{"id":6366,"date":"2021-03-08T14:34:00","date_gmt":"2021-03-08T14:34:00","guid":{"rendered":"https:\/\/www.iquanta.in\/blog\/?p=6366"},"modified":"2022-02-13T23:05:52","modified_gmt":"2022-02-13T17:35:52","slug":"npa-non-performing-assets","status":"publish","type":"post","link":"https:\/\/www.iquanta.in\/blog\/npa-non-performing-assets\/","title":{"rendered":"NPA (Non Performing Assets)\u00a0and Bad Banks"},"content":{"rendered":"

\u00a0<\/b>What is the extent and effect of the NPA problem in India?<\/b>\u00a0<\/b><\/p>\n

Banks give loans and advances to borrowers. Based on the performance of the loan, it may be<\/span> categorized as: (i) a standard asset (a loan where the borrower is making regular repayments), or<\/span> (ii) a non-performing asset. NPAs are loans and advances where the borrower has stopped<\/span> making interest or principal repayments for over 90 days.<\/span>\u00a0<\/span><\/p>\n

Escalating NPAs require a bank to make higher provisions for losses in their books. The banks<\/span> set aside more funds to pay for anticipated future losses; and this, along with several structural<\/span> issues, leads to low profitability. The profitability of a bank is measured by its Return on Assets<\/span> (RoA), which is the ratio of the bank\u2019s net profits to its net assets. Banks have witnessed a<\/span> decline in their profitability in the last few years, making them vulnerable to adverse economic<\/span> shocks and consequently putting consumer deposits at risk.<\/span>\u00a0<\/span><\/p>\n

What led to the rise in NPAs<\/b>\u00a0<\/b><\/p>\n

A lot of the loans currently classified as NPAs <\/span>originated in the mid-2000s<\/span>, at a time when the<\/span> economy was booming and the business outlook was very positive. Large corporations were granted<\/span> loans for projects based on extrapolation of their recent growth and performance. With loans<\/span> b<\/span>eing available more easily than before, corporations grew highly leveraged, implying that most<\/span> financing was through external borrowings rather than internal promoter equity. But as economic<\/span> growth stagnated following the global financial crisis of 2008, the repayment capability of these<\/span> corporations decreased. This contributed to what is now known as India\u2019s Twin Balance Sheet<\/span> p<\/span>roblem, where both the banking sector (that gives loans) and the corporate sector (that takes and<\/span> has to repay these loans) have come under financial stress.<\/span>\u00a0<\/span><\/p>\n

When the project for which the loan was taken started underperforming, borrowers lost their<\/span> capability of paying back the bank. The banks at this time took to the practice of \u2018evergreening\u2019,<\/span> where <\/span>fresh loans were given to some promoters to enable them to pay off their interest<\/span>. This<\/span> effectively pushed the recognition of these loans as non-performing to a later date but did not<\/span> address the root causes of their unprofitability.<\/span>\u00a0<\/span><\/p>\n

Further, recently there have also been frauds of high magnitude that have contributed to rising<\/span> N<\/span>PAs. Although the size of frauds relative to the total volume of NPAs is relatively small, these<\/span> frauds have been increasing, and there have been <\/span>no instances of high-profile fraudsters being<\/span> penalized<\/span>.<\/span>\u00a0<\/span><\/p>\n

What is being done to address the problem of growing NPAs?<\/b><\/p>\n

The measures taken to resolve and prevent NPAs can broadly be classified into two kinds \u2013 first,<\/span> regulatory means of resolving NPAs per various laws (like the Insolvency and Bankruptcy<\/span> Code), and second, remedial measures for banks prescribed and regulated by the RBI for internal<\/span> restructuring of stressed assets.<\/span>\u00a0<\/span><\/p>\n

The Insolvency and Bankruptcy Code (IBC) was enacted in May 2016 to provide a time-bound<\/span> 180-day recovery process for insolvent accounts (where the borrowers are unable to pay their<\/span> dues). Under the IBC, the creditors of these insolvent accounts, presided over by an insolvency<\/span> p<\/span>rofessional, decide whether to restructure the loan or to sell the defaulter\u2019s assets to recover the<\/span> outstanding amount. If a timely decision is not arrived at, the defaulter\u2019s assets are liquidated.<\/span> Proceedings under the IBC are adjudicated by the Debt Recovery Tribunal for personal<\/span> insolvencies, and the National Company Law Tribunal (NCLT) for corporate insolvencies. 701<\/span> cases have been registered and 176 cases have been resolved as of <\/span>March 2018 <\/span>under the IBC.<\/span>\u00a0<\/span><\/p>\n

Over the years, the RBI has issued various guidelines aimed at the resolution of stressed assets of<\/span> b<\/span>anks. These included the introduction of certain schemes such as (i) Strategic Debt Restructuring<\/span> (which allowed banks to change the management of the defaulting company), and (ii) Joint<\/span> Lenders\u2019 Forum (where lenders evolved a resolution plan and voted on its implementation). In<\/span> line with the enactment of the IBC, <\/span>the RBI, through a circular in February 2018, substituted all<\/span> the specific pre-existing guidelines <\/span>with a simplified, generic, time-bound framework for the<\/span> resolution of stressed assets.<\/span>\u00a0<\/span><\/p>\n

\"\"<\/a><\/p>\n

In the revised framework which replaced the earlier schemes, the RBI put in place a strict<\/span> deadline of 180 days during which a resolution plan must be implemented, failing which stressed<\/span> assets must be referred to the NCLT under IBC within 15 days. The framework also introduced a<\/span> p<\/span>rovision for monitoring of one-day defaults, where incipient stress is identified and flagged<\/span> immediately when repayments are overdue by a day.<\/span>\u00a0<\/span><\/p>\n

NOW<\/span>\u00a0<\/span><\/p>\n

Tackling <\/span>non-performing assets <\/span>will be a major challenge for the banking sector in the new year as many<\/span> companies, especially in the MSME sector, may not be able to withstand the heat of the coronavirus<\/span> p<\/span>andemic which led to a historic contraction of the economy in the first half of the current fiscal.<\/span>\u00a0<\/span><\/p>\n

Besides, muted private investment impacting the corporate loan growth will be another challenge that<\/span> b<\/span>anks will have to face in the coming months. Despite ample liquidity in the system, demand from the<\/span> corporate sector is very low and bankers hope that faster than anticipated recovery could bring in the<\/span> animal spirit as far as India Inc is concerned.<\/span><\/p>\n

Although the Indian economy witnessed a sharp recovery from a 23.9 percent contraction in the first quarter to<\/span> 7.5 percent contraction in the second quarter, it is yet to lift the sentiment of India Inc. For the past few<\/span> years, private investment has been low while public spending has been doing the heavy lifting for the<\/span> economy.<\/span>\u00a0<\/span><\/p>\n

Effective April 1, the United Bank of India and Oriental Bank of Commerce were merged with Punjab<\/span> N<\/span>ational Bank, making it the second-largest Public Sector Bank (PSB).<\/span>\u00a0<\/span><\/p>\n

Similarly, Andhra Bank and Corporation Bank were merged with Mumbai-based Union Bank of India.<\/span> Syndicate Bank was merged with Canara Bank while Allahabad Bank was amalgamated with<\/span> Chennai-based Indian Bank.<\/span>\u00a0<\/span><\/p>\n

“The merger has nearly stabilized… It happened very seamlessly despite the lockdown and the early<\/span> p<\/span>ositive signs of the amalgamation are now also visible,” Financial Services Secretary Debasish Panda<\/span> told PTI.<\/span>\u00a0<\/span><\/p>\n

“They now have a larger capital base and their capacity to lend has increased, and then you have<\/span> complementary products of the different banks that merged into the lead banks,” he said.<\/span>\u00a0<\/span><\/p>\n

To provide relief to millions of borrowers who faced disruption in their income due to the lockdown,<\/span> b<\/span>anks under the guidance of RBI extended the moratorium for six months till August.<\/span>\u00a0<\/span><\/p>\n

Over 40 percent of the system credit and 75 percent of the borrowers benefited from the decision and it<\/span> also resulted in an additional burden of around <\/span>\u20b9<\/span>7,500 crore for the government.<\/span>\u00a0<\/span><\/p>\n

For the large corporates, banks, under the direction of RBI, have implemented a one-time restructuring of<\/span> loans within strict parameters. Companies under stress have been given time till December to avail the<\/span> scheme.<\/span>\u00a0<\/span><\/p>\n

Coming to the issue of credit offtake, the core job of banks, it remained muted during most part of the<\/span> year. However, disbursal of agriculture and retail loans gather substantial momentum from September<\/span> onwards.<\/span>\u00a0<\/span><\/p>\n

“We have seen that there is a steady uptick in the credit growth. The retail loan, home loan, and agriculture<\/span> loan have picked up, and MSME, again, with the intervention of the government through the ECGLS and<\/span> other similar schemes also has picked up,” Panda said.<\/span><\/p>\n

There is some subdued growth in the corporate segment, he said, adding that banks and the government<\/span> are working together to revive demand for corporate loans and recently, the ECGLS was extended to<\/span> more distressed sectors.<\/span>\u00a0<\/span><\/p>\n

Under the Emergency Credit Line Guarantee Scheme (ECLGS), banks have sanctioned loans worth <\/span>\u20b9<\/span>2.05<\/span> lakh crore to 81 lakh MSMEs that were impacted by disruptions caused due to the pandemic.<\/span>\u00a0<\/span><\/p>\n

The K V Kamath Committee, which helped the RBI with designing a one-time restructuring<\/span> scheme, also noted that corporate sector debt worth Rs 15.52 lakh crore has come under stress<\/span> after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress before the<\/span> p<\/span>andemic. This effectively means Rs 37.72 lakh crore (72% of the banking sector debt to<\/span> industry) remains under stress. This is almost 37% of the total non-food bank credit.<\/span>\u00a0<\/span><\/p>\n

CONCLUSION<\/b>\u00a0<\/b><\/p>\n

the jury is still out on the trajectory of bad loans. One school of thought is that NPAs are bound to<\/span> increase largely because of MSMEs but bankers and policymakers are not that pessimistic.<\/span>\u00a0<\/span><\/p>\n

Gross NPAs of all banks may jump to 12.5 percent by the end of this fiscal under the baseline scenario<\/span> from 8.5 percent in March 2020, according to the Financial Stability Report (FSR) released by RBI in<\/span> July.<\/span>\u00a0<\/span><\/p>\n

However, due to faster than anticipated recovery, there is an uptick in the banking sector as well and most<\/span> of the banks, including private-sector lenders, have posted good profits during the July-September quarter.<\/span> This was mainly on account of treasury income and reduction in NPAs.<\/span>\u00a0<\/span><\/p>\n

“We don’t anticipate a big shock to hit public sector banks next year given the high provision coverage<\/span> ratio, steady decline in non-performing assets (NPA), and one-time restructuring corporate, among other<\/span> things,” Panda said.<\/span>\u00a0<\/span><\/p>\n

About the financial health of banks, Panda said that 11 out of the 12 public sector banks posted profit in<\/span> the last quarter. Even gross NPAs have gone down substantially and the provision coverage ratio has<\/span> increased, he added.<\/span><\/p>\n

To cushion against future shock, the secretary said that public sector banks have raised <\/span>\u20b9<\/span>40,000 crore in<\/span> the form of equity, and bonds and another <\/span>\u20b9<\/span>25,000 crore would be raised in the next three months.<\/span>\u00a0<\/span><\/p>\n

Besides, the government has allocated <\/span>\u20b9<\/span>20,000 crore for capital infusion into PSBs in the current fiscal.<\/span> Of this, the finance ministry has granted <\/span>\u20b9<\/span>5,500 crore to Punjab & Sind Bank to meet regulatory<\/span> requirements.<\/span>\u00a0<\/span><\/p>\n

THE OTHER SIDE OF THE COIN.<\/b>\u00a0<\/b><\/p>\n

For banks in India, tackling the ballooning non-performing assets (NPA) will be the biggest<\/span> challenge in 2021 as loan defaults have to spiked sharply in Covid-hit 2020. Many small and<\/span> medium-scale companies are still struggling to repay dues owed to banks.<\/span>\u00a0<\/span><\/p>\n

A large number of individuals are also struggling to repay their loans after losing income or<\/span> employment due to the historic economic crisis triggered by the coronavirus pandemic and the<\/span> initial lockdown.<\/span>\u00a0<\/span><\/p>\n

While banks have been reporting a decline in NPAs in the last few months, there is a high<\/span> possibility that forbearance on asset classification is masking bad loans that are constantly on<\/span> the rise, according to S&P Global Ratings.<\/span>\u00a0<\/span><\/p>\n

The global rating agency also mentioned in its report that the performance of Indian banks<\/span> exceeded expectations in the second quarter, but added that much of it was due to the<\/span> six-month loan moratorium and the Supreme Court\u2019s decision barring banks from classifying<\/span> loans as NPAs.<\/span>\u00a0<\/span><\/p>\n

It said banks could have seen their NPAs rise by 10-60 basis points if it had not been for the top<\/span> court’s ruling. The top court had allowed banks to maintain loan accounts as standard even as<\/span> borrowers defaulted.<\/span>\u00a0<\/span><\/p>\n

Thousands of crores worth of loans have gone sour due to non-payment by borrowers and the<\/span> amount of NPAs is likely to increase further. And the global rating agency is not too optimistic<\/span> about the <\/span>loan restructuring plan<\/span>.<\/span>\u00a0<\/span><\/p>\n

\u201cWe estimate that more than half of our estimated restructured book may eventually slip into<\/span> NPLs, leading to elevated NPL and credit cost levels in subsequent fiscal years,” S&P Global<\/span> Ratings said in its report.<\/span>\u00a0<\/span><\/p>\n

While there are other problems like low corporate loan growth, the NPA problem seems to be<\/span> the biggest \u201chidden\u201d issue that may erupt by 2022 when relaxations like loan restructuring come<\/span> to an end. But at the moment, the government and banks in the country are confident that there<\/span> are enough provisions to absorb any forthcoming shock.<\/span><\/p>\n

BAD BANKS<\/b>\u00a0<\/b><\/span><\/p>\n

What Is a Bad Bank?<\/span>\u00a0<\/span><\/p>\n

A bad bank conveys the impression that it will function as a bank but has bad assets to start with.<\/span> Technically, a bad bank is an asset reconstruction company (ARC) or an asset management<\/span> company that takes over the bad loans of commercial banks, manages them and finally recovers<\/span> the money over a period of time. The bad bank is not involved in lending and taking deposits, but<\/span> helps commercial banks clean up their balance sheets and resolve bad loans. The takeover of bad<\/span> loans is normally below the book value of the loan and the bad bank tries to recover as much as<\/span> p<\/span>ossible subsequently.<\/span>\u00a0<\/span><\/p>\n

Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in<\/b> the wake of a six-month moratorium it has announced to tackle the economic slowdown.<\/b>\u00a0<\/b><\/p>\n

Will a bad bank solve the problem of NPAs?<\/b>\u00a0<\/b><\/p>\n

Despite a series of measures by the RBI for better recognition and provisioning against NPAs, as<\/span> well as massive doses of capitalization of public sector banks by the government, the problem of<\/span> N<\/span>PAs continues in the banking sector, especially among the weaker banks. As the Covid-related<\/span> stress pans out in the coming months, proponents of the concept feel that professionally-run bad banks<\/span>, funded by private lenders and supported by the government, can be an effective<\/span> mechanism to deal with NPAs. The bad bank concept is in some ways similar to an ARC but is<\/span> funded by the government initially, with banks and other investors co-investing in due course.<\/span> The presence of the government is seen as a means to speed up the clean-up process. Many other<\/span> countries had set up institutional mechanisms such as the Troubled Asset Relief Programme<\/span> (TARP) in the US to deal with a problem of stress in the financial system.<\/span>\u00a0<\/span><\/p>\n

In May 2020, the Indian Banks\u2019 Association (IBA), a body representing major Indian<\/span> b<\/span>anks submitted a proposal to the RBI and Government to set up a national Bad Bank.<\/span> A<\/span>ccording to the proposal, the bad bank would initially start with a book of<\/span> approximately Rs.75000 Crores worth of bad loans.<\/span>\u00a0<\/span><\/p>\n

The IBA has proposed a corporate structure that would contain an asset reconstruction<\/span> company (ARC), to be owned by the Government along with an alternate investment<\/span><\/p>\n

fund (AIC) and an asset management company (AMC) that would have both \u2013 public<\/span> and private participation. The banks would cumulatively invest Rs.100 Crores in the<\/span> A<\/span>MC and the ARC would be capitalized by the Government to the tune of Rs.10,000<\/span> Crores.<\/span>\u00a0<\/span><\/p>\n

Many industry trade bodies, banks, and economists are in favor of creating a bad bank.<\/span> Proponents argue that it is important to clean the balance sheet of the banks. Stress in<\/span> the banking sector has prevented credit growth in the past, and it will also hinder the<\/span> efforts to recover the economy post-Covid.<\/span>\u00a0<\/span><\/p>\n

Associated Challenges<\/span>\u00a0<\/span><\/p>\n