Non Performing Assets pose a serious problem for the health of the financial sector in our Country. At the outset let us understand the definition of NPA. In simple terms NPAs refers to loans given by Banks and Financial Institutions that remain unpaid either on account of the outstanding principal and/or interest thereon.
According to the Reserve Bank of India (RBI) “an asset, including a leased asset, becomes non performing when it ceases to generate income for the Bank”. Thus, a ‘non performing-asset’ (NPA) was defined as a credit facility in respect of which the interest and/or instalment of principal has remained past due for a specified period of time.
The technical classification of an NPA was revised from time to time and from the year 31st March, 2004 onwards, the 90 days due norm was laid down whereby an NPA would be a loan / advance where:
- interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,
- the account remains ‘out of order’ for a period of more than 90 days, in respect of an Overdraft/Cash Credit (OD/CC),
- the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
- interest and/or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes, and
- any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.
Let us now look at some of the causes for Non Performing Assets. Major reasons progressively increase levels of NPA are:
- Ineffective Recovery Methods: The legal process of the law in our country is known to be long and winding. Even measures such as creation of Debt Recovery Tribunals for the expeditious recovery of loans have proved to be quite ineffective.
- Willful Defaults: Willful Defaulters, clearly the single biggest headache of the Banking System, are those having the means to repay but who manage to evade the recovery mechanism through various clever means.
- Defective Lending Process: Safety, Liquidity and Profitability are the cardinal principles of lending. Often times Bankers disregard these basic tenets of Banking and lend to borrowers of sub standard quality and doubtful intent or capacity to repay. An adequate credit appraisal system must be followed to ensure loans are only given to those willing and capable to repay.
- Economic Reasons: The general economic downturn in the world economy has also had an impact particularly on industries which are export driven with demand growth particularly in the developed world falling in recent times.
- Lack of technological Upgradation and Competition from Imports: Indian Manufacturing Industries have particularly faced competition from large scale imports particularly from China. Since Chinese products produced at a very large scale have been able to edge out Indian made products in many market segments leading to closure of businesses and consequent NPAs.
Over the past quarter of a century successive union governments have grappled with this problem through a variety of legislative and executive measures. These include:
- Debt Recovery Tribunals (DRT Act 1993): The earliest measure taken to address this challenge was the constitution of Debt Recovery Tribunals under the Recovery of Doubtful Debts to Banks and Financial Institutions Act 1993 (DRT Act). The DRTs were supposed to resolve application of the Bank for recovery of loan amounts within a period of six months.
- Credit Information Bureau (2001): The establishment of the Creation of Credit Information Bureau of India Ltd. (CIBIL) as a common platform for sharing credit information of borrowers to prevent erring defaulters from tapping alternative sources of funds after loan defaults.
- Compromise Settlements (OTS): Under the guidelines of RBI issued from time to time, Banks were given the authority to negotiate one time settlement under an OTS scheme where Banks took a hair cut both on the interest and partly upon the principal which was repaid in lumpsum.
- SARFAESI Act (2002): The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) was passed in order to permit Banks and financial institutions to recover NPAs without the intervention of the Courts. Using the provisions of this Act, Banks were empowered to take over secured assets and either sells such assets through auction sale or control the management of such assets until the same are sold as a going concern.
- Asset Reconstructions Companies (ARCs): ARCs are specially created entities registered under the provisions of the SARFEASI Act with the RBI, for unlocking value to Banks and Financial institutions who wanted to take stressed assets off their balance sheets. ARCs take over the stressed Assets through Special Purpose Vehicles (SPVs) and help the Banks make recovery on doubtful or loss assets which are transferred at deep discounts.
- Corporate Debt Restructuring (2005): Corporate Debt Restructuring (CDR) Mechanism is a voluntary non-statutory system based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA) and the principle of approvals by super-majority of 75% creditors (by value) which makes it binding on the remaining 25% to fall in line with the majority decision.
- Strategic Debt Restructuring (2015): Under this scheme Banks having outstanding loans repayable by Corporate Borrowers are given the right to convert (wholly or partly) such loans into equity shares in borrowing company. This minimizes the cash outflow in the stressed asset while giving the Bank a right to participate in the management and exit after the business stabilizes and recovers.
- Insolvency and Bankruptcy Code (2016): Seeking to consolidate the existing framework by creating a single law for insolvency and Bankruptcy, the I&BC Code outlines separate insolvency resolution processes for individuals, companies and partnership firms. The process may be initiated by either the debtor or the creditors. A maximum time limit, for completion of the insolvency resolution process, has been set for Corporates and individuals. For companies, the process will have to be completed in 180 days, which may be extended by 90 days, if a majority of the creditors agree.
- Amendment to Sec. 35A of Banking Regulation Act, 1935 (2017): Most recently, the promulgation of the Banking Regulation (Amendment) Ordinance, 2017 has witnessed the insertion of two new Sections (viz. 35AA and 35AB) after Section 35A of the Banking Regulation Act, 1949 which enable the Union Government to authorize the Reserve Bank of India (RBI) to direct banking companies to resolve specific stressed assets by initiating insolvency resolution process, where required. The RBI has also been empowered to issue other directions for resolution, and appoint or approve for appointment, authorities or committees to advise banking companies for stressed asset resolution.
As experience shows, the above stated measures have only been met with varying degrees of success. Clearly, a careful and caliberated approach, with the active involvement of all stake holders is required to deal with this challenging problem. We do seem to have a government that is serious about this issue. Interesting times lie ahead.
The above article has been written by Mr. Amit Kakri on invitation. As requested by some readers, we will now have articles written by experts on subjects like MANAGEMENT, ECONOMY, FINANCE, CDOMPLIANCE, HUMAN RESOURCES, BUSINESS HUMOR etc. Further suggestions are invited.
Thanks for reading.