WHAT ARE NPAS?

Generally speaking, NPA is any asset of a bank which is not producing

any income.
In other words, a loan or lease that is not meeting its stated principal
and interest payments.
On a banks balance sheet, loans made to customers are listed as
assets. The biggest risk to a bank is when customers who take out
loans stop making their payments, causing the value of the loan assets
to decline.
Criteria
Loans dont go bad right away. Most loans allow customers a
certain grace period. Then they are marked overdue. After a certain
number of days, the loan is classified as a nonperforming loan.
Banks usually classify as nonperforming assets any commercial
loans which are more than 90 days overdue and any consumer
loans which are more than 180 days overdue.
For agricultural loans, if the interest and/or the installment or principal
remains overdue for two harvest seasons; it is declared as NPAs. But,
this period should not exceed two years. After two years any unpaid
loan/installment will be classified as NPA.

Categories

1. Sub-standard: When the NPAs have aged <= 12 months.

2. Doubtful: When the NPAs have aged > 12 months.

3. Loss assets: When the bank or its auditors have identified the loss,
but it has not been written off.

After a certain amount of time, a bank will try to recoup its money by
foreclosing on the property that secures the loan. The way money is
recouped is a highly contentious issue not just with banks but also with
Micro-Finance Institutions (MFIs). We will discuss it later in the article.

All of this can be explained in a much more technical manner, but that
is not required here. For example, we do not need to list all the
conditions that make the banks declare an asset as NPAs like 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.

Only understanding the basic concepts will suffice. UPSC is not going to
ask you these details, but about the impact and solutions of NPAs.

Even in prelims, these details will not be asked. So we avoid

technicalities and jargons here. It is not useful for a GS paper, even if
some of it may be useful for Economics optional paper.

EXTENT OF NPAs

Gross NPAs of domestic banks jumped to 4.2 % of total lending by the

end of September 2013 from 3.6 % six months before, according to the
Reserve Bank of India (RBI).

As per a recent warning by the RBI, bad loans (NPAs) could climb to 7%
of total advances by 2015.

In absolute terms, gross NPAs are estimated to touch Rs 2.50 lakh

crores by the end of March this year. This is equal to the size of the
budget of Uttar Pradesh. The biggest chunk of the soured debts is with
state-run banks (Public sector banks or PSBs), which account for twothirds of loans but 80 % of the bad assets.

This is how the NPA curve has been moving in the recent years, as per
a news report in the Business Standard:

Private-sector and foreign lenders are better placed. Their NPAs in

proportion of their lending is lesser than that of the PSBs.

WHY IT MATTERS?

The higher is the amount of non-performing assets (NPAs), the weaker

will be the banks revenue stream.

In the short-term, many banks have the ability to handle an increase in

nonperforming assets they might have strong reserves or
other capital that can be used to offset the losses. But after a while, if
that capital is used up, nonperforming loans will imperil a banks
health. Think of nonperforming assets as dead weight on the balance
sheet.

Here is the impact of the NPAs:

As the NPA of the banks will rise, it will bring a scarcity of funds in
the Indian security markets. Few banks will be willing to lend if they
are not sure of the recovery of their money.

The shareholders of the banks will lose a lot of money as banks

themselves will find it tough to survive in the market.

This will lead to a crisis of confidence in the market. The price of

loans, i.e. the interest rates will shoot up badly. Shooting of interest
rates will directly impact the investors who wish to take loans for
setting up infrastructural, industrial projects etc.

It will also impact the retail consumers like us, who will have to
shell out a higher interest rate for a loan.

All of this will lead to a situation of low off take of funds from the
security market. This will hurt the overall demand in the Indian
economy. And, finally it will lead to lower growth rates and of
course higher inflation because of the higher cost of capital.

This trend may continue in a vicious circle and deepen the crisis.

Total NPAs have touched figures close to the size of UP budget.

Imagine if all the NPA was recovered, how well it can augur for the

Indian economy.

RBI governor Raghuram Rajan has recently said that NPAs must be
curbed before the problem becomes alarming.

WHY SUCH A SITUATION?

The rising incidence of NPAs has been generally attributed to the

domestic economic slowdown. It is believed that with economic growth
slowing down and rate of interest going up sharply, corporates have
been finding it difficult to repay loans, and it has added up to rising
NPAs. Even finance minister P Chidambaram stated that bad loans are
a function of the economy and hence, having bad loans during
distressed times is very natural.

However, The NPA mess is not entirely because of the reversal of

economic cycles.

Here we look at the other reasons behind this mess. Basically the
whole problem can be divided into two parts External problems and
internal problems as faced by the banks.

External Factors

REASONS RELATED TO THE CORPORATE SECTOR

1.

Apart from the slowdown in India, the global economy has also
slowed down.
This has adversely impacted the corporate sector in India.
Continuing uncertainty in the global markets has lead to lower
exports of various products like textiles, engineering goods, leather,
gems etc. It can be noted that imports and exports combined equal
to around 40% of Indias GDP!
A hurt corporate sector is finding it difficult to pay loans

2.

The ban in mining projects, delay in environmental related

permits affecting power, iron and steel sector, volatility in prices of
raw material and the shortage in availability of power have all
impacted the performance of the corporate sector. This has
affected their ability to pay back loans.

OTHER SECTORS

Banks in India are highly regulated. Priority sector lending (PSL) is

one of these regulations which require the banks to give a certain
% of their loans to certain sections of society. These are farmers,
SCs, STs, IT parks, MSMEs etc.

Naturally one would assume that the weaker sections covered

under PSL are the ones to be blamed for the situation. However, it

is not the case.

As per recent news reports, the Standing Committee on Finance will

be now examining the reasons for high NPAS in PSBs.

The data, shared with the Standing Committee, shows that NPAs in
the corporate sector are far higher than those in the priority or
agriculture sector.

Within the priority sector, incremental NPAs were more in respect to

micro small and medium enterprises followed by agriculture.

However, even the PSL sector has contributed substantially to the

NPAs.

As per the latest estimates by the SBI, education loans constitute

20% of its NPAs!

The sluggish legal system (Judiciary in India) and lack of

systematic and constant efforts by the banks make it difficult
to recover these loans from both corporate and non-corporate.

Internal Factors

1. Indiscriminate lending by some state-owned banks during the

high growth period (2004-08) is one of the main reasons for the
deterioration in asset quality.

2. Bankers say there is a lack of rigour in loan appraisal systems and

monitoring of warning signals at state-run banks. This is particularly
true in case of infrastructure projects, many of which are struggling
to repay loans. Besides, these projects go on for 20 to 30 years.

3. Poor recovery and use of coercive techniques by banks in

recovering loans

4. The wait and watch approach of banks have been often blamed
as the reason for rising NPAs as banks allow deteriorating asset
class to go from bad to worse in the hope of revival and often offer
restructuring option to corporates.

A Parliamentary panel, examining increasing incidents of NPAs, has

observed that state-owned banks should stop ever-greening or
repeated restructuring of corporate debt to check the constant
bulging of their non-performing assets. Members of the panel were
of the view that NPAs are the result of bad economic situation, but
there were also management issue of every-greening of loans,
which could be avoided by not renewing loans, particularly of
corporate.

Therefore, it can be clearly seen that it is only the economic slowdown

that is behind the NPAs. There are a whole range of factors.

WAY OUT

The simplest approach to cut down NPAs is to recover the bad loans.
Apart from the regular guidelines released by the RBI, to strengthen
further the recovery of dues by banks and financial institutions,
Government of India promulgated:
1.The Recovery of Debts Due to Banks and Financial
Institutions Act, 1993

2. The Securitization Reconstruction of Financial Assets and

Enforcement of Security Interest (SARFAESI) Act, 2002.

So, how can the banks legally recover their loans?

(i)

The Securitization and Reconstruction of Financial Assets

and Enforcement of Security Interest (SARFAESI) Act, 2002

The Act empowers Banks / Financial Institutions to recover their nonperforming assets without the intervention of the Court, through
acquiring and disposing of the secured assets in NPA accounts with
outstanding amount of Rs. 1 lakh and above. The banks have to first
issue a notice. Then, on the borrowers failure to repay, they can:

Take

possession

of

security

and/or

Take over the management of the borrowing concern.

Appoint

person

to

manage

the

concern.

(ii) Recovery of Debts Due to Banks and Financial Institutions

(DRT) Act: The Act provides setting up of Debt Recovery Tribunals
(DRTs) and Debt

Recovery

Appellate

Tribunals (DRATs) for

expeditious and exclusive disposal of suits filed by banks / FIs for

recovery of their dues in NPA accounts with outstanding amount of Rs.
10 lac and above. Government has, so far, set up 33 DRTs and 5 DRATs
all

over

the

country.

(iii) Lok Adalats: Section 89 of the Civil Procedure Code provides

resolution of disputes through ADR methods such as Arbitration,
Conciliation, Lok Adalats and Mediation. Lok Adalat mechanism offers
expeditious, in-expensive and mutually acceptable way of settlement
of

disputes.

Government has advised the public sector banks to utilize this

mechanism to its fullest potential for recovery in Non-performing
Assets (NPAs) cases.
Among the various channels of recovery available to banks for dealing
with bad loans, the SARFAESI Act and the Debt Recovery Tribunals
(DRTs) have been the most effective in terms of amount recovered.
The recent controversy surrounding loan recovery in India
Views of the SC

Banks have been alleged to engage in coercive practices to recover

the loans. Recently, there have been some judicial pronouncements
by the apex court determining the scope of powers of enforcement
of securities without the intervention of the courts, by the banks and
FIs under the SARFAESI Act. The apex court has reiterated the need
to protect the interest of borrowers, and emphasized that the
exercise of extraordinary powers of recovery, by banks and FIs must
be in compliance with the provisions of the SARFAESI Act.

As per the Supreme Court (SC) Liquidity of finances and flow

of money is essential for any healthy and growth oriented
economy. But certainly, what must be kept in mind is that the law
should not be in derogation of the rights which are guaranteed to
the people under the Constitution. The procedure should also be
fair, reasonable and valid, though it may vary looking to the
different situations needed to be tackled and object sought to be
achieved.

But, these are steps which cure the disease of NPAs. The issue of
NPAs needs to be tackled at the level of prevention rather than
cure.
Therefore, the steps that can prevent the piling up of NPAs are as
follows:

1. CONSERVATISM:
Banks need to be more conservative in granting loans to sectors
that have traditionally found to be contributors in NPAs.
Infrastructure sector is one such example. NPAs rise
predominantly because of long gestation period of the projects.
Therefore, the infrastructure sector, instead of getting loans from
the banks can be funded fromInfrastructure Debt Funds

(IDFs) or other specialized funds for infrastructural development

in the country.

2. IMPROVING PROCESSES:
The credit sanctioning process of banks needs to go much more
beyond the traditional analysis of financial statements and
analyzing the history of promoters. For example, banks rely more
on the information given by credit bureaus. However, it is often
noticed that several defaults by some corporate are not
registered in their credit history.

3. RELYING LESS ON RESTRUCTURING THE LOANS:

Instead of sitting and waiting for a loan to turn to a bad loan, and
then restructure it, the banks may officially start to work to
recover such a loan. This will obviate the need to restructure a
loan and several issues associated with it. One estimate says that
by 2013 there will be Rs 2 trillion worth of restructured loans.

4. EXPANDING AND DIVERSIFYING CONSUMER BASE BY

INNOVATIVE BUSINESS MODELS:

Contrary to popular perceptions,the NPA in non-corporate sector

is less than that in the corporate sector. Hence, there is a need to
reach out to people in remote areas lacking connectivity and
accessibility. More and more poor people in rural pockets should
be brought under the banking system by adopting new
technologies and electronic means. Innovative business models
will play a crucial role here. Otherwise, the NPAs may increase
instead of decreasing.

As said by the new M.D. of SBI, Mr. Viswanathan proposed ideas

such as a single demat account for all investments and credit
cards for school students (above class 8th) to make them aware
with the banking system.

CONCLUSION

Looking at the giant size of the banking industry, there can be hardly
any doubt that the menace of NPAs needs to be curbed. It poses a big
threat to the macro-economic stability of the Indian economy. An
analysis of the present situation brings us to the point that the problem
is multi-faceted and has roots in economic slowdown; deteriorating
business climate in India; shortages in the legal system; and the
operational shortcoming of the banks. Therefore, it has to be dealt at
multiple levels. The government cant be expected to rescue the state-

run banks with tax-payers money every time they fall into a crisis. But,
the kind of attention with which this problem has been received by
policymakers and bankers alike is a big ray of hope. Right steps, timely
and concerted actions and a revival of the Indian economy will put a lid
on NPAs. Prevention, however, has to become a priority than mere
cure.