NPAs – Causes & Resolution Mechanisms
🟠 Topic 49: NPAs – Causes & Resolution Mechanisms
📌 Introduction
Non-Performing Assets (NPAs) have been a major challenge for the Indian banking sector, particularly public sector banks (PSBs). High NPAs affect credit flow, profitability, and economic growth. Understanding the causes and mechanisms for NPA resolution is crucial for maintaining financial stability.
🔹 What is an NPA?
📖 Definition
A Non-Performing Asset (NPA) is a loan or advance where:
- Principal or interest payments remain overdue for more than 90 days.
- In case of agricultural loans, repayment due for two crop seasons (short-term crops) or one crop season (long-term crops) is classified as NPA.
Classification of NPAs
| Category | Duration |
|---|---|
| Sub-standard Asset | NPA for ≤ 12 months |
| Doubtful Asset | NPA for > 12 months |
| Loss Asset | Unrecoverable, though not written off |
📊 NPA Levels in India (2023)
| Bank Type | Gross NPA Ratio |
|---|---|
| Public Sector Banks | ~5.5% |
| Private Sector Banks | ~3% |
| Overall Banking Sector | ~4% |
🔹 Causes of NPAs
1️⃣ Economic Slowdown
- Low GDP growth, weak demand, and sectoral downturns (e.g., power, telecom) affect loan repayment capacity.
2️⃣ Corporate Mismanagement
- Poor project planning, over-ambitious expansions, and diversion of funds contribute to defaults.
- Many infrastructure projects suffer from time and cost overruns.
3️⃣ Policy Paralysis & Delays
- Delays in environmental clearances, land acquisition, and regulatory approvals disrupt projects, leading to debt default.
4️⃣ Wilful Defaults
- Some corporates deliberately avoid repayment despite having the capacity.
- High-profile wilful defaulters like Vijay Mallya and Nirav Modi highlight the problem.
5️⃣ Lending Practices & Risk Management Failures
- Aggressive lending during economic booms without proper due diligence.
- Weak credit appraisal systems, particularly in PSBs.
6️⃣ Sector-Specific Issues
- Steel, power, textiles, aviation sectors have faced global competition, price volatility, and overcapacity, leading to stress.
Case Study – Twin Balance Sheet Problem
- The Indian economy suffered from: ✔️ Over-leveraged corporate sector. ✔️ Stressed banking sector with rising NPAs.
- This led to low investment, poor credit growth, and low economic growth.
🔹 Impact of NPAs
1️⃣ Credit Crunch
- Banks with high NPAs reduce fresh lending, affecting investment and growth.
2️⃣ Profitability Decline
- Banks must provision heavily for NPAs, reducing their profitability and capital base.
3️⃣ Higher Borrowing Costs
- Risk premiums increase, raising interest rates for all borrowers.
4️⃣ Erosion of Public Trust
- Repeated bank recapitalisation using taxpayer money undermines trust.
5️⃣ Financial Stability Risks
- High NPAs can trigger a banking crisis if not managed in time.
🔹 Steps Taken to Resolve NPAs
1️⃣ Insolvency and Bankruptcy Code (IBC), 2016
📖 Key Provisions
- Time-bound corporate insolvency resolution process (CIRP).
- Maximum resolution period: 330 days.
- Resolution applicants include domestic and foreign investors.
📊 Impact
| Parameter | Value (2023) |
|---|---|
| Cases Admitted | ~6,500 |
| Cases Resolved | ~2,000 |
| Recovery Rate | ~32-35% |
✔️ Big cases like Bhushan Steel, Essar Steel resolved via IBC.
2️⃣ Asset Quality Review (AQR)
- Conducted by RBI in 2015.
- Mandated banks to recognize hidden NPAs and provision adequately.
- Brought transparency in NPA reporting.
3️⃣ Bank Recapitalisation
- Government infused capital into PSBs to improve their capital adequacy and support lending.
- ₹3 lakh crore infused between 2015-2023.
4️⃣ SARFAESI Act, 2002
- Allows banks to seize and auction assets of defaulting borrowers without court intervention.
- Used mainly for secured loans.
5️⃣ Debt Recovery Tribunals (DRTs)
- Quasi-judicial bodies set up to handle loan recovery cases.
- Focuses on expedited recovery, though plagued by delays due to case backlogs.
6️⃣ Bad Bank – NARCL (National Asset Reconstruction Company Ltd.)
- Government-backed Bad Bank launched in 2021.
- Acquires large stressed assets from banks.
- Works with IDRCL (India Debt Resolution Company) to resolve these NPAs.
7️⃣ One-Time Restructuring
- Permits restructuring of stressed loans under special circumstances (like COVID-19).
- Provides breathing space to viable businesses.
8️⃣ Credit Guarantee Schemes
- Government provides partial guarantees for loans to high-risk sectors (MSMEs), encouraging lending while mitigating default risks.
🔹 Role of RBI in NPA Management
| Role | Action |
|---|---|
| Early Warning Systems | Banks required to classify stressed accounts as Special Mention Accounts (SMA) |
| Prompt Corrective Action (PCA) | Restricts lending by weak banks |
| Circulars | Guidelines on loan restructuring and provisioning norms |
Case Study – Essar Steel Resolution via IBC
- Essar Steel owed ₹49,000 crore to creditors.
- Acquired by ArcelorMittal for ₹42,000 crore.
- Major win for IBC in resolving large corporate defaults.
🔹 Challenges in NPA Resolution
1️⃣ Delays in IBC Process
- Average resolution time still exceeds 400 days.
- Multiple legal challenges by promoters slow down process.
2️⃣ Low Recovery Rates
- Actual recovery rates (~35%) lower than initial expectations.
- Some sectors like real estate and textiles see very low recoveries.
3️⃣ Judicial Bottlenecks
- Overburdened NCLT (National Company Law Tribunal) slows down resolution.
- Legal complexities in group insolvency cases.
4️⃣ Coordination Issues
- Multiple creditors (banks, NBFCs, bondholders) make consensus building difficult.
5️⃣ Wilful Defaulter Accountability
- Weak action against wilful defaulters, especially those who flee the country (Vijay Mallya, Nirav Modi).
📚 Practice MCQ
1️⃣ Consider the following statements regarding NPA Classification:
- A loan overdue for more than 30 days is classified as NPA.
- Sub-standard assets are NPAs for up to 12 months.
- Loss assets are NPAs identified as uncollectible.
Which of the above statements are correct?
✅ Options:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2, and 3
2️⃣ Which legislation provides a time-bound insolvency resolution process in India?
✅ Options:
(a) SARFAESI Act
(b) RBI Act
(c) IBC, 2016
(d) Companies Act
3️⃣ NARCL is popularly known as:
✅ Options:
(a) India’s Central Bank
(b) India’s Bad Bank
(c) India’s Financial Ombudsman
(d) India’s Credit Bureau
