NPA and Bad Bank

Context

Finance Minister Piyush Goyal, has announced the formation of a committee to assess the idea of bad banks.

What is NPA?

NPA or Non-Performing Assets are loans or advances that are in default or are in arrears on scheduled payments of principal or interest, usually for a period of 90 days. Before the period of 90 days, they are called Stressed Assets.

Stressed assets= NPAs + restructured loans + Written Off Assets.

Types of stressed Assets:

• Sub-standard Assets – If borrower fails to repay the installment, interest on principal or principal for 90 days the loan becomes NPA and it is termed as Special Mention Account (SMA). If it remains SMA for a period less than or equal to 12 months it is termed as Substandard Assets.
• Doubtful Assets – If the Sub-standard assets remains so for 12 months or more, then it would be termed as Doubtful Asset.
• Loss Assets – If the loan is not repaid even after it remains substandard for more than three years it would be called as loss Asset.
• Written Off Assets -Written off assets are those on which the bank or lender doesn’t count the money borrower owes to it.

Data of NPAs

• Public sector banks (PSBs)- Rs 7.34 lakh crore by the end of 2017
• Private sector banks – Rs 1.03 lakh crore
• leading corporate houses and companies accounted for approximately 77 per cent of the total gross NPAs from domestic operations for the banks.

Reasons of NPA

During early 2000s, GFC or Global Financial Crisis happened in the west. It was a result of housing crisis. It was also called subprime crisis. However, the effects took time to role over to India.

However, in the late 2000s:

• Costs increased due to delays in environmental and land clearances.
• Revenues collapsed due to global downturn
• RBI increased interest rates due to rising inflation
• Rupee depreciated leading to higher debt-servicing liabilities

Other Factors:

• Supply Constraints – Lack of infrastructure e.g. Road, power etc
• Problems in Manufacturing sector
• Evergreening of loans – Restructuring of loans to extend the repayment times in hopes of project becoming viable
  
• Non- Coordination in banking system
  
• Governance issues in banks management

However, Indian economy survived because:-

• Corporates cannot expand excessively
• Corporates could not borrow in international market excessively
• They had the benefit of hindsight of their foreign counterparts

As per RBI reports, PSBs face much larger NPA exposure than private sector banks (as shown in figure)

Implications of NPAs:

• Twin Balance Sheet Syndrome – Over-leveraged corporates and stressed banks
• Credit Growth decreases
• Corporates investment ability decreases
• Production capacity of Economy decreases
• Unemployment increases

Effects on Banks:

• Regulatory norms like CAR need to be strengthened
• Net income of banks decrease
• Provisioning (money kept aside in anticipation of an NPA according to Basel norms) increases
• Operating earnings fall
• Shares of PSBs fall

Steps taken so far:

SDR – Strategic Debt Restructuring – Creditors could take over and sell to new owners.

CDR – Corporate Debt Restructuring – Creditors came together to restructure the debt of companies so as to provide timely support.

5/25 Scheme – It allows banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven years

S4A – Scheme for Sustainable Structuring of Stressed Assets – deep financial restructuring of big debt projects by allowing lender (bank) to acquire part equity of the stressed project and restructuring the other part

ARCs – Asset Reconstruction Companies – The idea is Efficient division of labour, so that, banks concentrate on the business of deposits and loans. On the other hand, ARCs specialize in the business of NPA resolution

DRTs – Debt Recovery Tribunals – Debt Recovery Tribunals were established to facilitate the debt recovery involving banks and other financial institutions with their customers. They are quasi-judicial authorities.

SARFAESI Act – Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2016 – Banks utilize this act as an effective tool for bad loans (NPA) recovery where non-performing assets are backed by. Upon loan default, banks can seize the securities (except agricultural land) without intervention of the court.

Indradhanush Plan – It is a comprehensive plan for recapitalisation of public sector lenders, with a view to make sure they remain solvent and fully comply with the global capital adequacy norms, Basel-III.

JLF – Joint Lenders Forum – It is a dedicated grouping of lender banks that is formed to speed up decisions when an asset (loan) of more Rs 100 crore or more turns out to be a stressed asset

Recapitalisation plan

Above figure shows the recapitalization plan of government in banking system.

Bad Bank

Bad bank or PARA (Public Sector Asset Rehabilitation Agency) was proposed in Economic Survey 2016-17. Bad Bank is an institution which specializes in loan resolution process, so that banking system is free to focus on core banking solutions.

Moving away from the decentralized approach of presently existing schemes, PARA is a centralised resolution of NPA crisis.

Need for PARA

According to Economic Survey, need for PARA arises because:

• Early resolution so that Funds for creation of new credit can be used
• Wilful Defaulters cannot escape because of non-coordination in Joint Lenders’ Forum
• Large Defaulters comprise more value of NPAs, as 50 top defaulters account for 71% of NPAs. Therefore, PARA, with focus on top cases can lead to faster recovery
• PARA with its mandate on time-bound resolution, may be better equipped with decision making capabilities, in comparison to bank management, who feared CVC and CAG enquiry on debt write-offs.
• ARCs have not been successful, as they have bought only 5% of NPAs, according to ES 2016-17
• Without PARA, banks have resorted to refinancing, which leads to delaying the cases. This further leads to lack of credit and investment in the economy.
• PARA helps to enhance investment in banks and improves credit ratings, so that Indian firms have access to cheap global credit.

Working of Bad Bank

Issues with PARA

• Accusations of favoritism against the decision-making body
• Independence and Professionalism will be compromised if government has a majority stake
• Persistent Scrutiny from government investigative agencies like CVC and CAG
• Lack of Political will to implement the steps recommended by PARA
• Establishing prices of stressed advances is a time consuming and debatable issue
• Cleaned balance sheets may lead banks to lend more freely
• Huge capital is required for recapitalisation
• Setup is time consuming process

Solution by Economic Survey 2016 -17

• Autonomy of PARA
• Permanency of AQR (Asset Quality Review)
• Professional Staffing of PARA, both from private and public sector

Way Forward

Economic Survey has proposed 4 steps with the name of 4Rs for resolution of NPA crisis.4 Rs refer to Recognition, Recapitalization, Resolution, and Reform.

• Recognition – Banks must value their assets accurately as far as possible
• Re-capitalisation – Banks’ capital position must be safeguarded via infusions of equity
• Resolution– The underlying stressed assets in the corporate sector must be sold or rehabilitated
• Reform –future incentives for the Private Sector and corporates must be set-right to avoid a repetition of the problem

The Economic Survey 2014-15 had proposed a 4-D prescription to the Indian banking sector, which is hobbled by policy constraints, which create double financial repression, and, by structural factors, impede competition. The four Ds include:

• De-regulation– addressing the statutory liquidity ratio (SLR) and priority sector lending (PSL)
• Differentiation – within the public-sector banks in relation to recapitalisation, shrinking balance sheets, and ownership
• Diversification – of source of funding within and outside banking
• Disinterring – by improving exit mechanisms

Also, there are certain short-term measures to improve the situation:

• Reform Insolvency and Bankruptcy Code keeping the current challenges in mind
• Take steps to discourage wilful defaulters and provide adequate support to officials acting against them. For eg. Fugitive Economic Offenders Bill
• Amend Prevention of Corruption Act to shield bankers and professionals from investigative witch-hunts