Non Performing Assets (NPAs) and its impact on Indian economy

Context:

The Centre on Tuesday unveiled an ambitious plan to infuse Rs. 2.11 lakh crore capital over the next two years into public sector banks (PSBs)saddled with high, non-performing assets and facing the prospect of having to take haircuts on loans stuck in insolvency proceedings.

Introduction:

• The move is vital for the slowing economy, as private investments remain elusive in the face of the “twin-balance sheet problem” afflicting corporate India and public sector banks reflected in slow bank credit growth.
• The Government has decided to take a massive step to capitalise PSBs in a front-loaded manner, to support credit growth and job creation.
• The government’s capitalisation package for public sector banks will provide a strong booster dose of relief for the capital starved public sector banks.

What are Non-Performing Assets?

• A loan or lease that is not meeting its stated principal and interest payments.
• A loan is an asset for a bank as the interest payments and the repayment of the principal amount create a stream of cash flows.
• Banks usually treat assets as non-performing if they are not serviced for some time. If payment has not been made as of its due date then the loan gets classified as past due.
• Once a payment becomes really late the loan gets classified as non-performing. 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.

Types of NPA’s:

Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets:-

• Substandard assets: An assets which has remained NPA for a period less than or equal to 12 months.
• Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
• Loss assets: As per RBI, “Loss 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.”

What are the reasons for growth?

Governance Issues:

• Diversion of funds by companies for purposes other than for which loans were taken.
• Due diligence not done in initial disbursement of loans.
• Inefficiencies in post disbursement monitoring of the problem.
• Restructuring of loans done by banks earlier to avoid provisioning. Post crackdown by RBI, banks are forced to clear their asset books  which has led to sudden spurt in NPAs
• During the time of economic boom, overt optimism shown by corporates was taken on face value by banks and adequate background check was not done in advancing loan
• In the absence of adequate governance mechanism, double leveraging by corporates, as pointed out by RBI’s Financial Stability Report.

Economic Reasons

• Economic downturn seen since 2008 has been a reason for increasing bad loan
• Global demand is still low due to which exports across all sector has shown a declining trend for a long
• In the case of sectors like electricity, the poor financial condition of most SEBs is the problem; in areas like steel, the collapse in global prices suggests that a lot more loans will get stressed in the months ahead
• Economic Survey 2015 mentioned over leveraging by corporate as one of the reasons behind rising bad loans
• Another factor that can contribute to the low level of expertise in many big public sector banks is the constant rotation of duties among officers and the apparent lack of training in lending principles for the loan officers
• Poor recovery and use of coercive techniques by banks in recovering loans

Political reasons

• Policy Paralysis seen during the previous government affected several PPP projects and key economic decisions were delayed which affected the macroeconomic stability leading to poorer corporate performance.
• Crony capitalism is also to be blamed.
• Under political pressure banks are compelled to provide loans for certain sectors which are mostly stressed

Problems of Exit

• In the absence of a proper bankruptcy law, corporate faced exit barriers which led to piling up of bad loans
• Corporates often take the legal route which is time consuming leading to problems for the banks

Impacts of NPAs:

• The higher is the amount of non-performing assets (NPA) the weaker will be the bank’s revenue stream.
• Indian Banking sector has been facing the NPA issue due to the mismanagement in the loan distribution carried by the Public sector banks.
• As the NPAs of the banks will rise, it will bring a scarcity of funds in the Indian 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 of money as banks themselves will find it tough to survive in the market.
• This will lead to a crisis situation in the market.
• The price of loans, 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, who will have to shell out a higher interest rate for a loan.
• All these factors hurt the overall demand in the Indian economy.
• Finally, it will lead to lower growth and higher inflation because of the higher cost of capital. 

Current developments on NPA:

• According to the Reserve Bank of India’s latest “Financial Stability Report”, Gross Non-Performing assets (NPAs) rose from 9.2% in September 2016 to 9.6% in March 2017.
• Stress tests conducted by the RBI indicate that this number could rise to 10.2% under the baseline scenario.
• Return on assets is negative.
• The net non-performing advances (NNPA) ratio marginally increased to 5.5% in March 2017 from 5.4% in September 2016.
• The RBI in its Financial Stability Report (FSR) highlighted that stressed advances ratio declined from 12.3 % to 12% due to fall in restructured standard advances.

Recent NPA issues in India:

• The Internal advisory committee (IAC) of the Reserve Bank of India (RBI) had recently identified 12 accounts for insolvency proceedings with each of them having over Rs 5,000 crore of outstanding loans, accounting for 25 percent of total NPAs of banks.
• According to RBI, these 12 accounts would qualify for immediate reference under the Insolvency and Bankruptcy Code (IBC).
• The total amount for gross non-performing assets (NPA) as on March was estimated to 11 Lakh crore
• Any missed installment not paid to the bank until the due date is a bad loan. If this further extends beyond 90 days, it is termed as Non-performing asset or (NPA).

Steps proposed by RBI:

• Restructured standard account provisioning has been increased to 5% making it easier for banks to go for restructuring. On the flip side, this has the potential to enhance tendency of ever greening of loans.
• RBI has directed banks to give loans by looking at CIBIL score and is encouraging banks to start sharing information amongst themselves.
• RBI has directed banks to report to Central Repository of Information on Large Credit (CRILC) when principle/interest payment not paid between 61-90 days
• RBI has asked banks to conduct sector wise/activity wise analysis of NPA
• SEBI has eased norms for banks to convert debt of distressed borrowers into equity

5/25 scheme

• For existing and new projects greater than 500 crores and also for existing projects which have been classified as bad debt or stressed asset, bank can provide longer amortization periods of 25 years with the option of restructuring loans every 5 or 7 year
• The advantage of this scheme is that it provides for longer lending period with inbuilt flexibility. Shorter lending periods leads to companies stretching their balance sheet to pay back loan
• From bank’s point of view it is helpful as freshly restructured asset is considered as bad debt and requires 15% provisioning by banks against such loans leading to erosion of profitability for banks

Strategic Debt Restructuring Scheme

• This scheme provides for an alternative to restructuring. Wherever restructuring has not helped, banks can convert existing loans into equity. The scheme provides for creation of Joint Lenders Forum which is to be given additional powers with respect to
  • Management change in company getting restructured
  • Sale of non core assets in case company has diversified into sectors other than for which loans were guaranteed
  • Decision by JLF on debt restructuring by a majority of 75% by value and 60% by number
• On the positive side, willful defaulters are dissuaded as they fear the loss of their company

Issues with the scheme:

• Banks do not have expertise of managing companies
• The Joint Lenders Forum mechanism has an inherent conflict between large banks and small lenders. The large banks have huge exposure and thus they want to restructure the loans so as to avoid provisioning. The smaller lenders fear arm twisting by large banks. Since they have less exposure they are unwilling to throw good money after bad and prefer to sell their exposure to ARCs as HDFC did in case of EssarSte

Assessment of SDR

• SDR is not performing too well. Of the 21 cases in which SDR has been invoked, only 4 have been closed. The problems are:
• Difficulty in finding buyers
• Buyers demanding prices that are unacceptable
• Creditor’s concern over their source of funding and credibility
• In the absence of potential buyers, bank wouldn’t want to hold onto these assets indefinitely. Unless and until a mechanism is devised which charts out a course of what to do thereafter, it doesn’t make much sense to do this conversion
• Disagreement over valuations
• Banks not willing to take severe haircuts
• Problem particularly acute in the infra sector where the valuations have drastically declined over the past 2-3 years
• Scheme for sustainable structuring of stressed assets – Thisallows banks to split the stressed account into two heads – a sustainable portion that the bank deems that the borrower can pay on existing terms and the remaining portion that the borrower is unable to pay(unsustainable). The latter can be converted into equity or convertible debt giving lenders a chance to eventually recover funds if the borrower is unable to pay. The Scheme will help those projects which have started commercial operations and have outstanding loan of over Rs 500crore. Banks will also need to set aside higher provisions if they choose to follow this route.
  • Advantages of new scheme
    • To help restore credit flow to stressed sectors such as steel etc as credit lending condition have been eased in the scheme
    • Banks can rework their stressed accounts under the oversight of an external agency. This means greater transparency in functioning of banks. This is a provision of the scheme itself. Banks had earlier complained of activism by investigative agencies in probing bad debt which made it difficult for them to go for restructuring in even genuine cases
    • This scheme would not only strengthen the lenders’ ability to deal with stressed assets, but would also put real assets back on track, benefitting both banks and the promoters of troubled entities.

Other suggestions:

• Banks need to be more conventional in yielding loans to sectors that have a history of being found as contributors in NPAs.
• The loan sanctioning process of banks needs to be harsher and well beyond the conventional practices of analysis of financial statements and history of promoters.
• A suitable agenda to attract and reassure quality professionals to join the discipline of insolvency professionals is vital.
• Any plan to alleviate the current scenario especially relating to the Debt recovery tribunals must be given urgency, to ease the burden on NCLT
• If the public sector has to compete in the fierce financial markets, they have to create and nurture a good cadre of officers in various disciplines.
• As per the RBI directive, banks will now have to agree to a common approach forrestructuring or recovery of each non-performing loan (NPL).
• The common approach will be the one adopted by the lead bank, along with a few more banks so as to meet the thresholds of 60% of lenders by value and 50% by number.
• This approach assumes that the interests of all banks need to be aligned with or subsumed within the interest of the lead bank.
• There is an urgent need to develop specialized skills in the area of appraisal, monitoring and recovery to ensure the quality of credit portfolio.
• Banks should be equipped with latest credit risk management techniques to protect the bank funds and minimize insolvency issues.
• Banks should explore the possibilities to develop credit derivative markets to avoid these risks.
• Timely follow up is the key to keep the quality of assets intact and enables the bank to recover the interest/installments in time.
• Selection of right borrowers, viable economic activity,adequate finance and timely disbursement, end use of funds and timely recovery of loans should be the focus areas so as to prevent or minimize the incidence of fresh NPAs.

What is Bankruptcy code?

• The Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India that administers the insolvency proceedings and establishes a framework for insolvency resolution processes effectively.
• The Insolvency and Bankruptcy Code was introduced by (FM) ArunJailtely in December’15 and was subsequently passed by the LokSabha on 5 May’16. However the act was finally approbated on 28 May 2016.

Key Features:

• The Code outlines separate insolvency resolution processes for individuals and companies
• The Code acts as a regulator by establishing the Insolvency and Bankruptcy Board of India.
• The board oversees the insolvency proceedings in the country and regulates the entities registered below it. The Board has 10 members, which includes representatives from the Ministries of Finance and Law, and the Reserve Bank of India.
• The insolvency process is accomplished by licensed professionals. These professionals also control the assets of the debtor during the insolvency procedure
• The Code proposes two distinct tribunals to supervise the process of insolvency resolution, for individuals and companies:

How NPA are different from stressed assets?

Stressed assets:

• A stressed asset is an indicator of the health of the banking system.
• It is a combination of NPA, Restructured loans and Written off assets.
• Assets of the banking system comprises of loans given and investment in bonds made by banks.
• Quality of the asset indicates how much of the loans taken by the borrowers are repaid in the form of interests and principal.

Restructured loans:

• These are assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing.
• Under restructuring a bad loan is modified as a new loan.
• This is because a restructured loan was a past NPA or it has been modified into a new loan.
• Corporate Debt Restructuring Mechanism (CDM) allows restructuring of loans.

Written off Assets:

• These are those bank or lender doesn’t count the money borrower owes to it.
• The financial statement of the bank will indicate that the written off loans are compensated through some other way.
• The ratio of stressed assets to gross advances of the Indian Banking System is increasing from 2013 onwards.
• It has risen from around 6 per cent at end of March 2011 to 11.1 per cent by 2015.

Government initiatives to tackle NPAs:

• Promulgation of Banking Regulation (Amendment) Ordinance: It helps in the following ways:
• It empowers the RBI to direct Banks to initiate insolvency resolution, wherever such need arises.
• It also give advise to baking agencies on ways of tackling with its stressed asset problems.
• It aims to check this menace in a time bound manner and helps in timely recovery of the stressed assets.
• Incorporation of SARFAESI ACT:The Securitization and Reconstruction of Financial assets and Enforcement of Security Interest Act 2002 empowers the banking systems to auction residential or commercial properties (except agricultural land) to recover their loans.
• Debt Recovery Acts: These laws established debt recovery tribunals with the power to recover debts of Banks and Financial Institutions.
• Concept of Bad Banks: In this concept the banking institutions sell their bad loans to an intermediary and thus they write off their bad loan and intermediary has to recover the loan from the defaulter.
• Mediation for loan recovery: This concept was introduced so that genuine defaulter, who are unable to pay off their loans, but are not able to put forward their situations with the banking authorities, hire a mediator, who discusses this with the banking officer and come to a solution.
• Strategic Debt Restructuring (SDR): Creditors could take over the assets of the firms and sell them to new owners.
• Sustainable Structuring of Stressed Assets (S4A): An independent agency hired by the banks will decide on how much of the stressed debt of a company is sustainable
• The government recently passed an ordinance to amend certain sections of the Banking Regulation Act, 1949: This allow the banking companies to resolve the issue related to stressed assets by initiating the insolvency proceedings whenever required. This is in addition to the recently promulgated Insolvency and Bankruptcy Code, 2016 which provides for time bound resolutions of stressed assets.
• Government promulgated the Banking Regulation(Amendment) Ordinance, 2017 with the following features:
• It was passed to deal with stressed assets, particularly those in consortium or multiple banking arrangements.
• It authorize the RBI to direct banking companies to resolve the issue related to specific stressed assets, by initiating insolvency resolution process wherever required.

Public asset reconstruction agency(PARA):

The Public Sector Asset Rehabilitation Agency (PARA) colloquially called “Bad Bank” is a proposed agency to assume the Non-Performing Assets (NPA) of public sector banks in India and to deal with the recovery of the bad loans. This agency has been proposed in Economic Survey 2016-17.

How would a PARA actually work?

• It could solve the coordination problem since debts would be centralised in one agency.
• It could be set up with proper incentives by giving it an explicit mandate to maximise recoveries within a defined time.
• It would separate the loan resolution process from concerns about bank capital.
• It would purchase specified loans from banks and then work them out, depending on professional assessments of the value-maximising strategy.
• Once the loans are off the books of the public sector banks, the government would recapitalise them, thereby restoring them to financial health.
• Similarly, once the financial viability of the over-indebted enterprises is restored, they will be able to focus on their operations, rather than their finances.

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.  The recommendations given by RBI are a welcome step in this regard.