Non-performing asset (NPA) refers to the classification for loans or advances that are in default or in arrears. An asset including a leased asset, becomes non-performing when it ceases to generate income for the bank.
Loan arrears: principal or interest payments are late or missed and Loan default: Lender considers the loan agreement to be broken and the debtor is unable to meet obligations.
In general, loans become NPAs when they are outstanding for 90 days or more, though some lenders use a shorter window in considering a loan or advance past due.
A non-performing asset (NPA) is a loan for an advance where,
- Interest 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” with respect to an overdraft/cash credit (OD/OC) if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power.
- 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 remains overdue for one and two crop seasons for long and short duration crops respectively.
Classification of NPA
- Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months are known as substandard assets.
- 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: 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.
Impact of NPA on Banking Sector & Indian Economy
- Banks must adhere to the provisioning norms set by RBI for the bad loans for having lesser capital to deploy, shareholders losing money and banks finding it tough to survive in the market.
- If banks do not classify an asset as NPA, they naturally have more money to advance for earning interest income on.
- If large NPAs goes unreported, bank reach a situation, where it has advanced more money than it has available leading to a situation of technical bankruptcy. Considering attaining the Basel norms, the burden on maintaining Capital Adequacy Ratio increases.
- It also affects the competitive position of banks.
- It is disadvantageous for economy and leads to declining Gross Capital Formation affecting economic growth.
- Rising of NPAs will lead to a crisis of confidence in the market. The price of loans, i.e. the interest rates will shoot up affecting infrastructural, industrial projects etc.
- It will lead to lower growth rates and of course higher inflation because of the higher cost of capital.
- The trend may continue in a vicious circle and deepen the crisis.
India and NPA
- India’s bad loans stood at fifth highest in the world in December 2019.
- NPA rose drastically in India from 2015.
- RBI tightened norms for NPA recognition in 2015. Forced banks to identify standard assets as NPA.
- NPA originated in mid- 2000s due to economic boom. Corporations granted loans based on performance. Recession led to stagnated economic growth.
- Reserve Bank of India (RBI) released its Financial Stability Report where the central bank warned that the gross nonperforming assets (GNPA) ratio of all scheduled commercial banks (SCBs) may increase from 8.5% in March 2020 to 12.5% by March 2021.
- Recent Update: Top five private sector banks namely HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank and IndusInd Bank may see their slippages double to 5% due to the poor loan offtake and the moratorium-driven contraction in net interest margins as per the report by India Ratings
How to reduce the NPA?
Banks today have a herculean task of both effectively managing the NPA’s as well as leaping their profitability intact. Banks need a well-established credit monitoring system for this. We have the following ways to tackle or reduce NPA:
- Timely matched on the performance of the borrowers must be kept so that recovery of installments becomes easy.
- A bank needs to properly evaluate the credit proposals they receive.
- A centralized model for sanctioning and recovery of loans should be set up.
- Bank convert debt to equity and instead of acting as lenders, become the owners of these defaulting companies, appoint the board, govern these companies, and bring them back to profit.
How To Recover NPA?
- Possession/ sale of collateral.
- Restructure loans to maintain cash flow.
- Convert bad loans into equity.
- Selling of loan on discount to collection agency.
Laws Framed for NPA recover and management
In the year 1991, Narsimham committee recommended many reforms to tackle NPAs. Some of them were implemented. Here are some of the important NPA reforms
- Debt Recovery Tribunals (DRTs) 1993: To decrease the time required for settling cases. They are governed by the provisions of the Recovery of Debt Due to Banks and Financial Institutions Act, 1993. However, their number is not sufficient therefore they also suffer from time lag and cases are pending for more than 2-3 years in many areas.
- 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.
- SARFAESI Act 2002 (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002): This 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.
- ARC (Asset Reconstruction Companies): The RBI gave license to 14 new ARCs recently after the amendment of the SARFAESI Act of 2002. These companies are created to unlock value from stressed loans. Before this law came, lenders could enforce their security interests only through courts, which was a time-consuming process.
- Corporate Debt Restructuring 2005: It is for reducing the burden of the debts on the company by decreasing the rates paid and increasing the time the company has to pay the obligation back.
- Mission Indradhanush 2015: 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.
COVID-19 Relief Package for NPA
- Due to the ongoing coronavirus situation, it was decided to grant moratorium or deferment for amounts, which were standard as on March 1, 2020.
- 90-day NPA norm shall exclude the moratorium period, i.e., there would an asset classification standstill for all such accounts from March 1, 2020 to May 31, 2020.
- NBFCs have flexibility under the prescribed accounting standards to consider such relief to their borrowers.
- At the same time, risk build-up in banks’ balance sheets on account of firm-level stress and delays in recoveries are also kept in mind.
- With the objective of ensuring that banks maintain sufficient buffers and remain adequately provisioned to meet future challenges, they will have to maintain higher provision of 10% on all such accounts under the standstill, spread over two quarters, i.e., March, 2020 and June, 2020.
Non-performing asset Quiz
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