003-2004, it was seen that the problem of rising NPA was increasing rapidly. During this period, the world economy and the Indian economy were flourishing. Seeing this scenario, many Indian firms borrowed huge amounts to take advantage of the opportunities and grow their businesses on wrong assumptions.
- Financial crisis: Before the financial crisis of 2008 India’s economy was in a boom phase. During this period banks lent extensively to corporates in the expectation that the good times will continue in future. But the assumptions proven wrong.
- Earning of the corporates: Low earnings affected their ability to pay back loans. This is one of the most important reasons behind the increase in NPA of public sector banks.
- Relaxed lending norms: Another major reason for rising NPA was the relaxed lending norms for corporate houses.Their financial status and credit rating were not analysed properly.
- The priority sector lending (PSL) sector: Targeted lending has contributed substantially to the NPAs. Priority sectors include agriculture, education, housing, MSMEs & agriculture.
- Diversion of fund by promoters: There are also cases of credit default by promoters, where the funds have been diverted by over-invoicing imports, sourced via a promoter owned subsidiary abroad or exporting to shell companies and then declaring that they defaulted.
Government Inventiveness to tackle NPA:
The problem of NPAs has been going on for a long time in India, and the government of India is taking various steps at legal, financial, and policy levels. Some of them are:
- 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 willful 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 to manage NPA
NPA can be managed in the following three ways:
- Recovery through various means
What is write-off of Loan:
From the bank’s point of view, the loan is an ‘asset’ and the interest that will accrued on it, will be ‘income’. In the bank’s balance sheet the loan amount will be shown as an asset so long as the account is considered normal. But if borrower stop repaying the monthly installments, the bank will generate lower revenue due to lack of interest payments. But the loan amount remains as an ‘asset’ in its books since the bank still hopes that borrower will pay back the money. But beyond a point, as per RBI norms, if there is no income – in this case, interest – coming from an asset, the bank will have to first provide for the loss of the ‘asset’ and then eliminate it from its balance sheet.This process of declassifying the loan as an ‘asset’ in the books is what is termed as write-off.But this write-off does not mean that the bank will not try to recover money from you. After write-off also the Bank might either try to continue to recover the money themselves or sell the loan to a recovery company. The asset has been written off from a creditor’s book but not from its memory. The borrower continue to owe the money of the Bank.Once a loan is written off by a bank, it goes out from the asset book of the bank. The bank writes off a loan after the borrower has defaulted on the loan repayment and there is a very low chance of recovery. The lender then moves the defaulted loan, or NPA, out of the assets side and reports the amount as loss.
The writing off NPAs is a regular exercise carried by banks to clean up the balance sheet.It is primarily intended at cleansing the balance sheet and achieving taxation efficiency.In Technically Written Off accounts: loans are written off from the books at the Head Office, without foregoing the right to recovery.Write-offs are generally carried out against accumulated provisions made for such loans.Once recovered, the provisions made for those loans flow back into the profit and loss account of banks.
Mainly two advantages a bank have in writing off loan. One, it gives a true and fair picture of the ‘assets’ that are making money. After all,there is no point in having a huge asset base that doesn’t give any returns. And two, by writing off the loan the bank gets a tax break on the losses incurred.
Why do banks write off loans?
- After a loan turns bad, a bank writes it off when chances of recovery are remote.
- It helps the bank reduce not only its NPAs but also taxes since the written off amount is allowed to be deducted from the profit before tax.
- After write-off, banks are supposed to continue their efforts to recover the loan using various options. They have to make provisioning also.
Contemporary Write-off exercise by PSU Banks:
According to data furnished by the Reserve Bank of India (RBI), the mega write-off exercise has enabled banks to reduce their non-performing assets (NPAs) or defaulted loans by Rs 10,09,510 crore ($123.86 billion) in the last five years.But, banks have been able to recover only 13 percent of it so far. This huge write-off would have been enough to wipe out 61 per cent of India’s estimated gross fiscal deficit of Rs 16.61 lakh crore for 2022-23.The banking sector reported a decline in gross NPAs to Rs 7, 29,388 crore, or 5.9 per cent of the total advances as of March 2022. Gross NPAs were 11.2 per cent in 2017-18.Public sector banks reported the maximum share of write-offs at Rs 734,738 crore accounting for nearly 73 per cent of the exercise.
Consequences of Write-off
Government loses tax revenues as the losses are set-off against tax. Banks makes provisioning out of their profit. At the time of write off of NPA, either they use their provisioning (if 100% provided for) or profit. In both the cases, Banks reduce their profit and in turn pay less tax to government. As per one estimate the huge write-off in last five years would have been enough to wipe out 61 per cent of India’s estimated gross fiscal deficit of Rs 16.61 lakh crore for 2022-23.
Not only the government but customers too faces the consequences. Banks that have a high level of non-performing asset tend to have low deposit rates and keep lending rates high in order to recover the losses on these assets.
Government, despite of losing tax revenue, why does it, along with the central bank, encourage write-offs?
Most of the public sector banks were inflating their asset base by continuing to show the defaulting accounts as normal, and not lending money to others who needed it. Before writing off the toxic assets, recapitalisation of banks would not have been of much use as banks would have used this money to hide their losses. In order to encourage lending and kick starting the economy, banks are now being encouraged, rather forced, by the government and central Bank to clean up their balance sheets and start afresh.
Non-Performing Assets are both a political and financial issue. Bad loans are a huge problem for Indian banks as it directly impacts their profitability. Other sectors are also affected because of the failure of banks. Therefore, banks and financial institutions must take the necessary steps to tackle the NPA issue. They must ensure fair and effective retrieval of loans which enables the smooth functioning of the banking sector. The banks must be active in adopting policies that help prevent NPAs.