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NPAs: Issues and the Path Ahead

  Aug 05, 2020

NPAs: Issues and the Path Ahead

Indian banking sector have been reeling with NPAs, which poses formidable challenge to Indian Economy in terms of investment, jobs, demand and exports.

What are NPAs?

Non-performing assets, also called non-performing loans, are loans, made by a bank or finance company, on which repayments or interest payments are not being made on time. Generally speaking, NPA is any asset of a bank which is not producing any income. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.

What is the magnitude of NPAs in Indian Banking Sector?

In March 2018, non-performing assets (NPAs) at commercial banks amounted to Rs.10.3 trillion, or 11.2% of advances. Public sector banks (PSBs) accounted for Rs.8.9 trillion, or 86%, of the total NPAs. The ratio of gross NPA to advances in PSBs was 14.6%. These are levels typically associated with a banking crisis. In 2007-08, NPAs totaled Rs.566 billion (a little over half a trillion), or 2.26% of gross advances.

How did the NPA problem arise at the first place?

The origin of the crisis lies partly in the credit boom of the years 2004-05 to 2008-09. In that period, commercial credit (‘non-food credit’) doubled.  It was a period in which the world economy as well as the Indian economy was booming. Indian firms borrowed furiously in order to avail of the growth opportunities they saw coming. 

Most of the investment went into infrastructure and related areastelecom, power, roads, aviation, steel. Businessmen were overcome with exuberance, partly rational and partly irrational. They believed, as many others did, that India had entered an era of 9% growth.

Thereafter, as the Economic Survey of 2016-17 notes: Many things began to go wrong. Thanks to problems in acquiring land and getting environmental clearances, several projects got stalled. Their costs soared.

At the same time, with the onset of the global financial crisis in 2007-08 and the slowdown in growth after 2011-12, revenues fell well short of forecasts. Financing costs rose as policy rates were tightened in India in response to the crisis. The depreciation of the rupee meant higher outflows for companies that had borrowed in foreign currency.

This combination of adverse factors made it difficult for companies to service (i.e maintain and repay) their loans to Indian banks.

When was the problem of NPAs highlighted?

The year 2014-15 marked a watershed because of tightening of banking norms. The Reserve Bank of India (RBI), acting in the belief that NPAs were being under-stated, introduced tougher norms for NPA recognition under an Asset Quality Review.

NPAs in 2015-16 almost doubled over the previous year as a result. It is not as if bad decisions had suddenly happened. It’s just that the cumulative bad decisions of the past were now coming to be more accurately captured.

Higher NPAs mean higher provisions on the part of banks. [A provision is an amount that you put in aside in your accounts to cover a future liability. The purpose of a provision is to make a current year's balance more accurate, as there may be costs which could, to some extent, be accounted for in either the current or previous financial year]

Provisions rose to a level where banks, especially PSBs, started making losses.

  • Their capital got eroded as a result.
  • Capital from the government was slow in coming and it was barely adequate to meet regulatory norms for minimum capital. Without adequate capital, bank credit cannot grow.

Once NPAs happen, it is important to effect to resolve them quickly. Otherwise, the interest on dues causes NPAs to rise relentlessly.

What are the steps that govt. took to handle the crisis?

The steps taken can be summed up under 4Rs framework highlighted by The Economic Survey 2016-17

Under Recognition-  Asset Quality review(AQR) was taken out extensively in 2014-15, JLF (Joint Lending Forum), The Legal Entity Identifier (LEI) code for borrower and report it to Central Repository of Information on Large credit.

[LEI is conceived as a key measure to improve the quality and accuracy of financial data systems for better risk management post the Global Financial Crisis. LEI is a 20-digit unique code to identify parties to financial transactions worldwide.]

Under Resolution- Insolvency and Bankruptcy Code, Banking regulations Act to empower RBI to take necessary decisions regarding the same, Amendment to SARFAESI Act, Project Sashakt-  to resolve problem through market led approach (resolution and recovery)

Under Recapitalization- Rs. 2.11 lakh have been committed and subsequently disbursed by GoI to boost up their capital requirements.

Reforms- Mission Indradhanush on banking reforms, PSB reform Agenda- Separate monitoring mechanism for loans above Rs.250 crore, Fugitive economic offender Act,2018, The Prompt Corrective Action (The PCA framework is aimed at nudging the banks to take corrective measures in a timely manner, in order to restore their financial health).

What has been the impact of 4Rs strategy?

The impact of 4Rs framework have been conspicuous in the sense that-

1. The NPAs have started declining for eg. Rs. 8.95 lakh crore(March,2018) to 8.06 lakh crore (March 2019) to 7.89 lakh crore (July 2019)

2. Increase in profitability and liquidity of banks

3. Effective Monetary Policy transmission

4. Credit to various sectors of economy

5. On borrowers - lower cost of capital

What is the way forward?

The way forward is to strengthen the fabrics of Indian banking sector through long terms and sustainable reforms such as –Robust Risk management from branch level to higher level, Governance reform(appointment) privatization of weaker banks, increase operational efficiency, improving the process of project evaluation and infusion of capital further.