Non Performing Assets

Any loan for which the principal or the interest payment remains overdue for more than 90 days is known as a Non performing Assets (NPA) in India. It is a bad loan for which there is very little chance of recovery by a bank.

Mounting NPAs has the potential of bringing down the whole banking system of a country, and therefore a robust banking system always makes sure to keep the lending activity responsible enough to not allow NPAs to build beyond a manageable level.

Status of a failing Loan:

The RBI classifies bad loans into under following categories:

• Special mention Account – 0 (SMA-0): Interest/Principal payment overdue for 0-30 days.
  • SMA – 1: 30-60 days.
  • SMA – 2: 60-90 days.
• Non Performing Asset:
  • For any asset, when the Principal/interest payment remains overdue for 90 days, it is classified as an NPA.
  • Agriculture:
    • Short-duration crop: Non-payment after 2 crop seasons.
    • Long-duration crops: Non-payment after 1 crop season.
  • NPAs are further classified as:
    • Substandard Asset: Remained NPA for less than 12 months.
    • Doubtful Asset: Remained substandard for 12 months.
  • Loss Asset: An ‘Uncollectible’ asset; having “such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value”.

If the NPA Divergence, i.e. the difference between RBI’s assessment and that reported by the lender/ banks is more than 10%, then RBI orders the bank to report them.

Insolvency

Insolvency is a situation where individuals or companies are unable to repay their outstanding debt.

NPA is a natural occurrence in any economy. After each business cycle, several businesses fail. This may be resolved by changing the repayment plan of loans, writing off some outstanding debt or making operational changes in the management of a company. If insolvency cannot be resolved, the assets of a debtor (person who owes money) may be sold to raise money for repayment of outstanding debt.

The problem that India faces is that the average duration for insolvency resolution in India is 4.3 years, which is significantly higher than the prevailing norm of 2.6 years in South Asia and 1.7 years in the OECD high-income countries.

This creates two problems:

1. The entrepreneur is stuck with the failed assets and is unable to focus energy on new business ideas.
2. The value of the asset keeps on declining and the banks are unable to salvage any value out of it, making huge losses.

History of NPAs in India

In the Decade before the nationalization of banks in 1969, there was an average of more than 35 private bank failures every year. However, after the nationalisation, the NPAs largely remained under control.

NPAs after the Global Financial crisis of 2008

As Indian GDP surged @9-10%/annum in the 2000s, Corporate profitability rose. They launched new projects, particularly in infrastructure-related areas. Everything seemed fine and therefore loans in the economy rose.

Once the 2008 financial crisis hit many of these projects failed particularly in the infrastructure and metal sectors.

Sectors Ruined by the NPA Crisis in India

Power Sector: power distribution companies (DISCOM) made losses due to various factors Declining renewable energy prices turned the existing expensive agreements into a burden. The rapid rise in private thermal capacity forced government companies into losses. Inefficiency: Several plants are operating at well below viable levels of capacity utilization. Telecom sector: Dramatically reduced due to the introduction of Jio killed most existing players.

By 2013, a significant portion of corporate debt was held by companies with poor debt-servicing capacity, and by 2016, 40% of companies had an interest coverage ratio under 1, signalling financial distress.

Interest Coverage Ratio

The Interest Coverage Ratio (ICR) is a financial metric used to measure a company’s ability to pay interest on its outstanding debt from its operating income. It indicates by what factor the earning is greater than the Interest Expense. Where: EBIT = Earnings Before Interest and Taxes (operating income) Interest Expense = Total interest payments on outstanding debt

Twin Balance Sheet Syndrome

Unlike in the US and Europe, India’s economy did not stagnate, partly due to its unusual banking structure and persistent supply-side constraints that provided room for growth.

Further, the government’s response involved restructuring loans and extending financial support, hoping that time would allow stressed companies to recover. However, this just delayed the problem and the NPAs kept on rising.

Two types of companies bore the brunt of the crisis:

1. By 2016, many smaller companies, especially MSMEs, faced severe cash flow issues, and corporate investment slowed significantly. The balance sheet of companies was stressed.
2. The banks were unable to lend more due to high NPA, i.e. the balance sheets of banks were under stress.

This stagnated the Indian economy. This is the real challenge that NPAs pose in the economy.

How to deal with NPA?

As we have seen, NPAs can be lethal for the banking system. If the NPAs ever build up in an economy, there are only two ways of dealing with the problem:

• By ensuring Growth: In Principle, it indeed can be sustainable, but two scenarios would occur:
  1. “Phoenix” scenario: accelerating growth would gradually raise the cash flows of stressed companies, eventually allowing them to service debts. It means we can infuse money into the companies and expect them to rise again. But this might mean providing an extension to fundamentally failed business ideas.
  2. “Containment” scenario: NPAs would merely need to be limited in nominal terms. They would shrink as a share of the economy and the economy would grow out of the problem. This enables banks to remain healthy and bad ideas to fail gradually. It provides a safe landing the the economy instead of a crash landing.
• By Regulation: This is the long-term approach by which NPAs can be prevented from building up. It enables banks to behave responsibly and prevent NPA built-up in the economy.

Dealing with NPAs

We have various mechanisms through which NPAs can be dealt with in the Indian economy.

SARFAESI Act (2002)

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act), enacted in 2002 by the Government of India, aims to improve the recovery of non performing asset (NPAs) and reduce the burden of bad loans on financial institutions.

1. Liquidation without court intervention: The SARFAESI Act empowers banks and financial institutions to take possession of the collateral (assets) pledged against loans in case of default by the borrower. This can be done without the intervention of the courts. However, borrowers can challenge the action before the Debts Recovery Tribunal (DRT) if they believe the actions are unjust.
2. Asset Reconstruction: It allows for the creation of Asset Reconstruction Companies (ARCs), which can purchase bad loans from banks and financial institutions at a discounted price, restructure them, and attempt to recover the outstanding amount.
3. Securitisation: It facilitates the process of securitisation, where banks can pool together loans and sell them as securities in the market. This helps banks reduce their NPA burden and generate liquidity.
4. Recovery Process: Lenders can issue a demand notice to borrowers who have defaulted on loans. If the borrower fails to repay or settle within 60 days, the lender can proceed with taking possession of the asset or initiating recovery actions.

Asset Reconstruction Companies (ARCs):

Introduced under the SARFAESI Act (2002), the ARCs act as specialists in the task of resolving problem loans, they could relieve banks of this burden. They purchase the assets (such as failing companies) from the banks and try to run these assets with new management.

• Debt Restructuring: In theory, ARCs have the power to infuse capital into the asset and make it viable after getting rid of the old inefficient management.
• Problems with ARCs: ARCs find it difficult to resolve the assets they have purchased, so they are often only willing to purchase loans at low prices. As a result, banks have been unwilling to sell them loans on a large scale.

Debt Recovery Tribunals (DRTs):

A Debt Recovery Tribunal (DRT) is a quasi-judicial body established in India under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (or the DRT Act), which was later amended in 2000.

• The DRT is set up to address the problem of rising NPAs and provide an expedited legal mechanism for the recovery of loans and debts due to banks and financial institutions.
• Problems: Currently, properties can be sold with the help of DRT-appointed officials adding to the delay. According to the Ministry of Finance, by 2022, around 2.5 lakh cases were pending across the 39 DRTs in India. The total amount of dues involved in these pending cases was estimated to be in the range of ₹10 lakh crore.

Reasons for Backlog:

• Resource Constraints: DRTs are understaffed, and there are delays in appointing judges and officials to handle the growing number of cases.
• Legal Complexity: Many cases involve complex legal issues and require extensive hearings, prolonging the time needed to resolve them.
• Appeals Process: After a case is decided at the DRT level, the aggrieved party can appeal to the Debt Recovery Appellate Tribunal (DRAT), leading to additional delays in the final resolution of cases.

Steps taken by RBI to deal with NPAs

RBI has over the past few years introduced several mechanisms to deal with the problem:

1. Asset Quality Review (AQR)

The Asset Quality Review (AQR) is a process initiated by the Reserve Bank of India (RBI) to assess the true health of the banking sector, i.e. NPA. It forced banks to accurately recognize, classify, and disclose their NPAs, thereby improving the transparency and stability of the financial system.

The outcome of the RBI-initiated Asset Quality Review was that –

1. More than 4/5^th of NPAs were in PSBs reaching 12%.
2. On the corporate side: 40% of debt was owed by companies with an interest coverage ratio less than 1.

Failed Schemes of RBI

Corporate Debt Restructuring: It is a mechanism that encourages investment in the ARCs, in the hope that they would buy up the bad loans of the commercial banks. This would mean efficient division of labour, as banks could resume focusing on their traditional deposit-and-loan operations. However, the ARCs have found it difficult to recover much from the debtors. Strategic Debt Restructuring (SDR): Under SDR, creditors could take over firms and sell them. Banks could convert their debt to 51% equity and sell them to the highest bidders, subject to authorization by existing shareholders. However, only 2 sales had materialized by 2017. Sustainable Structuring of Stressed Assets (S4A): Unlike the SDR arrangement, this involves no change in the ownership of the company. It involves two types of mechanisms: Sustainable structuring: which allowed Debt reductions of up to 50% to restore their financial viability. ‘Unsustainable’ assets were to be converted into equity and preference shares. However, only one small case was resolved till 2018 and subsequently, it was withdrawn. 5/25 Refinancing of Infrastructure Scheme: It was a scheme for existing and new projects in the infrastructure of more than 500 Cr under 8 core industries and for existing projects that have been classified as bad debt or stressed assets, it offered a larger window for the revival of assets. Banks could extend amortisation periods to 25 years with interest rates adjusted every 5 years. This arrangement meant that the companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional loans (evergreening of loans). These Schemes failed to stop the NPA crisis in India and therefore were withdrawn in 2018.

2. Prudential Framework for Resolution of Stressed Assets (PFRSA), 2019:

It provides for early resolution of stressed assets in a transparent and time-bound manner by:

1. Giving complete discretion to lenders about the design and implementation of resolution plans,
2. Disincentives for delay in implementation of resolution plan or initiation of insolvency proceedings,
3. It makes mandatory the signing of an inter-creditor agreement, providing for a majority decision (>50%) made by all lenders.

Insolvency and Bankruptcy Code (IBC)

Provisions of the IBC Act:

1. Two separate tribunals for companies and Individuals or partnerships.
2. Power to a committee of creditors to finally decide on the resolution process.
3. Time-bound resolution, including the power to liquidate the asset.
4. Secured debt and employees’ wages are given more priority than unsecured debt and government liabilities respectively.
5. Prohibition of promoters from participating in the resolution plan.

Insolvency Professionals:

• Licenced Insolvency professionals (IPs) will conduct the resolution process. They will take over the management of a company, assist creditors in the collection of relevant information, and manage the liquidation process.
• Insolvency professional agencies (IPAs): To regulate the function of IPs. They’ll conduct examinations, certify IPs, and enforce a code of conduct for their functioning. Further, the IPA will furnish a performance bond to the regulator (IBBI) on the commencement of insolvency resolution by a member IP. This bond will act as a surety against any misconduct by the IP during the resolution process.
• Information utilities (IUs): to collect, collate and disseminate financial information to facilitate the process. Information will be collected from creditors and include records of debt, liabilities and defaults of a debtor. However, it does not specify that full financial information about a company will be accessible through a single query from any IU. This may lead to information being scattered across these IUs.

Insolvency and Bankruptcy Board of India (IBBI):

The IBBI will regulate the functioning of IPs, IPAs and IUs. It will also oversee the insolvency proceedings in the country and regulate the entities registered under it. It will have 10 members, including representatives from the M/o Finance, Law Ministry, and RBI.

Bankruptcy and Insolvency Adjudicator:

The Code proposes two adjudicating authorities to:

1. Evaluate applications for initiating insolvency proceedings,
2. Approve the appointment of IPs, and
3. Approve resolution plans.

Insolvency Tribunals

Two separate tribunals to oversee the process of insolvency resolution:

National Company Law Tribunal (NCLT):

• It will oversee the insolvency process for Companies and Limited Liability Partnership firms; It was established in 2016 under the Companies Act 2013.

• In the first phase, the Ministry of Corporate Affairs has set up 11 Benches: Principal Bench in Delhi. These will be headed by the President 16 Judicial Members and 09 Technical Members at different locations.
• NCLT has the power under the Companies Act to adjudicate:
  • Proceedings Initiated before the Company Law Board under the Companies Act 1956;
  • Proceedings Pending before the Board for Industrial and Financial Reconstruction (BIFR), including those pending under the Sick Industrial Companies (Special Provisions) Act, 1985;
  • Pending before the Appellate Authority for Industrial and Financial Reconstruction;
  • Pertaining to claims of oppression and mismanagement of a company, winding up of companies and all other powers prescribed under the Companies Act.

• Successful matters solved: Essar Steel ₹80,000Cr and Bhushan Steel ₹45,000Cr.

Debt Recovery Tribunal (DRT):

The DRTs would function as they did under the SARFAESI Act for individuals and partnerships.

National Company Law Appellate Tribunal

Decisions of the NCLT may be appealed to the National Company Law “Appellate” Tribunal. The government has notified that the appeals against the NCLT won’t be entertained by the Supreme Court of India.

Resolution Process under IBC:

1. Initiation: Either the debtor or the creditors may apply to NCLT/DRT to initiate the resolution process. Once the application is approved, the resolution process will have to be completed within 180 days. It may be extended by 90 days if a majority of the creditors agree.
2. Appointment of interim IP: He will:

• Take control of the debtor’s assets and the company’s operations,
• Collect financial information of the debtor from information utilities, and
• Constitute the

3. Committee of Creditors (CoC): representing the above creditors: It will oversee the management of the debtor’s assets and appoint a permanent IP to conduct the resolution process.
   • IPs are to be appointed by the CoC or resolution plan with a 66% vote share.
   • Other decisions taken by 51% vote.
   • The process can be withdrawn altogether by a 90% vote.
4. Resolution: The creditor’s committee will decide to:
   • Restructure the debt: by preparing a resolution plan (such as revising the repayment plan), OR
   • Liquidate(sell) the assets: To repay loans. If no decision is made during the resolution process, the debtor’s assets will be liquidated to repay the debt.
5. Approval of plan: On the approval of a resolution plan by the CoC (by 66% vote), the IP will submit it to the tribunal for final approval. The tribunal will approve the plan based on criteria which includes ensuring that operational creditors have received as much as they would have received during liquidation. The resolution plan will then be implemented.
6. Liquidation: In case of liquidation, proceeds from the sale of the debtor’s assets will be used to repay outstanding dues. A secured creditor may choose to not participate in the process, and enforce his security under any other law (such as the SARFAESI Act). The financial obligations of the debtor will be repaid in the following order:

• Fees of the IP and other costs related to the resolution process,
• Secured creditors (if they choose not to enforce his security)
• Employee wages (up to 12 months),
• Unsecured creditors including advances by home buyers,
• Government dues and remaining debt owed to secured creditors (residual amount if the creditor enforces his security),
• Any remaining debt including Operational Creditors, i.e. those creditors to whom money is owed by the company in the normal course of operations for the supply of goods and services.
• Shareholders.

Not allowing previous Management to take control.

In 2017, the Centre passed an ordinance that significantly amends the original law. The categories of persons ineligible to be a resolution applicant include:

1. Promoters and those in management whose loan accounts are classified as NPAs for one year or more,
2. Any person disqualified to act as a director under the Companies Act.
3. It would be retrospective: covering even those people whose cases are already referred to NCLT.

Aim: To strengthen further the insolvency resolution process, it has been considered necessary to provide for the prohibition of certain persons from submitting a resolution plan, who on account of their antecedents, may adversely impact the credibility of the process.”

It’ll create a Better credit environment. Many unscrupulous and wilful defaulters have put banks and other creditors in substantial financial hardship.

Relaxations are given only to certain MSMSE.

Criticism: It hurts more than helps: The category is too broad and risks the very objectives of the original code.

1. Unfair: In many businesses Loans have turned sour due to the weak environment; Ex – the Steel sector. This is unfair to both entrepreneurs and enterprises.
2. Profit Maximization: By not letting the promoters and people in management rebuy the firms, the cost of the asset may not get recovered due to low bidding. IBC was not intended to serve as a mere instrument of liquidation. Instead to provide an enabling legal framework for “reorganization and insolvency resolution of corporate persons… in a time bound manner for maximization of value of assets of such persons.”

Positives of IBC

In 2019 the Supreme Court noted during a hearing on IBC that:

1. The amount realized from the resolution process under IBC was 202% higher liquidation value than the earlier method.
2. Approximately 3,300 cases have been disposed of by the adjudicating authority based on out-of-court settlements involving claims amounting to over ₹ 1,20,390 Crore.
3. IBC has witnessed an improvement in the total flow of resources to the commercial sector.

RBI has pushed some 40 of the country’s biggest corporate defaulters into bankruptcy proceedings through greater powers given to it as a part of the Banking sector reforms programme.

Successes of IBC

1. Lesser resolution time: From an average of 4.3 years before IBC 2016 to 433 days in 2021. However, it is still more than the statutory limit of 330 days.
2. Early detection of default Possible: The Adjudicating Authority are often approached, before a business becomes insolvent, at the outset of a default.
3. Wider coverage: It has consolidated and amended the laws relating to re-organization and insolvency resolution of corporate persons, partnership firms, and individuals.
4. Painless revival mechanism: For entities, a resolution plan may agree on the revival of the asset by instead of liquidation, the asset is sold to bring a new management.
5. Empowering operational creditors — typically micro, small and medium enterprises — a powerful tool to negotiate the payment of dues with the larger firms. About half of the cases have been initiated by operational creditors.
6. Boosting India’s Image: The Insolvency and Bankruptcy Code (IBC) has been able to change the image of India being a ‘defaulter’s paradise’.

Key challenges of the IBC-2016:

1. Low recovery value: financial creditors have realised only Rs 2.45 lakh crore or 36% of their total claims under the insolvency resolution process till July 2021 (still much better than without IBC).
2. Delays in proceedings: Over 80% of the ongoing insolvency resolution proceedings had crossed the 270-day threshold.
3. Weak Resolution outcome: India is showing poor delivery in terms of the resolution of stressed assets. Only 25% of the company is led to resolution and 75% leads to liquidation (which is of only 25% value).
4. Too many assets on sale would reduce recovery value: If insolvency happens on a bulk scale then the available liquidity in the market would not be able to absorb all the assets, pushing the recoverable value down. This would eventually be a loss-making situation for the creditors.
5. Large-scale economic disruption: If too many firms are closed, it would eventually lead to high rates of unemployment and supply chain disruptions.
6. Against entrepreneurial spirit: The original mechanism and the subsequent 2017 ordinance, prevented the owner of the control of the firm, which they had set up with sweat and blood.

Ways to improve the system:

1. Not allowing Promoters to manipulate the system: by putting penalties or attaching personal assets.
2. Adhering to timelines: Frequent hearings, and setting up the timelines for resolution which need to be strictly adhered to as speedy resolution was one of the most appealing aspects of IBC.
3. Capacity augmentation: The capacity of the system to handle cases also needs to be augmented by increasing the number of benches and appointing more insolvency professionals.
4. Pre–packaged scheme: an arrangement wherein the corporate debtor proposes a resolution plan to the secured creditors before the initiation of corporate insolvency resolution procedure (CIRP) must be the prime way.
5. Profit Maximization: By not letting the promoters and people in management rebuy the firms, the cost of the asset may not get recovered due to low bidding. Thus, promoters may be allowed to participate in the final bidding to rebuy the firm.

4R’s Strategy for Improving the Banking System

It requires a 4R strategy to resolve the NPA issue: Recognition, Resolution, Recapitalization, and Reform. Based on this an Indradhanush Plan was launched too which has successfully dealt with the NPA situation in India.

Recognition:

RBI has decisively taken steps for the recognition of NPAs such as AQR (Asset Quality Review) as seen before.

Resolution:

The RBI and Government have taken various steps:

1. The Insolvency and Bankruptcy law.
2. Prompt corrective Action (PCA) framework: RBI deploys PCA to monitor the operation of weaker banks more closely to encourage them to conserve capital and avoid risks. RBI had placed 11 banks under the PCA framework, forcing them to start reducing the scale of their banking operations in 2016, most of these were public sector banks (PSBs).
3. “Large write-offs will be required to restore viability to large companies.”
4. Market-Based Mechanism: “Most economic problems are best resolved through market-based mechanisms. The Bad bank can be one such mechanism for the resolution of assets.

Prompt Corrective Action (PCA) Framework

The RBI had set 4 types of triggers for the banks which are poor capital bases, if the threshold were crossed, the banks would have to severely restrict their lending activity. Indicator Risk Threshold 1 No dividend allowed Risk Threshold 2 No Expansion allowed Risk Threshold 3 Capital expenditure is not allowed CRAR = min CAR + Conservation buffer; 2.5% below the prescribed level 2.5%-4% below the prescribed level 4% below the prescribed level CET 1 + Capital conservation buffer (CCB) 1.625% below the prescribed level 1.625% – 3.125% below the prescribed level 3.125% below the prescribed level Net NPAs 6-9% 9-12% >%12 Regulatory Minimum Tier 1 Leverage Ratio Up to 0.5% below regulatory min. 0.5% – 1% below regulatory min. More than 1% below regulatory min. Further, no borrowing from the inter-bank market and a Special audit and action plan were sanctioned.  This forced Indian banks to raise more than ₹37,000 crore by issuing additional tier-I bonds (AT1) in FY22, and the Finance Ministry infused ₹20,000 crore.

Recapitalization:

Once the loans are off the books of PSBs, the government would recapitalise them, thereby restoring them to financial health and allowing them to shift their resources.

Plan carved out of ‘PSB Manthan’ meet: The government raised more than 2 Lakh crores through bonds, dilution of shares and budgetary provisions to recapitalise the banks to make them viable.

Further, the stressed Yes Bank has been prevented from failure. It was infused with money by a host of private and public banks, along with issuing additional equity to the general public.

Reform:

The NPA problem is the natural state of the Indian economy and would recur without long-term steps being taken to improve governance. The government would need to take the following reforms for any significant improvement in the governance of the banks.

1. Privatization: Allowing majority private sector ownership can save PSBs from lazy banking. For example, IDBI Bank: privatization is intended. It has got about ₹3000Cr for recapitalization.
2. Disinvestment:
   • The government is to repeal the following laws that require the Government to keep a shareholding of more than 50% and appoint CMDs and board directors, including the Bank Nationalisation Act (1970, 1980) and the SBI Act and SBI Subsidiaries Act.
   • The minimum government stake in PSBs had been relaxed to 52% from 58% but the actual holdings in many of the banks are more than 80% – CII has urged the government to dilute it further to 33%.
3. Mergers: India has too many banks but none are large enough to fund the large-scale infrastructural needs. Therefore, there is a need for identifying synergies and exploiting efficiencies of scale so that enough capital can be made available for Indian businesses.

Several Committees have recommended the merger of Indian banks:

• Narasimhan Committee, 1990, calls for only 3 Large, 8-10 National banks at Tier 2 and a large number of regional and local banks.
• PJ Nayak Committee, 2014 called for the government should privatize or merge PSBs.
• Kelkar committee: RRBs (regulated by NABARD) must be amalgamated.

As of now, more than 20 banks are consolidated into 12 banks:

1. SBI merger: State banks of Bikaner, Jaipur, Mysore, Travancore, Hyderabad, and Patiala have been merged into the State Bank of India. This has enabled the SBI to have 23% of India’s total market share with a Market cap of 32 Lakh Crore.
2. Oriental Bank and United Bank merged with Punjab National Bank, making it the 2^nd largest bank with an 11% market share.
3. Dena/Vijaya/BoB have been merged into one.
4. Canara and Syndicate.
5. Union Bank, Corporate Bank and Andhra Bank have been merged.
6. Indian Bank and Allahabad Bank.
7. Better Accounting standards: We need a robust mechanism to catch financial impropriety in the companies as well as banks. In the past, frauds have caused huge losses for banks in both the private and public spheres. For example, the PNB fraud by Nirav Modi and the Yes Bank fraud.
   • Indian Accounting Standards (Ind AS): An Accounting standardadopted by companies in India and issued under the supervision of the Accounting Standards Board (ASB). This can bring greater transparency in the Indian corporate climate. It has been made mandatory for all banks, NBFCs and insurance companies.

PJ Nayak Committee on the Revamping the Functioning of PSBs

It was formed by the RBI in 2014 to reform the functioning of Public Sector Banks (PSBs) to ensure greater financial stability in the country. Appointment: On the vacant posts in important positions in PSBs. In the past, the governance of PSB has been hit due to delayed appointments on its key posts. Bank Board Bureau (BBB): The PJ Nayak committee recommended creating a Bank Board Bureau to bring transparency to future appointments, replacing the Appointments Board of Government. It is a super authority (Autonomous Body) of eminent professionals and officials for PSBs. It’ll constantly engage with the boards of all 22 PSBs to formulate appropriate strategies for their growth and development. It will guide banks on mergers and consolidations and will also find ways to address the bad loans problem among other issues. Financial Services Institution Bureau: The BBB was created in 2016 and in 2022, it was replaced with the Financial Services Institution Bureau. It has the same mandate of making key appointments in the Public Sector Banks of India. De-stressing:  Through a stronger Insolvency Law and Asset Quality review, both of which have been done by the government. It also called for the protection of honest employees from investigation for solving insolvency. Recapitalization and Mergers: Already done by the government. Empowerment and Framework for accountability: The bank officials must be empowered to resolve the bad loans on their level because delay turns bad loans into worse. However, a system of accountability must be placed to ensure that no frauds are conducted using this freedom. Managing Government’s Investment in Banks: The government should set up a Bank Investment Company (BIC), under the Companies Act, 2013. As a “Core investment company”. And all Banks must become subsidiaries of this company. Financial inclusion and Digital Banking: Through UPI and Aadhar.

Bad Bank

Any bank that is designed to acquire bad NPAs and thereby clean the balance sheet of banks is referred to as a bad bank. This idea was mooted in the Economic Survey of 2016 for the first time.

In July 2021, the Government set up the National Asset Reconstruction Company Ltd. (NARCL) and India Debt Resolution Company Ltd. (IDRCL) to deepen the distressed asset market. NARCL-IDRCL is designed to deal with the large stock of legacy NPAs in the Indian Economy. These are dubbed as the bad banks in the Indian banking system.

NARCL

NARCL is an Asset Reconstruction Company (ARC) set up by the banks to aggregate and consolidate stressed assets for their subsequent resolution. In essence, it would acquire the large bad assets from the banks for their quicker resolution.

• It is intended to resolve stressed loan assets above ₹500 crore each amounting to about ₹ 2 lakh crore:
• In phase I, fully provisioned assets of about Rs. 90,000 crores are expected to be transferred to NARCL, while the remaining assets with lower provisions would be transferred in phase II.

Capital Structure of NARCL

• Capitalization of NARCL would be through equity from banks and Non-Banking Financial Companies (NBFCs). It will also raise debt as required.
• PSBs will maintain 51% ownership in NARCL.

Resolution Mechanism by NARCL

• The NARCL will acquire assets by making an offer to the lead bank. The lead bank is the one that has provided the greatest amount of loan to the failed business.
• Once NARCL’s offer is accepted, then, IDRCL will be engaged for management and value addition.

India Debt Resolution Company Ltd. (IDRCL)

IDRCL is a service company/operational entity that manages the asset and engages market professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs hold a maximum of 49% stake and the rest will be with private sector lenders.

Government Guarantee:

• GoI Guarantee of up to Rs 30,600 crore will back Security Receipts (SRs) issued by NARCL upon resolution or liquidation. The guarantee will be valid for 5 years. The guarantee shall cover the shortfall between the face value of the SR and the actual realisation. These SRs would be tradable.
• To disincentivize delay in resolution, NARCL has to pay a Guarantee fee which increases with the passage of time.

Progress till now:

• NARCL has acquired 18 accounts with a loan exposure of around ₹92,000 crore, including Srei Infrastructure Finance Ltd and Srei Equipment Finance Ltd. Offers on assets worth ₹1.25 lakh crore (1 Trillion rupees) are in various acquisition stages, with due diligence and evaluations ongoing for assets worth ₹40,000 crore.
• It aims to acquire assets worth more than ₹2 Lakh Crore by FY26.

Advantages of Bad Bank

• Assets acquired by NARCL clear bank balance sheets, freeing capital for further lending.
• It will improve liquidity and competition in the distressed asset market.
• The Indian Banking system is generally considered small. Therefore most businesses take loans from multiple lenders. The resolution of such assets is difficult since multiple banks do not agree on a resolution plan. NARCL will acquire the asset in its entirety and make the resolution smooth.

Criticism:

• Capital Provisions: NARCL has been infused with a lot of capital and may need a lot of capital support in the future as well;
• Pricing issues: There are challenges in pricing bad loans over the bank.
• It cannot deploy dramatically different tools to extract better value from underlying assets. It would only window dress banks to attract investors.
• It would still face scrutiny from CAG and CVC.
• Political repercussions: Concern that setting up a bad bank will free lenders from the repercussions of their actions.
• Morality issue: there may not be any incentive for banks to focus on the quality of credit extended, or for them to monitor loans, and guard against ever-greening.
• Not a long-term solution: A bad bank does not address the structural weaknesses in public sector banks.

Conclusion: While the idea of setting up a bad bank may sound appealing, this once-in-a-generation crisis must not be used to taper over the inherent problems in the banking system.

Financial Stability and Development Council

It is an apex-level autonomous body constituted in 2010 aimed to ensure financial stability and regulate the entire financial sector of the country. It is headed by the finance minister and heads of financial sector regulatory authorities are its members (RBI, SEBI, IRDA). It is designed to prevent a 2008-type financial meltdown in the country through coordination between various financial regulatory bodies. Financial literacy is one of its objectives.

 

FAQs related to Non Performing Assets