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Harry Potter and the Sorcerer’s Stone tops the chart of our all-time favourites. The flying brooms, magic potions, the unimaginable creatures, and the death threatening spells chill the spine to the core throughout the movie. But, one idea that fascinated us the most was that of a wizard bank (Gringotts Wizarding Bank). The idea followed us to the real world, making us believe that banks are invincible. However, it took us a few newspaper articles and a reality check with the Indian banking system to realize how wrong we were. Banks are, certainly, not invincible.

This mysterious spell that’s making the public banks susceptible to huge losses is termed as Non-Performing Assets (NPAs). Non Performing Assets are a bank’s liability. RBI defines NPAs as loans on which interest or instalment of principal remains overdue for a period of more than 90 days from the end of a particular quarter. This means that if a customer has borrowed a loan and is, somehow, unable to pay either the interest or a part of principal (or both), the borrowed loan becomes a Non-Performing Asset or a bad loan. These bad loans become assets of banks that do not generate any return and are, therefore, reduced to the bank’s liability.


NPAs have been broadly classified into 3 categories:

  • Substandard assets: Assets which are deemed as “non-performing” for a period of 12 months or less.

  • Doubtful assets: Assets which have remained non-performing for a period exceeding 12 months.

  • Loss assets: In this case, the loss is identified by the bank, but the amount isn’t written off wholly or partially.

“Avada Kedavra”

The NPA problem in India was realized in 2017 when TransUnion CIBIL reported over 1 lakh crore rupees that the Indian defaulters owe to banks. The top spot among the defaulters was grabbed by Winsome Diamonds and Jewellery Ltd., Forever Precious Jewellery & Diamonds Ltd. (Rs. 5466 cr.), followed by Kingfisher Airlines Ltd. (Rs. 3097 cr.). The RBI’s Financial Stability Report blames the basic metals and cement industries as the most indebted, with 45.8% and 34.6% stressed assets respectively.


The problem doesn’t end there. Among Indian banks, IDBI Bank, which has 24.11% gross NPAs tops the list for lending institutions with the highest exposure to liabilities. Indian Overseas Bank has 23.6% NPAs while fellow private lenders like Kotak Mahindra Bank and HDFC fare better with only 2.58% and 1.24% gross NPAs. State Bank of India, which is saddled with the most stressed assets in absolute terms, has a gross NPA ratio of 9.97%. Despite the clear domination of PIIGS (Portugal, Ireland, Italy, Greece, and Spain) countries in the list of highest NPA holders – with an exception of Spain – India hasn’t lagged back in the rankings. According to a recent report published by Credit Analysis and Research Limited (CARE) ratings, India reserves the spot as the sixth country with most NPAs worldwide, with 9.98% NPA.


The reasons as to why NPAs pose a threat to the Indian economy are more implicit than perceived. Suppose a bank suffers huge profit lowering margins due to bad loans. Owing to the unavailability of allotted financial assets, it would be forced to impose higher interest rates. There would be fewer amounts that could be made available to fund viable projects that would also lead to a decline in the entrepreneurial sector. The rise in NPAs also leads to a bank decreasing its deposit rates in order to recover bank loss. The continuous erosion of bank capital to provide for NPAs has made it increasingly difficult for the banks to make new advances. Due to non-repayment of loans by current borrowers, the banks are prevented from lending to new borrowers. As a result, corporate credit has been stagnating over the past few years. If it’s a public bank, the bad health of the bank would equal to a bad return for a shareholder which means that the Government of India gets less money as a dividend. Therefore, it may impact easy deployment of money for social and infrastructure development and would result in detrimental outcomes for the national economy.


The History Behind the Spell

The rise of NPAs in India was triggered during the 2000-2008 period when the Indian economy was under a boom but marked a stark slowdown in the global economy. The public banks which had lent huge amounts to large conglomerates suffered staggering blows on their profit margins. These banks account for 80% of the credit to industries, which forms a huge part of NPAs. Bad loans written off by the public sector banks doubled in the last 4 years, as informed by the data from the parliament papers released in August earlier this year. Another reason why bad loans occur, in the first place, is the absence of concrete lending norms in India. This leads to a poor analysis of a financial corporation. On the other hand, the banks, in order to tackle competition, sell unsecured loans which contribute to NPAs in high amounts.


As opposed to popular opinion, priority sector lending isn’t the only factor that leads to bad loans. NPAs in the corporate sector are far higher than those in the priority or agriculture sector. The corporate and industry loans account for almost 73% of the NPAs in public sector banks. The reasons behind these adverse numbers lie with the banks’ inadequate risk management policies, business failures, frauds and inefficient credit rating analysis of the Indian banks. Even the PSL sector has contributed substantially to the NPAs. As per the latest estimates by the SBI, education loans constitute 20% of its NPAs.


In order to reduce loss margins through NPAs, banks come up with restructuring policies. When a bad loan arises, the banks, in consultation with the borrower, come up with restructuring models which make it easier for the borrower to return the sum borrowed. These models are usually directed towards decreasing the interest rate on the borrowed sum, or increasing the time of repayment or converting the loan partly into equity. However, restructuring usually hurts the banks, as the only profitable consumer in this case is the borrower. The problem that triggers the rise in NPAs in India owing to banks’ restructuring policies is their inability to manage restructuring without resulting in a non-performing asset.


Defence Against Dark Arts

The Government, saddened by the current state of affairs with the persisting economic plague, often came out with different measures to keep the NPA-struck economy in check. In order to achieve the said goal, the government proposed the following at different stages of the NPA timeline:


The Financial Resolution and Deposit Insurance (FRDI) Bill: The need for the FRDI Bill rose after the Great Depression of 2008 which witnessed mass bankruptcy of major conglomerates and corporations in India as well as abroad. The Financial Resolution and Deposit Insurance bill aims to provide a mechanism for corporations – which are on the verge of failing – to help save themselves from going bankrupt. The objective behind doing so was to prevent the huge economic imbalance that followed after the mass bankruptcies of 2008 of major business giants that influenced the financial markets.


The FRDI Bill directs a provision for setting up of a resolution corporation which monitors financial firms, anticipates their risk of failure, takes corrective action and resolves them in case of failure. It also classifies the respective financial firms as low, moderate, material, imminent, or critical based on their risk of failure. One eye-catching factor of the Bill was its ability to bail-in a bank, which allowed the bank to use the deposited amount to save it from failure. This created a huge storm amongst the masses who opposed the unacceptable use of their deposited amount. After a huge disarray of displeased bank customers, the government dropped the bill in August earlier this year.


Insolvency and Bankruptcy Code (IBC): The Insolvency and Bankruptcy Code was introduced in 2016 in India in order to consolidate the framework for bankruptcy and insolvency. It helped to improve the NPA problems in India by suggesting stern corrective measures to the banks or the corporate parties even in case of the very first default and by increasing certainty and clarity in the overall process to achieve a speedy recovery. Despite the great anticipated expectations of IBC’s fast track recovery policies, the government came up Project Sashakt which counter a number of policies laid down by the Code.


Project Sashakt: This resolution mechanism is the most recent advancement of Ministry of Finance in India in its war against NPAs. It divides the bad loans based on the amounts defaulted and tackles them accordingly. Small loans up to INR 50 crores can be handled at the individual bank level and the subsequent category of default amount up to INR 500 crores would be dealt with by authorising the lead bank – through interbank agreements – to execute a resolution plan within 180 days, else it would be directed to the National Company Law Tribunal. The defaults exceeding 500 crores would go through a 3-step mechanism procedure – Asset Reconstruction Company (ARC), Alternative Investment Fund (AIF) and Asset Management Company (AMC) – through which an AMC will collaborate with AIF to buy stressed assets from banks through an ARC.


Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act: The SARFAESI act, 2002 was released as a canon in favour of banks against their arch nemesis – NPAs. The Act emerged as a saviour that allowed the banks to enforce securities held as collateral to loans disbursed by them – in case these loans turn out to be a liability for the subject – without the interference from the courts. The prerequisite for a bank to be eligible to enforce the collateral is the defaulter’s declaration as a ‘wilful defaulter’ – as defined by the RBI.


However, banks never shy away from turning a safe-mechanism into a profit-building resource for personal good. It often happens that the creditors secured from the SARFAESI Act misuse the power they’re entrusted with, by ignoring the norms laid down by RBI and classify all MSME NPAs as ‘wilful defaulters’ and holding them liable under the Act. For example, in a number of cases, the banks have gone overboard and filed against the defaulter even before 15 days of default and declaration of NPA.


Asset Reconstruction Companies (ARCs): Asset Reconstruction Companies are financial powerhouses which help banks clear their balance sheets by buying their NPAs and allowing them breathing space to focus on other projects. Use of asset reconstruction in India is not very common. A surge of foreign capital inflow into the distressed markets would incentivise ARCs o take more risks and bid bigger assets. The establishment of the IBC, inception of new FDI route and likely industry consolidation are all factors influencing the transcendence of ARCs into actual turnaround specialists.


The Patronus Charm

The NPA debate in India has stretched far too long and has been gaining heat year by year. Despite the rising plight of economic welfare, the solutions proposed for the same are invariably ambiguous to be held true or false in the status quo. One of such proposed solutions is privatisation of public banks in the market. The proponents argue in favour of its feasibility owing to the statistical difference represented in the surging amount of NPAs in public banks as compared to their private counterparts. Privatisation, in return, would improve the efficiency, decrease the political corruption associated with the sector and would thereby, increase the social welfare.


However, the conventional market is far more intricate to define than perceived by the arguments in favour of privatisation. Privatisation isn’t the answer to better functioning of the banking system, rather tackling the problems faced while functioning is. For example, consider the recent Punjab National Bank and (alleged) Nirav Modi scam. The incident perfectly characterises all that is wrong with the current banking practices, which the alleged officials were successfully able to channel their profits. The ultimate key for reducing NPAs in India is the self-regulation of banks. What banks need right now is a mechanism to recover the huge amount of NPAs, which has been proven as a problem pertaining to both private and PSBs.


In order to tackle this economic evil spell under which the Indian economy has been taking a dip gradually, lies a couple of factors within the banking system. With a number of PSBs lending out huge amounts without a proper analysis of the debtor’s credit rating, the need for a reformed lending mechanism seems to be more appropriate than ever. On the corollary, the banks often overlook a proper diagnosis of a ‘wilful defaulter’, in order to strike personal gains. This two-fold challenge can be easily achieved with a more efficient lending mechanism with proper risk projections.


NPAs have long left the banking sector of India stupefied at the hands of the national economy and their treacherous baits have been on the rise ever since their inception. Despite the constant increase in the influence of NPAs in the Indian financial markets, the future seems to be bright with the Government innovating on different levels to join the war against NPAs. With the recent positives arising out of a number of Government introduced projects like the IBC, the opponents of the stressed assets have started recognising it as their silver lining in the time of an impending economic storm that leaves the fate of the local as well as the global economy in ambiguity.


By Anvesh Agrawal and Tejas R. Singh

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