The assets which are in default (the principal amount is not paid) or in arrears (interest on the borrowings is not paid) are classified as Non-Performing Assets (NPAs) by the banks. In recent times, due to the piling up of a large amount of NPAs in the Indian banking sector, this matter has been the subject of continuous debates. According to official reports, these figures are going to escalate due to the outbreak of the Coronavirus Pandemic in the country in March this year, therefore this has again stirred fears over the mounting bad loans.
This article aims to discuss the problem of bad loans in India, what are its reasons, and what effect it has on the economy.
Mounting- increasing or rising
Stipulated- to state exactly what something must be or how something must be done
Menace- be a threat or danger
Moratorium- a legal authorization to debtors to postpone payment.
We are all aware of the working of a bank, they accept deposits from people and use it to lend money to others. The funds received from the borrowers by the way of interest on such loans and the repayment of the principal amount are the main sources of revenue for the banks. But, what happens when such amount is not paid back within the stipulated time? These unpaid amounts turn to “Non-Performing Assets” (NPAs). In simple words, it can be said that NPAs are those assets which have ceased to generate an income for the banks. The Reserve Bank of India (RBI) defines NPA as, “ A credit facility in respect of which the interest and/ or installment of principal has remained ‘past due’ for a specified period.”
The banks need to keep a track of their NPA as a large number of such assets discredit the bank and affect its lending capacity, it might also affect its future growth possibilities.
Due to the rising volume of NPAs, the issue has become a subject matter of much discussion and scrutiny in the Indian Banking Sector. This discussion becomes even more important as the smooth functioning of the banking sector ensures a healthy economy, therefore if the mounting NPAs are not controlled, it would harm the economy of the country.
Classification of NPA
Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues:
- Sub-standard Assets: An asset would be classified as sub-standard if it remained NPA for a period less than or equal to 12 months.
- Doubtful Assets: An asset is required to be classified as doubtful if it has remained NPA for more than 12 months.
- Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation Department or by the RBI inspection but the amount has not been written off, wholly or partly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
Some of the loans concerning which most NPAs arise are as follows:
- Term Loans: As per the Reserve Bank of India (RBI), “Term loan means a loan which is repayable after a specified term period.” In the case of term loans, if the borrower does not repay the interest and principal amount for more than 90 days, it will be declared as NPA.
- Cash Credit/Overdraft Facilities: These are kind of short term loan facilities provided by the banks or financial institutions to its customers. When these accounts remain ‘out of order’ for more than 90 days, they can be declared as NPA.
- Agricultural Loans: These are the loans that are provided to the farmers for cultivation. They become NPAs when: a) the installment of principal or interest thereon remains overdue for two crop seasons for short duration crops, and b) the installment of principal or interest thereon remains overdue for one crop season for long duration crops.
Reasons for Rising NPAs
According to PRS India, “Some of the factors leading to the increased occurrence of NPAs are external, such as decreases in global commodity prices leading to slower exports. Some are more intrinsic to the Indian banking sector.” Further, they explain the reasons as:
“A lot of the loans currently classified as NPAs originated in the mid-2000s, at a time when the economy was booming and the business outlook was very positive. Large corporations were granted loans for projects based on extrapolation of their recent growth and performance. With loans being available more easily than before, corporations grew highly leveraged, implying that most financings were through external borrowings rather than internal promoter equity. But as economic growth stagnated following the global financial crisis of 2008, the repayment capability of these corporations decreased. This contributed to what is now known as India’s Twin Balance Sheet problem, where both the banking sector (that gives loans) and the corporate sector (that takes and has to repay these loans) have come under financial stress.
When the project for which the loan was taken started underperforming, borrowers lost their capability of paying back the bank. The banks at this time took to the practice of ‘evergreening’, where fresh loans were given to some promoters to enable them to pay off their interest. This effectively pushed the recognition of these loans as non-performing to a later date but did not address the root causes of their unprofitability.
Further, recently there have also been frauds of high magnitude that have contributed to rising NPAs. Although the size of frauds relative to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high profile fraudsters being penalized.”
NPA and Indian Economy
The proper functioning of the Banking Sector is imperative for a prosperous Economy. However, the growing menace of NPAs in the banking sector, especially the public banks is like a plague that has hit the economy. The surge in the volume of bad loans has raised concerns because of the impact that it has on the economy as a whole.
A high volume of NPA reduces the ability of the banks to lend money, resulting in even less income for the bank and slowing down of the economy. This in turn will lead to a situation of scarcity of funds in the economy and reduction in the purchasing power of the consumers. It would also amount to contraction of money stocks, i.e., less income for the shareholders (in case of public banks, mostly the government), therefore creating a ‘Crisis of Confidence’, i.e., people would start losing confidence in the banks. So, to attract the people to deposit money, the banks would increase the interest offered on such deposits, which will in turn shoot up the interest on borrowing from the banks. In such a situation, the apprehension of an increase in NPAs would further rise, thus creating a vicious cycle.
According to estimates by PRS India, “As of March 31, 2018, provisional estimates suggest that the total volume of gross NPAs in the economy stands at Rs 10.35 lakh crore and about 85% of these NPAs are from loans and advances of public sector banks.
Moreover, in the last few years, gross NPAs of banks (as a percentage of total loans) has increased from 2.3% of total loans in 2008 to 9.3% in 2017. This indicates that an increasing proportion of a bank’s assets have ceased to generate income for the bank, lowering the bank’s profitability and its ability to grant further credit.”
Furthermore, due to the pandemic, these figures are set to worsen. Due to the slowdown of the economy during the lockdown, fresh NPAs are bound to emerge. This is because the production processes and other activities of the industries that are already heavily debt-ridden (like infrastructure, hospitality, automotive), have taken a serious hit during this time. “The banks’ gross bad loan ratio could rise to 12.5% by March 2021, the highest in over two decades, from 8.5% a year earlier, the RBI predicted in a report last month.”
Moreover, many people have lost their jobs or suffered pay-cuts during the pandemic, thus impairing them of the capability to discharge their debt obligations. This poses a threat to a further increase in NPAs. The six-month-long moratorium also came to an end on August 31 further adding to the problem, as the NPAs will now start getting recognized.
It is crystal clear now that the constantly rising NPA is detrimental to the economy. It is a matter of serious concern and additional guidelines need to be made to resolve the matter of stressed assets of banks. The RBI has taken various steps in this direction over time, from the introduction of ‘The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act’ in 2002 to the introduction of the Strategic Debt Restructuring (which allows the banks to convert loans into equity shares) and enactment of ‘Insolvency and Bankruptcy Code’ in 2016 (which provides a time-bound 180-day recovery process for insolvent accounts). But, there is still a long way to go before India’s bad loan problem can be resolved, especially now with the problem escalating due to the pandemic.