Non-Performing Assets

An NPA is a loan or advance for which the principle or interest payment remained overdue for a period of 90 days.

Banks are further required to classify NPA into:

Key Facts about India’s NPA Problem

• The financial position of India’s Public Sector Banks has deteriorated sharply since 2011.
• Gross NPA has risen to 9.5 percent of total advances in 2015-16.
• Gross NPA has expected to rise further and touch 11.5 percent in coming years.
• At the aggregate level, PSBs reported a loss of 17672 crores in 2015-16.
• Most of the loans were made during the boom period of 2004-2008.
• The banks inspired by the boom kept on lending to business houses without inspecting the projects.
• When Global Crisis happened, the projects become unviable, and losses started to happen.
• Healthy Banking relies on healthy debt contracts. A debt contract is an agreement between a borrower and a lender, where the borrower promises to repay the lender principle with interest as per scheduled timeline. If the borrower can not repay, he is in default.
• In India, most of the defaulters in recent years are not the small retail borrowers but are large borrowers and corporate houses.
• Across the World, when a borrower defaults irrespective of how big he is, the borrower has to make sacrifices if he defaults. Sacrifices can be in terms of asset confiscation, taking over of firms etc.
• The biggest problem in India’s Banking system is lack of incentives the big borrower has to repay the loans back. They do not have to make many sacrifices if they default. This is the single most major reason of the NPAs in Public Sector Banks.
• In much of the Globe when large borrower defaults they are filled with guilt and desperate to convince their lenders that they should continue their trust in them.
• In India, however, large borrower insists on their divine right to stay in control despite their unwillingness to put in new money. The firms and its workers, as well as past bank loans, are taken as hostages in this game. The promoters threaten to run the enterprise into the ground unless the government do not bail them out.

Reasons for NPAs

How to Tackle Problem of NPAs

Resolving the NPA Problem

• The legacy of the NPAs must be resolved as quickly as possible so that banks can focus on resuming lending.
• Some assets that are classified as Loss assets should be written off from banks books.
• The new Bankruptcy code can be a game changer but will take time to operationalise.
• In many cases, the projects can be turned around through a combination of fresh capital from investors and new management.
• RBI has devised two schemes in this regard: the Strategic Debt Restructuring Scheme, which allows the bank to convert their debts into equity, take control of the company and then induced a new management to turn it around.
• Action has been initiated under the SDR, but no successful revival has been completed so far.
• The second RBI scheme is the Scheme for Sustainable Structuring of Stressed Assets (S4A) under which bank can offer existing management an opportunity to rehabilitate the project by dividing the debt into two parts: a “sustainable component” which can be serviced by the project based on some assumption by revenue and the “excess component” which can be converted into equity or redeemable preference shares.
• Sustainable debt must be more than 50% of the total debt.
• S4A leaves the project in the hands of existing managements and also gives the banks more flexibility in the time taken to resolve the problem. A key issue is how large a part of the debt is deemed to be sustainable. Management and banks are bound to differ on this issue.
• There is much talk of selling assets to privately managed asset reconstruction companies (ARCs), which can then organize the turnaround.
• Another idea is that the proposed National Infrastructure and Investment Fund (NIIF), operating with private partners, provide both equity and new credit to stressed infrastructure projects going through the SDR mechanism.
• The problem could be solved by creating a government-owned “bad bank” which purchases problem loans from the banks and concentrates on turning the projects around, possibly with the help of private ARCs.
• Bank managements will be much more willing to sell assets at a discounted price to another public sector company, which will then undertake the task of negotiating the best deal with potential new owners. The terms of reference of the new entity can be sufficiently clarified to encourage it to negotiate the best possible deal with new private managements. It could work in partnership with ARCs to fulfil this mandate.

Improving the Quality of Lending

• The quality of lending by PSB must be improved in future so that the same problem does not arise again.
• To provide Public sector banks with greater autonomy the shareholding of the government can be reduced to less than 50 percent or 33 percent.
• The P.J. Nayak committee had suggested that if the dilution of shareholding is not acceptable, it should be possible to distance the government from the managements of the banks by creating a public sector holding company and vesting the government’s shares in the holding company. Some statements have been made that this may be acceptable and the newly created Banks Board Bureau is the first step in this direction.
• There are two key elements in any effort to distance government. One is that the public sector banks should deal with only one regulator, RBI, and the extensive quasi-regulatory control exercised by the department of financial services should be ended. The role of the government as the owner would be performed by the holding company, and the government would deal only with the holding company on all issues.
• A second requirement is that public sector banks should become board-managed institutions, with the board responsible for all appointments, including that of the chief executive officer (CEO). If the shares of the government are actually transferred to a holding company, then decisions regarding appointments could be taken by the board of the new company on the recommendation of the board of the bank.
• The objective of creating a genuinely commercial environment in which public sector banks can function and managements are made accountable can only be achieved if the government is willing to step back from exercising direct control. Unless strong action is taken along these lines, we can assume that things will continue as they have.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University