Relevance: GS-3: Indian Economy and issues relating to Banking Sector & NBFCs.

Key phrases: NPA, Restructure Advance, stress asset, fugitive offender,

Why in News?

• Banks’ asset quality may get dented, going forward, as incipient stress remains in the form of increased proportion of restructured advances (RSA) and the possibility of higher slippages arising from sectors that were relatively more exposed to the Covid pandemic, cautioned the Reserve Bank of India (RBI).

What is Non-performing asset (NPA)?

• A non-performing asset (NPA) is a classification used by financial institutions for loans and advances on which the principal is past due and on which no interest payments have been made for a period of time.
• 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.

Sub-Classifications for Non-Performing Assets (NPAs)

• Standard Assets: They are NPAs that have been past due for anywhere from 90 days to 12 months, with a normal risk level.
• Sub-Standard Assets: They are NPAs that have been past due for more than 12 months. They have a significantly higher risk level, combined with a borrower that has less than ideal credit. Banks usually assign a haircut (reduction in market value) to such NPAs because they are less certain that the borrower will eventually repay the full amount.
• Doubtful Debts: Non-performing assets in the doubtful debts category have been past due for at least 18 months. Banks generally have serious doubts that the borrower will ever repay the full loan. This class of NPA seriously affects the bank’s own risk profile.
• Loss Assets: These are non-performing assets with an extended period of non-payment. With this class, banks are forced to accept that the loan will never be repaid, and must record a loss on their balance sheet. The entire amount of the loan must be written off completely.

Significance of NPAs

• It is important for both the borrower and the lender to be aware of performing versus non-performing assets. For the borrower, if the asset is non-performing and interest payments are not made, it can negatively affect their credit and growth possibilities. It will then hamper their ability to obtain future borrowing.
• For the bank or lender, interest earned on loans acts as a main source of income. Therefore, non-performing assets will negatively affect their ability to generate adequate income and thus, their overall profitability. It is important for banks to keep track of their non-performing assets because too many NPAs will adversely affect their liquidity and growth abilities.
• Non-performing assets can be manageable, but it depends on how many there are and how far they are past due. In the short term, most banks can take on a fair amount of NPAs. However, if the volume of NPAs continues to build over a period of time, it threatens the financial health and future success of the lender.

Reasons for the rise in NPAs:

• Some are macroeconomic factors such as lower exports due to global recession, downturn in commodity price cycles, etc.
• Most of today’s NPAs are from loans in the mid-2000s, when the economy was booming and business confidence was buoyant. But as economic growth stagnated post the global financial crisis of 2008, the repayment capacity of these borrowers declined. This lead to what is called the India’s Twin Balance Sheet problem, where both the banking sector and the corporates are reeling under financial stress.
• Also political factors like crony capitalism too has caused high NPAs in India.
• Further, recently there have also been frauds of high magnitude that have contributed to rising NPAs. Although the size of frauds as compared to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high profile fraudsters such as Vijay Mallya, Nirav Modi and Mehul Choksey being penalised.

Recent Developments and Ways to Tackle NPA:

• Insolvency and Bankruptcy Code (IBC): With the RBI’s push for the IBC, the resolution process is expected to quicken while continuing to exercise control over the quality of the assets. There will be changes in the provision requirement, with the requirement for the higher proportion of provisions going to make the books better.
• Credit Risk Management: This involves credit appraisal and monitoring accountability and credit by performing various analyses on profit and loss accounts. While conducting these analyses, banks should also do a sensitivity analysis and should build safeguards against external factors.
• Tightening Credit Monitoring: A proper and effective Management Information System (MIS) needs to be implemented to monitor warnings. The MIS should ideally detect issues and set off timely alerts to management so that necessary actions can be taken.
• Amendments to Banking Law to give RBI more power: The present scenario allows the RBI just to conduct an inspection of a lender but doesn’t give them the power to set up an oversight committee. With the amendment to the law, the RBI will be able to monitor large accounts and create oversight committees.
• More “Haircuts” for Banks: For quite some time, PSU lenders have started putting aside a large portion of their profits for provisions and losses because of NPA. The situation is so serious that the RBI may ask them to create a bigger reserve and thus, report lower profits.
• Stricter NPA recovery: It is also discussed that the Government needs to amend the laws and give more power to banks to recover NPA rather than play the game of “wait-and-watch.”
• Corporate Governance Issues: Banks, especially the public sector ones, need to come up with proper guidance and framework for appointments to senior-level positions.
• Accountability: Lower-level executives are often made accountable today; however, major decisions are made by senior-level executives. Hence, it becomes very important to make senior executives accountable if Indian banks are to tackle the problem of NPAs.

Way Forward:

• With the potential solutions above, the problem of NPAs in Indian banks can be effectively monitored and controlled, thus enabling the banks to achieve a clean balance sheet. Provisional supervisory data suggest a moderation in the Gross Non-Performing Assets (GNPA) ratios of banks to 6.9 per cent by end-September 2021 from 7.3 per cent by March-end 2021.

Source: The Hindu BL

Mains Question:

Q. What is Non-Performing Assets? What can be the possible reasons for NPAs? What are the various steps taken to tackle NPAs? Illustrate.