Non-Performing Assets (NPAs)

NPAs or Non-Performing Assets refer to the accrued money in the form of principal or interest amount that is not being paid back to the bank as per the loan agreement. These loans or advances are considered in arrears or default when no payment is received for over 90 days.

Understanding NPAs

• Arrears and Default: A loan is considered in arrears when the principal or interest payments are late or missed. It can also be in default when the lender believes the loan agreement is broken and the debtor cannot meet their commitments.
• RBI Definition: According to the Reserve Bank of India (RBI), an NPA is a loan account where the interest or installment amount is overdue for more than 90 days.
• Categorization of NPAs: NPAs are further classified into three categories:
  • Substandard Assets: These are NPAs where the principal or interest is overdue for less than 12 months.
  • Doubtful Assets: These are NPAs where the principal or interest is overdue for 12 to 36 months.
  • Loss Assets: These are NPAs where the principal or interest is overdue for more than 36 months.

Significance for Banking and Finance Aspirants

Banking and finance aspirants should understand NPAs in detail, as they are crucial in assessing the financial health of banks and the overall banking sector. It is essential to grasp concepts like CIBIL, write-off, and the impacts of rising NPAs to excel in competitive exams.

NPAs represent a significant challenge for banks and the financial system. By understanding the concept of NPAs and their implications, banking and finance aspirants can gain valuable insights into risk management and the stability of the banking sector.

Non-Performing Assets (NPAs)

A loan is considered an NPA if the installment of principal or interest remains overdue for a specified period. The duration of this period depends on the type of crop for which the loan was granted.

Out of Order Status:

• NPA accounts are classified as “Out of Order” if the balance remains continuously in excess of the limit or drawing power.
• If the outstanding balance in the principal operating account is less than the limit or drawing power, there are no credits continuously for 90 days as on the date of the Balance Sheet or credits are not enough to cover the interest debited during the same period.

Overdue:

Any amount due to the bank under any credit facility is considered “overdue” if it is not paid on the due date as fixed by the bank.

Categories of NPAs:

Pre-Sanction Phase:

• Lack of skilled professionals to analyze and select borrowers.
• Insufficient scrutiny of creditworthiness, project scope, uncertainties, and technical, legal, and environmental viability.
• Inadequate or bogus security attached to loans.
• Acceptance of impractical repayment schedules with exaggerated returns.

Post-Sanction Phase:

• Lack of proper follow-up of borrowers by banks.
• Defaults due to business risks or uncertainties.
• Insufficient understanding of borrowers’ problems and lack of support for rehabilitation and restructuring.
• Failure to select appropriate third parties for loan disbursement and monitoring.
• Delayed detection of wilful defaulters.
• Lack of cooperation from borrowers.
• Inadequate manpower for efficient recovery processes.

Other Reasons:

• Delays in legal formalities.
• Lack of policies for tackling bad loans.
• Frequent transfer of recovery officers.
• Absence of decentralized systems for quick decisions on bad loans.
• Macroeconomic factors like recessions leading to defaults.
• Intense competition in market segments contributing to NPAs.
• Deficiencies in Management Information Systems (MIS) and financial accounting systems, affecting credit collection and allocation.

Additional Resources:

• Risks in Banking Sectors

Impacts of Rising NPAs on Banks

• NPAs not only reduce the current profits of banks but also jeopardize their future prospects, leading to lower returns on investments and affecting current earnings.
• Limited liquid money due to bad assets restricts banks’ ability to lend sufficient amounts of money.
• Higher NPAs impact banks’ revenue strength, leading to charges on free-of-cost services like ATM withdrawals, internet transactions, etc.
• Reduced investor confidence due to high NPAs significantly impacts banks’ share prices, resulting in the suspension of dividend payouts to shareholders.

Initiatives Undertaken for Recovery of NPAs

• In the late 1990s and early 2000s, the banking industry faced significant NPA challenges.
• The Narasimham Committee I and II, along with the Andhyarujina Committee, recommended legislation empowering banks and financial institutions to take possession of securities and sell them without court intervention.

Steps Taken to Curb Rising NPAs in India

• Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002 (SARFAESI Act)

  • Approved by Parliament based on committee recommendations.
  • Empowers financial institutions to take possession of collateralized assets, manage assets, and sell or lease parts of the borrower’s business.
  • Applicable to secured borrowers with security interest over INR 1 lakh.
  • Excludes agricultural loans.

• Asset Reconstruction Companies (ARC)

  • Formed under the provisions of the SARFAESI Act.
  • Recommended by the Narasimham Committee II to transfer NPAs from banks.
  • Acquire NPAs from banks and financial institutions.
  • Regulated by the Reserve Bank of India.

• DRTs & DRATs

  • The Recovery of Debts due to Banks and Financial Institutions (RDDBFI) Act 1993 was in place before the SARFAESI Act and is still implemented.
  • Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs) are quasi-judicial bodies established under the RDDBFI Act.
  • DRTs adjudicate recovery cases involving debts above INR 10 lakh, while DRATs hear appeals against DRT orders.

• Lok Adalats

  • Alternative dispute resolution mechanism for settling disputes outside the formal court system.
  • Banks can refer NPA cases to Lok Adalats for speedy resolution.

• Prompt Corrective Action (PCA)

  • Framework implemented by the Reserve Bank of India to address financial distress in banks.
  • Imposes restrictions on banks with high NPAs, such as limiting lending and dividend payments. # Recovery of Non-Performing Assets (NPAs)

Debt Recovery Tribunals (DRTs) and Debts Recovery Appellate Tribunal (DRATs)

• The RDDBFI Act established Debt Recovery Tribunals (DRTs) with original jurisdiction and Debts Recovery Appellate Tribunal (DRATs) with appellate jurisdiction to deal with NPAs of both secured and unsecured borrowers.
• DRTs handle loan amounts of INR 20 lakh or more, enabling speedy recovery of money and disposal of cases without resorting to regular courts.
• Aggrieved individuals or entities can appeal against DRT orders to DRATs.

Lok Adalats

• Lok Adalats are formed under the Legal Service Authority Act of 1987 to provide a means for banks to ensure asset recovery.
• Banks engage in out-of-court settlements to resolve disputes, sometimes referred to Lok Adalats by the Tribunal itself.
• State Legal Service Authorities conduct Lok Adalats to facilitate speedy settlements.

Prompt Corrective Action (PCA)

• The PCA framework is a set of guidelines used by the Reserve Bank of India (RBI) to assess banks that fall below certain norms in capital ratios, asset quality, and profitability.
• PCA serves as an early intervention resolution mechanism when banks exhibit weak financial performance.
• The RBI introduced the PCA scheme in 2002 to discipline banks with poor and risky financial performance.

Types of Security Interests

Lenders or banks can adopt various types of security interests depending on the collateral involved and circumstances:

Pledging

• Pledging involves the lender (pledgee) taking actual possession of movable assets as security.
• The pledgee retains possession of the goods until the borrower (pledger) repays the entire debt amount.
• Examples include gold/jewelry loans and advances against goods/stock.

Hypothecation

• Hypothecation creates charges against movable assets, but the borrower retains possession of the security.
• In case of default, the lender must first take possession of the security before selling it.
• Examples include car/vehicle loans where the borrower possesses the asset, but the hypothecation is with the lender/bank.

Mortgage

• Mortgage involves creating charges against immovable property like land, buildings, etc., that are attached to the earth or permanently fastened to anything attached to the earth.
• Mortgages are commonly used when obtaining home or housing loans.

Financial Concepts

Lien

• The lender has the right to hold a property or machinery as collateral against borrowed funds.
• The lender cannot sell the property or asset unless specified in the contract.
• Examples: rent receivable, unpaid fees, etc.

Assignment

• Another type of charge on current or fixed assets.
• The charge is created on assets held in the books.
• Provides security against borrowing.
• Example: a bank can finance against book debts, where the borrower assigns the book debts to the bank.

CIBIL

• Formerly known as Credit Information Bureau (India) Ltd., TransUnion CIBIL Limited is India’s first Credit Information Company, established in 2000.
• Collects and maintains credit-related information of individuals and corporations from financial institutions.
• CIBIL is a database of credit information and does not make lending decisions.
• CIBIL reports and scores are crucial in one’s financial journey and determine loan and credit card eligibility.
• CIBIL also influences interest rates.
• CIBIL scores range from 300 to 900, with scores above 750 considered good and those below 750 considered low by lenders and credit grantors.

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