Finding a Cure to the NPA Crisis — Part 1: The Problem
A look at the NPA situation in India and the various options for dealing with them. Part 1 in a two-part series on India’s NPA crisis and resolution mechanisms…
In the wake of the pandemic and the economic slowdown, the financial and banking sector has been under considerable stress. Plenty borrowers have been hit by the ongoing black swan event and loan recollection is under duress. To offer respite to the borrowers, the RBI, in March, imposed a 3-month moratorium on debt repayments which further saw a 3-month extension. But, with the mist clearing up a bit, it seems like an NPA crisis is looming. Now, this isn’t an untrodden territory. A lot has been written about and discussed regarding India’s NPA issue over the past few years. However, our current positioning is unique and merits a deeper look.
What is an NPA?
Loans have two components to them — the periodic interest payments and the principal repayment. In case the interest payments or the principal repayment on a loan is overdue for over 90 days (typically), the asset gets classified as an NPA. Banks further classify NPAs as substandard, doubtful and loss assets. These assets are usually ‘written off’ (an expense which impacts both the income statement and balance sheet) or are ‘provisioned for’ (a move which impacts the balance sheet alone). If there’s any recovery from the debtors, it can be added back into the financial statements.
What’s the Problem Now?
The country’s banking sector has been facing a bit of an NPA predicament. In the early-2000s, India witnessed a growth spurt and lending progressed vigorously. A slack leash on corporate lending prevailed with inadequate post-disbursal monitoring and contingency planning. Come the next decade with its multitude of complications including fund diversions and frauds, the fall of ILFS, economic shocks, dropping export prices due to dumping, overleveraging combined with lower income, trade wars and the current health crisis and many bank assets were in disarray. The Asset Quality Review unearthed the deep extent of the issue, bringing to light a large percentage of NPAs.
Now, rising NPAs is indicative of a weak banking sector and could stymie economic growth. So the RBI ramped up in high gear, placing unhealthy banks under Prompt Corrective Action. The Insolvency and Bankruptcy Code of 2016 also served as a potent weapon to combat the NPA surge. It placed a 180-day time limit on recovery of insolvent accounts through restructuring or sale of assets, with liquidation otherwise. This helped improve the recovery of stressed assets in 2018–19.
Despite the mess that was 2020, the current NPA numbers do seem palatable as the moratorium offered quite some breathing room in terms of executing provisioning. However, it effectively kicked the can down the road somewhat. While the economic recovery, vaccine progress, sufficient cash balances and the 2021 outlook do offer some hope regarding the future of these assets, some analysts expect the proportion of stressed assets in the banking sector to jump to 18% in a few years. That’s alarming!
How are NPAs Resolved?
Once NPAs are written off, there are multiple means of tackling them.
- In the case of collateralised loans, banks can seize the pledged security in return for the loan. This could usually involve significant haircuts though. And, in the event of an uncollateralized loan, this isn’t possible.
- Banks can consider rejigging the terms of the loan, offer flexibility on the payment period or waive off some payments. This is known as restructuring. Corporate Debt Restructuring, Strategic Debt Restructuring, S4A schemes are some means of doing the same. The recent suggestions provided by the KV Kamath-led panel offers a blueprint on the restructuring of loans impacted by the Covid-19 pandemic.
- Banks can sell their NPAs to asset reconstruction companies (ARCs) which purchase these loans for a discount and take up the job of recovery.
- The 5:25 Rule, Lok Adalats, Debt Recovery Tribunals, and the IBC are some other fora and mechanisms that provide for resolution.
In May 2020, the Indian Banking Association submitted a proposal to the Ministry of Finance for setting up a bad bank, to tide over the NPA crisis. And, this has been a hot topic over the past few months, with various industry participants voicing out their views. So, what exactly is this bad bank proposal about? More on that in my next piece…
