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BankingSysteminIndiaNonPerformingAssets
ByINSIGHTS

NonperformingAssets(NPAs)

INTRODUCTION
InthelastarticleonUnderstandingthebankingsystem,wehaddiscussedtheBaselnorms.
WelearntwhatBaselnormsareandwhytheyholdsuchimportancefortheIndianbankingsystem.Thenwe
understoodthechallengesthebankswillhavetofaceinimplementingthem.Further,wesuggestedapossible
wayout.
Previousdiscussionhighlightedwhystabilityinthebankingsystemisimportant.Followingthatdiscussion,in
thisarticlewewillbediscussingoneofthebiggestchallengesthreateningthestabilityoftheIndianbanking
systemtheNonPerformingassets(NPAs).
ThebankingbusinesshasboomedsinceIndependence,particularlyaftertheLPGreforms.Thesectoris
currentlyvaluedatRs115lakhcroreandexpectedtomorethandoubleatRs288lakhcroreby2020.Outof
this70percentofbusinessisbeingdonebyPSUbanks.AninterestingfactisthatSBIsmarketshareoutof
totalbankingbusinessis22percent!
Lookingattheenormoussizeofthebankingindustry,theNPAsareabigcauseofconcern.
WewillfirstlookatsomeofthebasicsofNPAsthenmoveontounderstandtheircausesandimplicationsthen
examinethechallengesthatthebankswillfacebecauseofthemandfinallyputforwardpossiblesolutions.
ThediscussionwillalsocoverthesocialagendabehindthebankingandwhetheritisunviablefortheIndian
banks.

WHATARENPAS?
Generallyspeaking,NPAisanyassetofabankwhichisnotproducinganyincome.
Inotherwords,aloanorleasethatisnotmeetingitsstatedprincipalandinterestpayments.
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Onabanksbalancesheet,loansmadetocustomersarelistedasassets.Thebiggestrisktoabankiswhen
customerswhotakeoutloansstopmakingtheirpayments,causingthevalueoftheloanassetstodecline.

Criteria
Loansdontgobadrightaway.Mostloansallowcustomersacertaingraceperiod.Thentheyaremarked
overdue.Afteracertainnumberofdays,theloanisclassifiedasanonperformingloan.
Banksusuallyclassifyasnonperformingassetsanycommercialloanswhicharemorethan90
daysoverdueandanyconsumerloanswhicharemorethan180daysoverdue.
Foragriculturalloans,iftheinterestand/ortheinstallmentorprincipalremainsoverduefortwoharvestseasons
itisdeclaredasNPAs.But,thisperiodshouldnotexceedtwoyears.Aftertwoyearsanyunpaidloan/installment
willbeclassifiedasNPA.

Categories
1.Substandard:WhentheNPAshaveaged<=12months.
2.Doubtful:WhentheNPAshaveaged>12months.
3.Lossassets:Whenthebankoritsauditorshaveidentifiedtheloss,butithasnotbeenwrittenoff.

Afteracertainamountoftime,abankwilltrytorecoupitsmoneybyforeclosingonthepropertythatsecures
theloan.ThewaymoneyisrecoupedisahighlycontentiousissuenotjustwithbanksbutalsowithMicro
FinanceInstitutions(MFIs).Wewilldiscussitlaterinthearticle.

Allofthiscanbeexplainedinamuchmoretechnicalmanner,butthatisnotrequiredhere.Forexample,wedo
notneedtolistalltheconditionsthatmakethebanksdeclareanassetasNPAslikeInrespectofderivative
transactions,theoverduereceivablesrepresentingpositivemarktomarketvalueofaderivativecontract,if
theseremainunpaidforaperiodof90daysfromthespecifiedduedateforpayment.
Onlyunderstandingthebasicconceptswillsuffice.UPSCisnotgoingtoaskyouthesedetails,butaboutthe
impactandsolutionsofNPAs.Eveninprelims,thesedetailswillnotbeasked.Soweavoidtechnicalitiesand
jargonshere.ItisnotusefulforaGSpaper,evenifsomeofitmaybeusefulforEconomicsoptionalpaper.

EXTENTOFNPAs
GrossNPAsofdomesticbanksjumpedto4.2%oftotallendingbytheendofSeptember2013from3.6%six
monthsbefore,accordingtotheReserveBankofIndia(RBI).

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AsperarecentwarningbytheRBI,badloans(NPAs)couldclimbto7%oftotaladvancesby2015.
Inabsoluteterms,grossNPAsareestimatedtotouchRs2.50lakhcroresbytheendofMarchthisyear.Thisis
equaltothesizeofthebudgetofUttarPradesh.Thebiggestchunkofthesoureddebtsiswithstaterunbanks
(PublicsectorbanksorPSBs),whichaccountfortwothirdsofloansbut80%ofthebadassets.
ThisishowtheNPAcurvehasbeenmovingintherecentyears,asperanewsreportintheBusinessStandard:

Privatesectorandforeignlendersarebetterplaced.TheirNPAsinproportionoftheirlendingislesserthanthat
ofthePSBs.

WHYITMATTERS?
Thehigheristheamountofnonperformingassets(NPAs),theweakerwillbethebanksrevenuestream.
Intheshortterm,manybankshavetheabilitytohandleanincreaseinnonperformingassetstheymight
havestrongreservesorothercapitalthatcanbeusedtooffsetthelosses.Butafterawhile,ifthatcapitalis
usedup,nonperformingloanswillimperilabankshealth.Thinkofnonperformingassetsasdeadweighton
thebalancesheet.
HereistheimpactoftheNPAs:
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AstheNPAofthebankswillrise,itwillbringascarcityoffundsintheIndiansecuritymarkets.Few
bankswillbewillingtolendiftheyarenotsureoftherecoveryoftheirmoney.
Theshareholdersofthebankswilllosealotofmoneyasbanksthemselveswillfindittoughtosurvivein
themarket.
Thiswillleadtoacrisisofconfidenceinthemarket.Thepriceofloans,i.e.theinterestrateswillshootup
badly.Shootingofinterestrateswilldirectlyimpacttheinvestorswhowishtotakeloansforsettingup
infrastructural,industrialprojectsetc.
Itwillalsoimpacttheretailconsumerslikeus,whowillhavetoshelloutahigherinterestrateforaloan.
Allofthiswillleadtoasituationoflowofftakeoffundsfromthesecuritymarket.Thiswillhurttheoverall
demandintheIndianeconomy.And,finallyitwillleadtolowergrowthratesandofcoursehigherinflation
becauseofthehighercostofcapital.
Thistrendmaycontinueinaviciouscircleanddeepenthecrisis.
TotalNPAshavetouchedfiguresclosetothesizeofUPbudget.ImagineifalltheNPAwasrecovered,
howwellitcanaugurfortheIndianeconomy.
RBIgovernorRaghuramRajanhasrecentlysaidthatNPAsmustbecurbedbeforetheproblembecomes
alarming.

WHYSUCHASITUATION?
TherisingincidenceofNPAshasbeengenerallyattributedtothedomesticeconomicslowdown.Itisbelieved
thatwitheconomicgrowthslowingdownandrateofinterestgoingupsharply,corporateshavebeenfindingit
difficulttorepayloans,andithasaddeduptorisingNPAs.EvenfinanceministerPChidambaramstatedthat
badloansareafunctionoftheeconomyandhence,havingbadloansduringdistressedtimesisverynatural.
However,TheNPAmessisnotentirelybecauseofthereversalofeconomiccycles.
Herewelookattheotherreasonsbehindthismess.Basicallythewholeproblemcanbedividedintotwoparts
Externalproblemsandinternalproblemsasfacedbythebanks.

ExternalFactors

Reasonsrelatedtothecorporatesector
1. ApartfromtheslowdowninIndia,theglobaleconomyhasalsosloweddown.
ThishasadverselyimpactedthecorporatesectorinIndia.Continuinguncertaintyintheglobalmarkets
hasleadtolowerexportsofvariousproductsliketextiles,engineeringgoods,leather,gemsetc.Itcanbe
notedthatimportsandexportscombinedequaltoaround40%ofIndiasGDP!
Ahurtcorporatesectorisfindingitdifficulttopayloans
2. Thebaninminingprojects,delayinenvironmentalrelatedpermitsaffectingpower,ironandsteelsector,
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volatilityinpricesofrawmaterialandtheshortageinavailabilityofpowerhaveallimpactedthe
performanceofthecorporatesector.Thishasaffectedtheirabilitytopaybackloans.

Othersectors
BanksinIndiaarehighlyregulated.Prioritysectorlending(PSL)isoneoftheseregulationswhich
requirethebankstogiveacertain%oftheirloanstocertainsectionsofsociety.Thesearefarmers,SCs,
STs,ITparks,MSMEsetc.
NaturallyonewouldassumethattheweakersectionscoveredunderPSLaretheonestobeblamedfor
thesituation.However,itisnotthecase.
Asperrecentnewsreports,theStandingCommitteeonFinancewillbenowexaminingthereasonsfor
highNPASinPSBs.
Thedata,sharedwiththeStandingCommittee,showsthatNPAsinthecorporatesectorarefarhigher
thanthoseinthepriorityoragriculturesector.
Withintheprioritysector,incrementalNPAsweremoreinrespecttomicrosmallandmediumenterprises
followedbyagriculture.
However,eventhePSLsectorhascontributedsubstantiallytotheNPAs.
AsperthelatestestimatesbytheSBI,educationloansconstitute20%ofitsNPAs!

Thesluggishlegalsystem(JudiciaryinIndia)andlackofsystematicandconstanteffortsbythebanks
makeitdifficulttorecovertheseloansfrombothcorporateandnoncorporate.

InternalFactors

1.Indiscriminatelendingbysomestateownedbanksduringthehighgrowthperiod(200408)isoneofthe
mainreasonsforthedeteriorationinassetquality.

2.Bankerssaythereisalackofrigourinloanappraisalsystemsandmonitoringofwarningsignalsatstaterun
banks.Thisisparticularlytrueincaseofinfrastructureprojects,manyofwhicharestrugglingtorepayloans.
Besides,theseprojectsgoonfor20to30years.

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3.Poorrecoveryanduseofcoercivetechniquesbybanksinrecoveringloans

4.ThewaitandwatchapproachofbankshavebeenoftenblamedasthereasonforrisingNPAsasbanksallow
deterioratingassetclasstogofrombadtoworseinthehopeofrevivalandoftenofferrestructuringoptionto
corporates.
AParliamentarypanel,examiningincreasingincidentsofNPAs,hasobservedthatstateownedbanksshould
stopevergreeningorrepeatedrestructuringofcorporatedebttochecktheconstantbulgingoftheirnon
performingassets.MembersofthepanelwereoftheviewthatNPAsaretheresultofbadeconomicsituation,
buttherewerealsomanagementissueofeverygreeningofloans,whichcouldbeavoidedbynotrenewing
loans,particularlyofcorporate.

Therefore,itcanbeclearlyseenthatitisonlytheeconomicslowdownthatisbehindtheNPAs.Therearea
wholerangeoffactors.

WAYOUT
ThesimplestapproachtocutdownNPAsistorecoverthebadloans.
ApartfromtheregularguidelinesreleasedbytheRBI,tostrengthenfurthertherecoveryofduesbybanksand
financialinstitutions,GovernmentofIndiapromulgated:
1.TheRecoveryofDebtsDuetoBanksandFinancialInstitutionsAct,1993
2.TheSecuritizationReconstructionofFinancialAssetsandEnforcementofSecurityInterest
(SARFAESI)Act,2002.
So,howcanthebankslegallyrecovertheirloans?

(i)TheSecuritizationandReconstructionofFinancialAssetsandEnforcementofSecurityInterest
(SARFAESI)Act,2002TheActempowersBanks/FinancialInstitutionstorecovertheirnonperforming
assetswithouttheinterventionoftheCourt,throughacquiringanddisposingofthesecuredassetsinNPA
accountswithoutstandingamountofRs.1lakhandabove.Thebankshavetofirstissueanotice.Then,onthe
borrowersfailuretorepay,theycan:
Takepossessionofsecurityand/or
Takeoverthemanagementoftheborrowingconcern.
Appointapersontomanagetheconcern.

(ii)RecoveryofDebtsDuetoBanksandFinancialInstitutions(DRT)Act:TheActprovidessettingup
ofDebtRecoveryTribunals(DRTs)andDebtRecoveryAppellateTribunals(DRATs)forexpeditiousand
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exclusivedisposalofsuitsfiledbybanks/FIsforrecoveryoftheirduesinNPAaccountswithoutstanding
amountofRs.10lacandabove.Governmenthas,sofar,setup33DRTsand5DRATsalloverthecountry.

(iii)LokAdalats:Section89oftheCivilProcedureCodeprovidesresolutionofdisputesthroughADRmethods
suchasArbitration,Conciliation,LokAdalatsandMediation.LokAdalatmechanismoffersexpeditious,in
expensiveandmutuallyacceptablewayofsettlementofdisputes.
Governmenthasadvisedthepublicsectorbankstoutilizethismechanismtoitsfullestpotentialforrecoveryin
NonperformingAssets(NPAs)cases.
Amongthevariouschannelsofrecoveryavailabletobanksfordealingwithbadloans,theSARFAESIActand
theDebtRecoveryTribunals(DRTs)havebeenthemosteffectiveintermsofamountrecovered.

TherecentcontroversysurroundingloanrecoveryinIndiaViewsoftheSC
Bankshavebeenallegedtoengageincoercivepracticestorecovertheloans.Recently,therehavebeensome
judicialpronouncementsbytheapexcourtdeterminingthescopeofpowersofenforcementofsecuritieswithout
theinterventionofthecourts,bythebanksandFIsundertheSARFAESIAct.Theapexcourthasreiteratedthe
needtoprotecttheinterestofborrowers,andemphasizedthattheexerciseofextraordinarypowersofrecovery,
bybanksandFIsmustbeincompliancewiththeprovisionsoftheSARFAESIAct.

AspertheSupremeCourt(SC)Liquidityoffinancesandflowofmoneyisessentialforanyhealthyand
growthorientedeconomy.Butcertainly,whatmustbekeptinmindisthatthelawshouldnotbeinderogationof
therightswhichareguaranteedtothepeopleundertheConstitution.Theprocedureshouldalsobefair,
reasonableandvalid,thoughitmayvarylookingtothedifferentsituationsneededtobetackledandobject
soughttobeachieved.

But,thesearestepswhichcurethediseaseofNPAs.TheissueofNPAsneedstobetackledatthelevelof
preventionratherthancure.
Therefore,thestepsthatcanpreventthepilingupofNPAsareasfollows:

1.Conservatism:

Banksneedtobemoreconservativeingrantingloanstosectorsthathavetraditionallyfoundtobecontributors
inNPAs.Infrastructuresectorisonesuchexample.NPAsrisepredominantlybecauseoflonggestationperiod
oftheprojects.Therefore,theinfrastructuresector,insteadofgettingloansfromthebankscanbefundedfrom
InfrastructureDebtFunds(IDFs)orotherspecializedfundsforinfrastructuraldevelopmentinthecountry.
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2.Improvingprocesses:
Thecreditsanctioningprocessofbanksneedstogomuchmorebeyondthetraditionalanalysisoffinancial
statementsandanalyzingthehistoryofpromoters.Forexample,banksrelymoreontheinformationgivenby
creditbureaus.However,itisoftennoticedthatseveraldefaultsbysomecorporatearenotregisteredintheir
credithistory.

3.Relyinglessonrestructuringtheloans:

Insteadofsittingandwaitingforaloantoturntoabadloan,andthenrestructureit,thebanksmayofficially
starttoworktorecoversuchaloan.Thiswillobviatetheneedtorestructurealoanandseveralissues
associatedwithit.Oneestimatesaysthatby2013therewillbeRs2trillionworthofrestructuredloans.

4.ExpandinganddiversifyingconsumerbasebyInnovativebusinessmodels:
Contrarytopopularperceptions,theNPAinnoncorporatesectorislessthanthatinthecorporatesector.
Hence,thereisaneedtoreachouttopeopleinremoteareaslackingconnectivityandaccessibility.Moreand
morepoorpeopleinruralpocketsshouldbebroughtunderthebankingsystembyadoptingnewtechnologies
andelectronicmeans.Innovativebusinessmodelswillplayacrucialrolehere.Otherwise,theNPAsmay
increaseinsteadofdecreasing.
AssaidbythenewM.D.ofSBI,Mr.Viswanathanproposedideassuchasasingledemataccountforall
investmentsandcreditcardsforschoolstudents(aboveclass8th)tomakethemawarewiththebanking
system.

CONCLUSION
Lookingatthegiantsizeofthebankingindustry,therecanbehardlyanydoubtthatthemenaceofNPAsneeds
tobecurbed.ItposesabigthreattothemacroeconomicstabilityoftheIndianeconomy.Ananalysisofthe
presentsituationbringsustothepointthattheproblemismultifacetedandhasrootsineconomicslowdown
deterioratingbusinessclimateinIndiashortagesinthelegalsystemandtheoperationalshortcomingofthe
banks.Therefore,ithastobedealtatmultiplelevels.Thegovernmentcantbeexpectedtorescuethestaterun
bankswithtaxpayersmoneyeverytimetheyfallintoacrisis.But,thekindofattentionwithwhichthisproblem
hasbeenreceivedbypolicymakersandbankersalikeisabigrayofhope.Rightsteps,timelyandconcerted
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actionsandarevivaloftheIndianeconomywillputalidonNPAs.Prevention,however,hastobecomea
prioritythanmerecure.

MODELQUESTIONS
PrelimsQuiz
(Incaseifyouareviewingthisarticleinyouremail,youdontseequizbuttonthere.Youhavetovisitthesiteto
takethisquiz)

EconomyQuizNPAs
Timelimit:0

Quizsummary
0of5questionscompleted
Questions:
1. 1
2. 2
3. 3
4. 4
5. 5

Information
NonPerformingAssetsQuiz
Youhavealreadycompletedthequizbefore.Henceyoucannotstartitagain.
Quizisloading...
Youmustsigninorsignuptostartthequiz.
Youhavetofinishfollowingquiz,tostartthisquiz:

Results
0of5questionsansweredcorrectly
Yourtime:
Timehaselapsed
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Youhavereached0of0points,(0)
Averagescore

Yourscore

Categories
1. Notcategorized0%
1. 1
2. 2
3. 3
4. 4
5. 5
1. Answered
2. Review
1. Question1of5

1.Question
Considerthefollowingstatements:
1. InIndia,theprivatesectorbankshavealargermarketsharethanthepublicsectorbanks.
2. TheNPAsoftheprivatesectorbanksarefargreaterthanthatofthepublicsectorbanks.
Choosethecorrectanswerusingthecodesbelow:
Correct
Solution:d)
Incorrect
Solution:d)
2. Question2of5

2.Question
WhichofthefollowingfactorsMAYadverselyaffectthelevelofNPAsoftheIndianbanks?
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1. Sloweconomicgrowth.
2. Substantialdelayinbankfundedinfrastructuralprojects.
3. PrivatizationofthePSBs.
Choosethecorrectanswerusingthecodesbelow:
Correct
Solution:a)
Incorrect
Solution:a)
3. Question3of5

3.Question
Considerthefollowingstatements:
Assertion(A):TheNPAsunderthecorporatesectoraremuchlesserthantheonesgivenunderPriority
Sectorlendingnorms.
Reason(R):ThePSLnorms,interalia,covertheweakersectionsofthesocietywhomaybeunableto
payloansontime.
Inthecontextofthestatementsabove,whichoftheseistrue?
Correct
Solution:c)
Incorrect
Solution:c)
4. Question4of5

4.Question
DisputesconcerningNPAsinIndia,canbesortedoutbywhichofthesemechanisms:
1. Arbitration
2. MovingtheLokAdalat
3. Movingtheconcernedquasijudicialandregulatoryauthoritiesincaseofinfrastructureprojects.
Choosethecorrectanswerusingthecodesbelow:
Correct
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Solution:a)
Incorrect
Solution:a)
5. Question5of5

5.Question
WhichofthefollowingcanbepossibleconsequencesofveryhighunmanageableNPAs?
1. Economicslowdownandpossiblerecession.
2. Riseininterestratesofloans.
3. Scarcityoffundsinthesecuritymarket.
Choosethecorrectanswerusingthecodesbelow:
Correct
Solution:d)
Incorrect
Solution:d)

Mains
1.Inyourview,whatcanbethepossiblereasonsbehindtheincreasinglyhighNPAsoftheIndianbanks?How
farcanthisbeattributedtotheconditionsprevailingintheIndianandglobaleconomy?(300words)
2.ExplainhowhighNPAscanbedamagingtotheIndianeconomy.(200words)
3.HowfarcanfinancialinclusionhelpincontainingthehighlevelofNPAsofbanksinIndia?Substantiateyour
viewswithtwoexamples.(200words)
4.WhatarethelegalmechanismsthatcanbeusedtocontaintheNPAs?Bringoutclearlytheroleofeach
actortheRBI,theGovernmentofIndia,andthebanksinachievinglowerNPAsthroughlegalmechanisms.
(300words)
5.TheInfrastructuralprojectsarefacedwithseveralproblemsespeciallyrelatedtofinancingoftheprojectsby
commercialbanks.Examinethebottlenecksinthepresentsystemoffinancing.Whatcanbedonetoaddress
theseissues?(200words)
6.DespitehavingamuchlargershareintheBankingmarket,thestateownedbankshavenotperformedwell
financially.Criticallyexamine.Cantheproblemberesolvedbydenationalizingthepoorlyperformingbanks?
(300words)
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