1 Introduction
Non-Performing Asset (NPA) is an asset of a financial institution/ bank which is non-productive or not producing any income. In short, it is not meeting its stated rules/principles. Loans made to customers are recorded as assets on the balance sheet of a bank. When customers who take out loans do not pay their installments/payments, it causes the value of the loan assets to decline and becomes the most significant risk to a bank.
1.1 Non-performing Assets
1.1.1 Criteria for defining the loan as non-performing
Loans don’t go wrong right away. A certain grace period has been given to most mortgages, and then they are marked overdue. But if the payment is still delayed then the loan is classified as a nonperforming loan after a certain number of days. The commercial loans which are more than 90 days late or the consumer loans which are more than 180 days overdue are classified as non-performing assets by the banks. Also for agricultural loans, if the interest and the payment or principal remains delayed for at least two harvest seasons; those loans are declared as NPAs and this period should not exceed two years. If it exceeds, then any unpaid loan/payment will be classified as a non-performing asset.
1.1.2 Categories of non-performing assets
1. When the NPAs have aged less than or equal to 12 months, the NPAs are Sub-standard.
2. When the NPAs have aged greater than 12 months, the NPAs are Doubtful.
3. When the bank or its auditors have identified the loss, but it has not been written off, the NPAs are Loss assets.
A bank will try to recover its money by excluding the property that secures the loan after a definite amount of time. The way money is recovered a highly debatable issue; not only with the banks but also with the Micro-Finance Institutions (MFIs).
1.1.3 Extent of Non-Performing Assets
Domestic banks had a gross NPAof about 4.4 % of total debt by the September 2013 which was a steep hike from 3.4 % in March 2013, according to the Reserve Bank of India (RBI). RBI has sanctioned a warning that bad loans (NPAs) could go up to 6.8% of total advances by end of 2015.
Gross NPAs are estimated to cross Rs 2.60 lakh crores by the March 2017. The estimated value of NPAs can be equated to the total expenditures of UP. PSBs (state-run banks) values to around two-thirds of the loans but has around 79% of bad assets, covers for a significant part of soured lending. In comparison private sector and foreign lenders are better placed with lesser NPAs as a proportion of their debts.
1.1.4 Effect on Bank due to NPA:
Banks have to follow Income Recognition and Assets Classification (IRAC) norms prescribed by RBI. As per IRAC norms any instalment plus interest or EMI as the case may be remains unpaid for more than 90 days. On 91st day, entire loan account will be classified as NPA. Banks cannot debit any further interest in this loan account and it has to make provision from its own profit on the entire loan outstanding. They will have to reverse the interest debited in the loan account since last 3 months and transfer it to an account called as ‘Unrealised Interest’ which will reduce Bank’s profit for that particular quarter substantially. Moreover, bank has to pay interest on deposits mobilised for this loan and apportion the capital. The loss to the bank is much more than the loan amount plus loss of reputation (Goodwill) because of increased NPA. Earlier, banks were permitted to restructure the repayment schedules without attracting the stigma of NPA. But, this relaxation in IRAC norms have been withdrawn by RBI w.e.f. April 1, 2015. Thus, bank has to classify the account as NPA if any change in repayment schedule is made afterwards. The bank's revenue stream is rendered weak if the amount of non-performing assets (NPAs) are higher. For a short-term, banks with high reserves or other capital that can be used to offset the losses, can accommodate an increase in NPA. But, once the surplus money exhausts, nonperforming loans will risk a bank’s health. NPA can act as a dead weight on the balance sheet, reducing the credibility and functionality of the firm.
1.1.5 Overall impact
As the NPA of the banks is rising, it will bring a scarcity of investments or funds in the Indian security markets. Few banks are willing to lend if they are not sure of the recovery of their money. The shareholders of the banks lose a lot of money as banks themselves find it tough to survive in the market. The rise of NPAs will lead to a crisis of confidence in the market. The price of loans, i.e., the interest rates will shoot up poorly. The rise in the interest rates will directly affect the investors who want to take loans for their infrastructural and industrial projects.
It will also impact the retail customers like us, who will have to give a high-interest rate for a loan. All of this leads to a situation of low removal of funds from the security market. The rise of NPAs will reduce the overall demand in the Indian economy. And, finally, it leads to low growth rates and of course high inflation because of the high cost of capital. The rise in NPAs may continue in a vicious circle and deepen the crisis. Total NPAs have touched figures close to the size of Uttar Pradesh budget. Just imagine if all the NPAs were recovered, how well it can be a sign for the Indian economy. RBI governor Raghuram Rajan had said that NPAs must be eliminated before the problem becomes hazardous.
1.1.6 Reasons for accumulation of NPA
The rising incidence of NPAs has been because of the domestic economic slowdown. It is believed that corporates have been finding it difficult to repay loans with the slowing down of the economic growth and the going up of the rate of interest, which has added up to rising NPAs. P Chidambaram, the finance minister stated that default loans are a function of the economy and hence, having default loans during the distressed times are very natural. However, the NPA issue is not entirely because of the reversal of the economic cycles. There are the other reasons behind this point, and mainly the whole problem can be divided into two parts – External matters and internal issues.
External Factors:
a) Corporate sector
The global economy has also slowed down along with the slowdown in India. This has severely impacted the corporate sector in India. Continuing uncertainty in the global markets has to lead the lowering of the exports of various products like engineering goods, textiles, leather, gems, etc. It can be noted that imports and exports combined equal to around 40% of India’s GDP. An affected corporate sector is finding it challenging to pay loans.
The ban on mining projects, delay in related environmental permits are affecting power, iron and steel sector. There is volatility in the prices of raw material, and the shortage in the availability of which impacted the performance of the corporate sector. This has affected their ability to pay back loans.
b) Other sectors
Banks in the India are highly regulated. The Priority sector lending (PSL) is one of these regulations which require the banks to give a specific percentage of their loans to the individual sections of the society. These are the farmers, SCs, IT parks, STs, MSMEs, etc.
Anyone would assume that the weaker sections are covered under PSL, and these are the ones to be blamed for the situation, but this is not the case. As per the news reports, the Standing Committee on Finance will be examining the reasons and the problems for high NPAS in PSBs.
The data shows that NPAs in the corporate sector are higher than those in the other sectors. As per the estimates by the SBI bank, the education loans constitute 22% of its NPAs.
The sluggish legal system, i.e., Judiciary in India and lack of the systematic and the constant efforts made by the banks make it a difficult task to recover these loans from both the corporate and the non-corporate sector.
Internal Factors
The banks often wait far too long before the assest is beyond control.To recover loans, the banks have been inefficient in using coercive techniques. Leniency in checking for warning has beena major setback causing a growth in NPAs. Many infra project, some over 30 yrs old, have not been scrutinized for inability to repay loan. During the high growth period, the state owned banks started providing indiscriminate lending, which in turn affected the asset quality and credibility.
1.1.7 Prevention of NPA
The Growth of the NPAs in can be controlled from the roots by
1. CONSERVATISM:
Banks need to be more conservative in granting loans to sectors that have previously been a contributor to NPAs. The infrastructure sector is one such example giving rise to NPAs due to its high gestation period. They can be funded from Infrastructure Debt Funds (IDF) or funds allocated for development of infrastructure in the country, rather than the state owned banks.
2. IMPROVING PROCESSES:
The loan sanctioning process needs to be stringent with thorough check before the loan is sanctioned. The process needs to go beyond the traditional analysis of the financial statement and the history of the promoters, without much reliance on the information from the credit bureaus which are often not updated regularly..
3. RELYING LESS ON RESTRUCTURING THE LOANS:
Taking action when there is time left is one of the starts that the banks need to take. Restructuring the loan shall be mitigated on taking proactive steps rather than reactive. According to one of the studies, it is INR 2 Trillion worth of restructured loans are estimated by 2013.
4. DIVERSIFICATION AND INNOVATIVE MODELS:
Corporate sector has far greater NPA than the non-corporate sector. People in remote areas have lesser connectivity and accessibility, but they are needed to be properly communicated and reached out to. New technologies and electronic means should help the unfortunate rural pockets to connect to the banking systems by adopting. Innovative business models shall play a crucial role in achieving this.
1.1.8 Recovery of NPA
NPA can be recovered using a holistic approach, some of which are already in place and some of which can be implemented.
1. A loan database comprising of all loans more than a certain threshold can be created
2. NBFC, insurance companies and other financial institutions can be involved in lending to reduce the load on Banks
3. Viable projects can be allowed to have restructure of loan and extension of loan, after monitoring and examining fully.
4. Bankers can take quick and easy possession of assets in case of wilful defaulters
5. Asset Quality Review can be conducted periodically to classify the stressed assets.
6. The bankers can be incentivized to take better decisions by extending their terms and eliminate the fear of continuous review of decisions by vigilance boards.
7. Use superior technology and infrastructure and also issue guidelines for compliance.
1.1.8.1 RECOVERY CAMPS:
Bank personnel jointly approach the defaulting borrowers for repayment at a place and time convenient to both the parties. These are more suited to small loans. Usually more number of the borrowers from rural and semi urban areas avail small loans than urban and metro centres. Hence instead of conducting the recovery camps at their branches, the banks usually conduct such recovery camps in centres like panchayat board offices, court buildings, government department buildings etc. recovery camps so that the borrowers find it convenient to attend the recovery camps. In some instances, the Bank Branch manager along with some branch officials go to each visit each house of the borrowers and recover the instalments due in respect of loans availed by them.
1.1.8.2 COMPROMISE PROPOSALS:
Compromise guidelines are made by the banks, where borrowers experience certain genuine difficulties and where normal recovery is not possible. It involves certain sacrifices on the part of the banks. Such proposals can be taken up considering the history of the borrowal account, net worth of the borrower/guarantor, security available etc.
1.1.8.3 TECHNICAL WRITE OFF:
Usually banks decide writing off small loans which have become bad. The recovery is not possible in those accounts because of the facts that the borrower might have been died or he does not have any means to repay the loan at any cost and there might be enormous losses in respect of the properties, assets etc. This type of non-performing accounts are best suited for this purpose.
1.1.8.4 ONE TIME SETTLEMENT SCHEME:
To decrease the amount of non-performing assets, Government of India along with Reserve Bank of India announced one time settlement schemes for the past few years. When the borrowers are farmers, small entrepreneurs etc. and they find it very difficult to pay their dues for various reasons like bad health; huge loss in their small business ventures, however, they are not wilful defaulters and they want to repay their debts to the banks, and this type of practice is very much helpful to the borrowers and the lending institutions. But on the downside, the banks are in a position to lose certain portion of their loan amount when they are conducting one time settlement schemes.
1.1.8.5 SUIT FILING:
This is taken up as a last recourse when all other remedies to recover non-performing assets fail. Banks can initiate recovery proceedings with or without intervention of the courts of law. To expedite the process, banks need to be alert and proactive in all stages of the proceedings.
1.1.8.6 TRIBUNALS for DEBT RECOVERY
For loans amounting for more than 10 lacs, the debt recovery tribunal act was initiated by Indian Parliament with an objective to facilitate the banks and financial institutions for speedy recovery of dues. The time limit envisaged under the act is not being adhered to in disposing off the suits because of inadequate infrastructure and shortage of recovery personnel with the DRTs. Allover, the DRT act had provided a huge improvement over the normal legal forum.
1.1.8.7 LOK ADALATS:
It is a legal forum for expeditious settlement of loan dues on consensus arrived between the bank and the borrowers mediated by the Lok Adalat
1.1.8.8 SECURITISATION ACT:
Objective of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) is to allow banks as secured creditors to take possession, manage and sell the securities without the intervention of court/tribunal. It also aims at Asset Reconstruction by securitization or Reconstruction Company. However, loan with balance below INR 1 lakh unsecured loans and loans against collateral of agricultural land are exempted from the purview of this act.
1.2 Unsuccessful/Unsettled auctions
1.2.1 Proper valuation of NPA
Assets are valued by a professional valuer before the auction. Banks only try to recover the amount that is outstanding. Hence they try conservative approach. The valuers keep the construction, location and the area in mind before valuing the property. The plausible value given by them helps to set the reserve price which is disclosed to the bidder beforehand. Banks usually do the due-diligence for these properties via asset reconstruction departments or sell the assets to the asset reconstruction companies (ARC). But they do not give any warranty and the buyer has to accept several unknown risks. These due-diligence can be properly documented and presented to the willing bidders to help them making purchasing decision.
The buyers who are participating in these bidding should inspect the property beforhand and check whether there are any dues pending against it. Banks may not know about any particular instances of subletting and can be overlooked. In that case, the purchaser of that property can not sell without the tenant’s approval. Sub-tenancy can create problems. No one will know that until someone actually resides in that property. Hence, the buyers must inspect the property beforehand the auction. Also, if banks can run a thorough background check on those properties before starting auction that might reduce the risk.
A distress sale is to recover their dues only and no profit can be made by the banks. Market price of that property will be higher than selling price. The selling price will be marked down or discounted price. The balance amount will be paid back to the defaulting borrower in case if the bid amount is higher than the amount of the loan default. Public sector companies should be asked/requested to buy such assets in their sector.
The Banking Regulation Bill, 2017 was introduced with a framework to monitor top 25-30% of NPA in all the banks.
1.2.2 ARC
The assets can be leased out or sold by ARC to recover assets value, at least partially. The recovered price of the asset will be divided between the Bank and ARC in the proportion of 85:15. Once the asset is sold off, it no longer remains NPA in its books.
To recover maximum NPA, best strategy for the Bank should be to pursue One time settlement as the first option. It has been observed, that only 5% of the case were fraudulent, rest were genuine cases. It would be judicious on the part of the RBI to ensure that the OTS option is exercised before going for securitisation and sale of the asset.
Sometimes, the borrower or the bank or both believe that a mutually agreed price of the loan would be a better option than acquiring and selling the asset under SAFRAESI Act. Then the Banking Ombudsman’s intervention as Arbitrator is requested to settle the distressed asset closure in those cases
Today, asset reconstruction companies (ARC) are facing challenges in terms of the capacity and expertise required to handle the growing stressed assets portfolio. The RBI should allow specialised financial institutions like infrastructure finance companies and non-banking financial companies that have adequate expertise in managing assets to acquire and deal with stressed assets.
The major problem an ARC faces is to persuade all banks to sell their bad loans all together. If at least 60 per cent of them has not agreed to sell their loans then it becomes difficult for an ARC to secure finance to rebuild assets. It might take minimum two years to convince majority of the banks which acts as a major roadblock for the process. This inadvertently delays the process of selling of NPA.
To solve this issue, ARCs want the concept of consortium sale to be materialized. Loan restructuring is done collectively. Similar arguments apply to sell bad assets.
The next major issue is valuation. Banks sometimes use impractical valuation price. Reserve price must not be set more than the loan value. If this occurs, then the deal will fail for sure.
ARCs are worried about the margins as well. As of now they have to pay 15 per cent of the asset purchase price in full cash. Earlier, ARCs could pay 10 percent in security receipts after using 5 percent cash.
Minimum 20-22 per cent margins are required to run ARC business. But with the cash component going up, the margins will come under pressure if banks do not agree on realistic prices. Banks usually offer 10-15 per cent discount on asset sale but 30 to 40 percent should be viable for the ARCs to have a respectable profit.
Banks usually wait for a long time before selling NPA. If they sell immediately, they can sell at 10 – 15 percent discount. Instead, they will search for a suitable buyer when the asset’s value diminishes by 40 – 50 percent, which is not lucrative for the buyers. Hence, sell the asset instead of sitting on it and waiting for loan recovery.
Compared to the public sector banks, Private-sector banks are more aggressive in selling NPA to the ARC. HDFC Bank recently had a transaction of Rs 550 crore to Edelweiss ARC at 40 per cent discount. Amongst all the public sector banks, SBI has adopted asset sale as a strategy to clean up its balance sheet and other banks should follow its footsteps.
According to SBI Chairman Arundhati Bhattacharya , they have a clearly laid-out system. A day is chosen on which, the information memorandum on whatever is there on the books of the stressed asset management group would be circulated. There would be a specific day when they receive bids from all the ARCs, and there is a date given when they open the bids. Everything is now according to a calendar. They have tried to take out the seasonality factor.
ARCs have their own problems as well. Raising capital is their biggest challenge. According to a study conducted by rating agency Crisil and Assocham, the capital base of 15 ARCs in the country was Rs 20,000 crore as on March 31, 2015. They need to double their capital base if they want to absorb the entire incremental NPA. Private equity and distressed asset funds need to be participating actively to rectify this.
1.2.3 Negotiated Settlement
1. There are a number of methods by which the banks approach this issue. Most popular one is trying to negotiate an OTS (One Time Settlement) with the borrower. In this, bank will negotiate with the borrower by giving a discount on the total dues to be paid. If the borrower is still reluctant to settle the loan and avoids the banks, then bank proceeds with SARFAESI act and takes the possession of the property. Finally, bank tries to sell the property through auction. If there are no securities, bank files suit.
2. The inception of bad bank which is on a conceptual stage where the government is thinking to transfer NPAs of different banks and expedite recovery. At present banks are selling their bad asset portfolio to ARCIL at a discount. ARCIL pursue the account holder on a case to case basis and sell the assets at a premium.
1.3 MSME as a loan defaulter and its effect
As regards the other aspects the banks have been found to be ignoring Project finance norms while lending to the MSMEs, save exceptions. Banks have sanctioned and released Term Loan for installing Plant and Machinery and the Cash Credit for working capital simultaneously. While the interest accruals during the project implementation period, i.e., until commercial production commences, need to be capitalised, they were found to be debiting the interest applied quarterly to the cash credit account with the result the entrepreneur is left dry just before going for commercial production. This resulted in many accounts becoming NPAs even before the commencement of commercial production.
2 Preventive Measures
● After the Mallya episode and its uninformed media trial, Banks are also afraid and are forced to act in heist. There is an overreaction on the part of RBI/Government forcing banks to enforce mass auctions of the stressed assets without making judicious distinction between viable and non-viable units and between wilful and circumstantial defaulters who are victim of factors beyond their control e.g. policy paralysis/economic recession, arm twisting by large corporates etc. This over enthusiasm of auctioning MSME units and their collateral securities is resulting counterproductive as there is a dearth of buyers for these auctions. If this situation is not addressed judiciously, there is a threat of losing the credibility of recovery mechanism in future. It can be observed from repetitive auction notices published in newspapers. These factors underline the importance of setting up a proper machinery to undertake an objective analysis of the need and urgency of taking a meaningful legal/coercive action which will prevent prevailing casual and bureaucratic approach of taking legal/coercive action against MSMEs, once these accounts are classified as NPAs. It is important to note that most of the MSMEs are in non-corporate sector, rather family units wherein the promoters pour in their entire resources to raise the capital and putting their other assets as collaterals. As they are totally involved in the unit, their financial wellbeing is also tagged with success or failure of the unit, unlike big corporates who are sick but their promoters are bashing their wealth. This makes MSMEs different from big corporate and hence deserves a judicious treatment. It must be made amply clear that no wilful defaulter should be pampered but circumstantial defaulter need to be rehabilitated.
● Unfortunately the withdrawal of relaxation in IRAC norms for restructuring of sick viable MSMEs w.e.f. 31st March 2015 has demotivated Banks from extending help to sick viable MSMEs which has further deteriorated the situation. Government should immediately restore the said relaxation to revive such units. A realistic view needs to be taken by opening the Restructuring Window specifically for MSMEs so that a breathing space is allowed to them. There should be a holistic approach encouraging Banks to restructure existing eligible standard accounts without attaching stigma of making them Substandard (NPA) so that concerns of Banks of increasing provision can be addressed to. Many prominent economists like Shri S.Gurumurthy are rightly raising questions over applying these western concepts of IRAC norms in Indian circumstances. It seems that even after the change of government, Regulators still believe in copy paste policy of western concepts which are totally irreverent in Indian context. MSME organisations like Laghu Udyog Bharati who have access to the policy makers need to exert vigorously.
● Holding on operations needs to be implemented in letter and spirit to provide adequate working capital during crisis to the eligible units as this will not only revive the units but it will also ensure full recovery of banks and other stakeholders also.
● In spite of big claims of collateral free loans, MSMEs have to offer collaterals for getting adequate credit. The monster of huge increase in NPAs has further worsened the situation as most banks are still stipulating 150% asset coverage ratio for additional finance even for their existing standard borrowers. The mechanism to provide seamless and timely credit needs to be strengthened.
● As a long term measure Credit Appraisal Mechanism of Banks needs to be strengthened qualitatively by sensitising Banks about the peculiar needs of MSMEs so that adequate and timely credit in a proper form is provided to them and monitored properly. In spite of reduction in Base Rate, MSMEs are not getting credit at affordable/reasonable rates may be because of their limited lobbying strength to fetch better pricing from lenders and fancy of banks for big ticket advances. It will be very challenging to say that Indian Banks truly understand very peculiar nature of MSMEs, even today.
● The provisions in the MSMED Act should be amended to make it obligatory for large corporates to issue orders to MSMEs along with Letter of Credits (LCs) so that MSMEs can be protected from vagaries of the big brothers. This will also help them in better management of working capital by discounting LCs. A beginning can be made in this regard by making it mandatory for all Public Sector Undertakings/Govt Departments for sourcing from MSMEs.
3 Final Recommendations
• Introduce incentives for proactive bankers who can identify NPA, take strict actions and try to contact the lender for at least partial payment. The bankers can be incentivized to take better decisions by extending their terms and eliminate the fear of continuous review of decisions by vigilance boards.
• Apart from the charge sheeted staff, no staff of the bank is concerned of these NPA account as salary is fixed and even if a bank is merged same salary is paid, we work for the GOI and the banks name can be changed anytime hence not much opposition for the idea of merger among staff members on the contrary it is a welcome idea.
• Private banks don't have such a huge NPA problem because firstly their executive are paid good salary and don't care to become ED/CMD of any bank hence are not motivated to inflate their balance sheets, secondly they never find fault and punish staff for a loan becoming NPA hence staff is motivated to do fresh good loans and lastly they engage with recovery agents who can use any way to recover the account easily even hurting the borrower physically if needed.
4 Learnings