The recommendations of the Report of the Narasimham Committee on the Financial System 1991 introduced financial sector reforms in India and the aim was to put the accounting system in place. Post these reforms, the grave problem of non-performing assets came into the limelight since the report reckoned its consequences for the commercial banks. Especially, during the period of strong growth and over-optimism in the economy i.e. during 2006-2008, banks started making mistakes by extrapolating previous growths and performance of the future, and thus originated the bad loans.[1]

The most heatedly discussed issue of the Indian Banking Industry is that of bad loans or Non- Performing. But, what are these Non- Performing Assets that have become a paramount subject of scrutiny? When banks give loans or advances to the borrowers and as per the performance of these loans, they are classified as a standard asset or a non-performing asset (NPA). A standard asset is the one where the borrower repays regularly, whereas an NPA is a loan or an advance for which the principal amount or the interest payment remained overdue for a specified period.

According to the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, the account of the borrower who defaults in the payment of the debt or any other interest to any secured creditor is classified as NPA in the books of account.[2] This classification is made, in the case when the bank or financial institution is regulated or administered by any authority or body established, constituted, or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body; and in any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank.[3]

This issue reflects the poor performance of the banking sector which is a prudential indicator of a robust economic scenario. This article discusses the factors causative of NPA accounts creation and how this issue is tackled in India.

Factors Responsible For Npa Creation

As in contradiction to the general perception, there is a lot more to the existence of NPAs than just the fact that the unscrupulous borrowers cause NPA creation. Where a loan acts as an asset for the bank as its the repayment of principal amount and interest payments create a flow of cash; it gets transformed into an NPA when it ceases raising income in the form of interest, commission, fees, or any other dues for the bank.

As far as the figures of NPAs are concerned, they have increased from 38385 crores in 1995 to 71047 crores in 2011 in the public sector, and from 6410 crores in 1995 to 17972 crores in 2011.[4] The factors of growing NPAs can be internal or external. One of the studies conducted by the Reserve Bank of India (RBI) in which it examined 800 NPA accounts in 17 banks, revealed certain reasons behind increasing NPAs, and found that the internal factors outweighed the external ones.[5]

The internal factors are in the banks’ control and include improper lending decision or flawed lending processes like non-compliance with the principles of safety, profitability and safety; deficiencies pertinent to product/ marketing, etc; inefficient management; unsuitable technology causing technical troubles; tense relationship amongst the labour; inappropriate SWOT analysis; managerial shortcomings; lack of proper credit appraisal system; fund diversion; the process of re-loaning; etc.[6]

On the other hand, the external factors, also the non-controllable factors, are effete statutory recovery procedures; changes in policies formulated by the Government like export-import duties; natural disasters; willful defaults; the macro environment changes like recession; poor demand; industrial sickness; etc.[7]

The instance of Bhushan Steel Ltd. represents how a flourishing company can become one of the biggest loan defaulters worth thousands of crores, hence strangling the banking system. The promoters of Bhushan Steel blamed insufficient regulation, global recession, and sheer misfortune for its NPA crisis, however, the striking rise and fall of the company unveil that the crisis is equally the consequence of public sector banks supporting risky bets of promoters wonted to developing their businesses on borrowed money.[8]

Addressing The NPA Muddle

For the NPA level is considered as an important evaluator of growth and performance of the financial sector and driver of financial stability in the economy, it becomes vital to have an appropriate credit assessment system and risk management mechanism in place to obviate economic contraction caused by NPA. Insolvency and Bankruptcy Code (IBC) 2016 came forth as a convincing solution to the problem of stressed assets. The code seeks rigidly accurate time-bound initiation of corrective measures even at the level of the primary default either to the business counterparties or to the banks.[9]
  The IBC aims at accomplishing the state of speedy resolution and high recoveries, and with time boost the lenders for higher levels of debt financing. It is noteworthy that the success of the code requires agility in the responsiveness of the Insolvency and Bankruptcy Board of India (IBBI), insolvency professionals, government, tribunals, and courts for nipping the issue in the bud. The recent IBC Ordinance prevents the promoters from bidding for their own companies if they do not first clear their stressed assets.[10]

The ordinance brought section 29A that makes certain persons like willful defaulters ineligible as a resolution applicant under the Resolution Applicants in the Corporate Insolvency Resolution Process.[11]

The Banking Regulation (Amendment) Ordinance promulgated in 2017 incorporated the provisions in the Banking Regulation Act 1949 to deal with the stressed asset related issues.[12] It invests the authority in RBI to issue directions to banks aimed at resolving the bad assets. RBI also has the power to specify the committees or authorities for this process and the members for the same are appointed by the central bank itself.

Also, the Prudential Framework 2019 formulated by RBI, post the failure of the Prior Framework which was struck down in the case of Dharani Sugars and Chemicals Limited v. Union of India[13], provides for the mandatory obligation of the lenders to review all accounts for a period of 30 days from the date of default during when they may decide a resolution plan. The lenders also need to sign an inter-creditor agreement, and after the expiry of the Review Period, they have 180 days to execute a resolution strategy.[14]

Furthermore, the SARFAESI Act 2002, enacted to assist banks and other financial institutions in the recovery of NPAs without court intervention, provides two methods for the same.[15] The institution either can take the possession of borrower’s secured assets along with the right to assign, sell or lease them or can take the business’s management into its own hands until the recovery happens. The act also empowers the financial institutions to sell the financial assets to Asset Reconstruction Companies (ARCs) according to the directions and guidelines issued by RBI. But, the recovery of amount under this act was found to be approximately 14.5% by the Economic Survey, which is way low in comparison to the IBC that exponentially rose the recovery rate.[16]

In addition, in the wake of consuming impacts of unprecedented times of COVID- 19 pandemic on the Indian Financial System, making it weak by approximate $140 billion of bad loans, and liquidity crisis at the shadow banks, the plan of creating a new structure of bad banks has been announced to resolve the surging problem of NPAs.

Bad Bank is basically an ARC or AMC (Asset Management Company) that functions as a bank but by taking over the bad loans of the commercial banks, managing them and finally recovering the due amount over a period of time. [17] The bank is facilitating quicken the debt restructuring process since it reduces the number of lenders who must agree to a purported deal. If it is a nonintegrated entity, it can also allow a bank for stemming losses, protecting depositors and cleaning up its balancing sheet.[18]

Conclusion
To conclude, the NPAs cripple the stream of cash flow of the banking system and stunt its growth and profitability. Hence, it calls for diligence and cautiousness on the part of banks and financial institutions instead of over-ebullience in increasing lending and compromising the quality of assets. An appropriate and reliable credit assessment and risk management system with pre-emptive strategies is requisite. Simultaneously, it is pivotal to raise awareness about how NPA is the root cause of financial indiscipline.

End-Notes:

1. Raghuram Rajan Explains the Origins of India’s NPA Crisis, The Wire, https://thewire.in/banking/raghuram-rajan-npa-parliamentary-committee-modi-government (last visited May 12, 2021
2. Sec. 2 (f) (i), SARFFAESI Act 2002
3. Sec. 2 (o), SARFAESI Act 2002
4. Vivek Rajbahadur Singh, A Study of Non-Performing Assets of Commercial Banks and its a recovery in India, 4 16 (2016).
5. 2 - Causes and Consequences of NPA | Capital Requirement | Banks, Scribd, https://www.scribd.com/doc/58757831/2-Causes-and-Consequences-of-NPA (last visited May 13, 2021).
6. Sikdar - ROLE OF NON PERFORMING ASSETS IN THE RISK FRAMEWOR.pdf, https://apps.aima.in/ejournal_new/articlesPDF/PallabSikdar.pdf (last visited May 13, 2021).
7. Id
8. NPA crisis: The rise and fall of Bhushan Steel into the great Indian debt trap, Hindustan Times (2017), https://www.hindustantimes.com/business-news/npa-crisis-the-rise-and-fall-of-bhushan-steel-in-the-great-indian-debt-trap/story-GHrvRRFIBsMLXKJzbqvaFN.html (last visited May 13, 2021).
9. Ashwini Mehra, Will Insolvency and Bankruptcy Code fix the Bank NPA issue?, mint (2018), https://www.livemint.com/Opinion/wfkP8ghPzUctlcYt8h6z7N/Will-Insolvency-and-Bankruptcy-Code-fix-the-Bank-NPA-issue.html (last visited May 13, 2021).
10. IBC may end NPAs problem, but won’t help banks get their money back, https://www.businesstoday.in/opinion/prosaic-view/npa-nclt-reserve-bank-of-india-liquidation-banks-ibc-process/story/265782.html (last visited May 13, 2021).
11. Shivangi Pathak & Aherar Patel, Critical Analysis of Section 29A of the Code, IBC Laws (2020), https://ibclaw.in/critical-analysis-of-section-29a-of-the-code/ (last visited May 13, 2021).
12. The Banking Regulation (Amendment) Ordinance, 2017, PRS Legislative Research, https://prsindia.org/billtrack/the-banking-regulation-amendment-ordinance-2017 (last visited May 13, 2021).
13. Dharani Sugars and Chemicals Limited v. Union of India, SC Civil Original/Appellate Jurisdiction Transferred Case (Civil) No.66 Of 2018 In Transfer Petition (Civil) No.1399 OF 2018
14. Resolution Of Stressed Assets - RBI’s New Framework - Insolvency/Bankruptcy/Re-structuring - India, , https://www.mondaq.com/india/insolvencybankruptcy/863070/resolution-of-stressed-assets--rbi39s-new-framework (last visited May 13, 2021
15. Suravi Mohapatra Says, Overview of SARFAESI Act 2002 & Note on the process of Enforcement of Security Interest under Section 13, TaxGuru, https://taxguru.in/corporate-law/overview-sarfaesi-act-2002-note-process-enforcement-security-interest-section-13.html (last visited May 13, 2021).
16. I. B. C. Laws, Resolution of Stressed Assets amid suspension of Insolvency Laws- “A shot in the dark” - By Saurabh Goswami and Adv. Kanhaiya Maheshwari, IBC Laws (2020), https://ibclaw.in/resolution-of-stressed-assets-amid-suspension-of-insolvency-laws-a-shot-in-the-dark-by-saurabh-goswami-and-adv-kanhaiya-maheshwari/ (last visited May 13, 2021).
17. Explained: The arguments for and against a bad bank, The Indian Express (2021), https://indianexpress.com/article/explained/npa-bad-bank-balance-sheet-loan-rbi-shaktikanta-das-7151841/ (last visited May 13, 2021).
18. How India Finally Got Around to Starting a ‘Bad Bank,’ Bloomberg.com, February 4, 2021, https://www.bloomberg.com/news/articles/2021-02-04/how-india-finally-got-around-to-starting-a-bad-bank-quicktake (last visited May 13, 2021).

Written By:

1. Navin Kumar Jaggi
2. Vanshika Mehra