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• The Gross non-performing assets (GNPAs) of Indian banks are expected to decline to 5% this fiscal year, and to 4% by March 31, 2024, as the economy is showing a strong post-pandemic economic recovery and higher credit growth, according to a study released by Crisil Ratings.
• The asset grade of the Indian banking sector also benefits from the sale of Non-Performing Assets (NPAs) to the National Asset Reconstruction Company Ltd. (NARCL).
• The study also raised concern about the highly unequal recovery in various sectors.
  • Maximum improvement was seen in the corporate sector, where gross NPAs may decline to 2% in the next fiscal year from 16% NPAs in March 2018.
  • However, Gross NPAs in the MSME sector may increase to 10-11% by March 2024 from 9.3% in March 2022.

 

Non-Performing Assets (NPAs)

• A non-performing asset (NPA) is a classification used by financial institutions for loans/credits/advances on which the principal is due and no interest payments have been paid for a period.
  • In easier words, if the clients do not repay the principal amount and interest for a certain period, then such loans are classified as Non-Performing Assets (NPAs).
• An account will be classified as NPA if the interest payment remains overdue for more than 90 days.
  • In the banking sector, accounts are classified as NPAs on the day the account becomes overdue for more than 90 days.
  • However, in many Non-Banking Financial companies (NBFC), this classification is made after the end of 90 or 180 days.

Types of NPAs

• Standard Assets: It is a kind of performing asset on which principal and interest are due for anywhere from 90 days to 12 months. These assets carry a normal risk and are not NPA in the real sense.
  • Therefore, no special provisions are required for standard assets.
• Sub-Standard Assets: Loans and advances which are non-performing assets for a period of 12 months, fall under the category of Sub-Standard Assets.
• Doubtful Assets: Assets are classified as doubtful when principal and interest for a period of more than 12 months are known as Doubtful Assets.
• Loss Assets: All those assets which cannot be recovered by the lending institutions are known as Loss Assets.

 

Concern

• The problem of NPAs in the Indian banking system had impacted the Indian Economy and negatively affected its Growth potential.
• It reduced the profitability and credit growth of the banks.
• According to the Basel norms, banks are required to maintain a Capital Adequacy Ratio of 8%.
  • Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital in relation to its risk-weighted assets and current liabilities. CAR is decided by central banks and bank regulators of a country.
  • In India, as per RBI guidelines, Indian banks are required to maintain a CAR of 9% while Indian public sector banks have to maintain a CAR of 12%.
  • Every increase in the NPAs level adds to risk-weighted assets which require banks to increase their capital under Capital Adequacy Ratio.
• To maintain profitability, banks decrease the interest rates on deposits and charge high-interest rates on loans/credit/advances. This negatively affects economic growth.
• The credibility of the Indian banking system might decline due to higher NPAs levels because it directly affects the public trust.

 

Steps to Manage NPAs

• Asset Reconstruction Company (ARC)
  • Asset reconstruction companies (ARCs) are specialized financial institutions that buy NPAs from banks and financial institutions and aid them in cleaning up their balance sheets.
  • They function under the regulatory supervision of the Reserve Bank of India.
  • ARCs save the time and effort of banks in going after defaulters and thus allow them to focus on normal banking activities.
• Bad Bank
  • A bad bank is a corporate structure that isolates high-risk assets or non-performing loans held by a bank or a financial organization.
  • Bad Bank aimed at easing the stressed assets burden of banks and allowing them to lend more actively.
  • It generally does not have a primary purpose of generating profits. It will mainly focus on resolving and restructuring accounts.
  • It works by demarcating assets into good assets (that are repaid within time) and toxic or bad assets (defaulted loans).
  • Such toxic assets are meant to be transferred from the books of banks to bad banks at a price below their book value, for the sole purpose of recovery of risky assets.
• National Asset Reconstruction Company Ltd
  • It is India’s first-ever Bad Bank, which was set up in 2021, and RBI has recently granted permission under the SARFAESI Act 2002.
  • If the bad bank is unable to sell the bad loan or has to sell it at a loss, then the government guarantee will be invoked.
  • To manage assets with the help of market professionals and turnaround experts, the Government will also set up India Debt Resolution Company Ltd. (IDRCL) along with NARCL.
  • The IDRCL is a service company or an operational entity wherein public sector banks (PSBs) and PFIs will hold a maximum of 49% stake and the rest will be with private-sector lenders. When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest.

 

Way Forward

• There must be a sunset clause in the resolution process. It is necessary to develop time-bound strategies for the resolution of assets, or else the bad bank will be reduced to a mere parking space for bad loans.
  • Bad Banks should have a suitable mechanism in place that can facilitate funding for maintaining the quality of assets till their resolution.
• Banks have to accept losses on loans (or ‘haircuts’). They must do voluntarily; without any fear of harassment by investigative agencies.
• Recently The Indian Banks’ Association has set up a six-member panel to oversee the resolution plans of lead lenders. To expedite resolution, more such panels are required.
• There is an urgent need to set up a Loan Resolution Authority, if necessary through an Act of Parliament. Also, the government must infuse at one go whatever additional capital is needed to recapitalize banks — providing such capital in multiple instalments is not helpful.
• Concerns and loopholes raised over bad banks (NARCL) must be readdressed to promote transparency and accountability in the mechanism and to ensure its independence.
• Global experiences show that the recovery process for NPSs must be made flexible as per the needs of the business and economic sectors.

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