Introduction:
The banking sector plays a major role in the economic development of a country. It is generally referred to as the backbone of the economy as it regulates and generates money to be reinvested into the economy so that the development could take place. The banking sector in India is regulated by the Reserve Bank of India (RBI) and is responsible for making rules and laws for governing the banking sector.
The banks provide loans to the customers in exchange for collateral and the customer is expected to repay the loan over some time along with the agreed interest over the same. But in recent years there has been a rising trend in the unprofitability of the banks due to a rise in the number of Non- Performing Assets (NPA’s). [1]NPA refers to the amount that is not recovered from the individual to which the loan was issued. The amount can include the principal or the interest that was due on the loan. The amount which is due if not recovered for 90 days from the date of recovery. Then that amount will be labeled as an NPA and the bank is required to take action accordingly.
Types of Assets in NPA
There are different types of assets in NPA’s and their division is based upon the timeframe in which the assets have stopped performing. These can be classified as-
Standard Assets
These are the assets where the default has occurred once or twice but the customer has paid the arrears and is regularly paying back the principal as well as the interest amount. The most important condition to determine this type of asset is the period of default must not exceed 90 days.
Sub-Standard Asset
When an asset Remains NPA for a period less than or equal to 12 months and no payments have been received from the customer then it is referred to as a Sub-Standard Asset.
Doubtful Asset
The asset which has remained NPA for a period longer than 12 months is referred to as Doubtful Assets as the customer has not made any payment towards the loan for the past 12 months and it is doubtful that he is going to make any repayments toward the same.
Loss Asset
The asset is no longer feasible to be pursued as a bankable asset as the current value might not even recover a fraction of the loan but still hold some value then it is referred to as a loss asset. The cost of recovering such an asset might even exceed the whole value of that asset.
All these types help in classifying the assets of the banks. This would mean that the banks have a better idea of their position regarding their assets and they can make informed decisions based on the classification.
Effects of NPA
The term NPA came on the recommendations of the Narsimham Committee. This term was coined by the committee as different banks have different methods of dealing with Bad debts and this committee wanted to streamline the process and make it uniform for the whole industry.[2] The committee and the RBI wanted the banks to acknowledge the bad debts and take serious corrective actions against the customers who were missing their payment dates as this was increasing the pressure on the industry.
In recent years, there has been an increasing trend in the NPA’s of the banks as the coronavirus pandemic struck and the businesses were unable to sustain themselves with the reduced demand. The pandemic had only made the situation worse as the economy was already under stress from the recession and the growth was stagnating.
The lockdowns made the sustenance of the business impossible as the factories were shut, economic activities were completely stopped and the demand for the non-essential products fell sharply. [3]The businesses that had already taken loans for themselves were in a tough spot as they were unable to generate any income and had to pay the installments on their loans. This increased the number of NPA’s in the bank’s books.
The pandemic is not the only reason for rising NPA’s. The bank has already been battling this problem for quite a few years. The rise in fraud and the magnitude on which the same have been committed had a huge impact on the industry. The high-profile cases of Nirav Modi, Vijay Mallya are some examples of high-profile frauds that are committed in the industry. Several steps are taken by the banks and the regulators to ensure that these kinds of Fraud are not committed again.
The NPA’s reduce the profitability of the bank and also reduce the level of trust that the general public has in the banking system. If the profitability of the bank reduces to chronic levels, then the public can lose trust in the bank and would start withdrawing their savings from the bank. The bank would not be able to generate enough cash flow that it could give out loans and hence the bank could collapse under its mounting debt and NPA’s. This could create a domino effect on the industry and the whole banking system could collapse. This would be a disaster as the whole economy is related to the banking system and then ultimately the whole economy could fall.
Other factors like climate change have also had an impact on the industry
Preventive Measures Taken
Several preventive measures are taken by the industry to reduce the impact of NPA’s and to make the industry more reliable and efficient.[4] Some of them are as follows-
- The credit information of the customer is to be verified by every bank before providing loans to the customers as this would ensure that the customer is reliable and is likely to pay back the loans that are taken by them.
- Use of an Alternate dispute mechanism in case of a dispute for faster and efficient recovery of debt and making the whole process smoother for all the parties involved.
- Taking actions against NPA’s and making use of different mechanisms present to recover the loan amount. This would ensure that the loss is a minimum possible and timely recovery of loan could be done.
- Reforms are implemented like the insolvency and bankruptcy code so that the people or corporates who have taken loans should pay back loans and if unable to do so then they must be forced into bankruptcy which would seriously hamper their normal functioning and thus prompt them to make serious and immediate payments towards their loans.
- The banks can also take a linear approach if the customer is making efforts towards the payment and is being successful then some kind of relaxation could be provided in the period of loan repayment.
- The repayment of the loan by a third party for the benefit of the customer should be made easier as the bank is provided with the repayment and thus there will be no arrears to be recovered.
- Appropriate measures should be taken to preserve the value of the collateral and certain steps should be taken to improve the value of the same only if it could be done without making any significant alterations to the property.
- Specialized entities should be set up to make the process of buyouts easier and better functioning of asset reconstruction companies.
- Adequate notices along with appropriate time should be provided to repay the loan and respond to the queries of the bank.
All these steps must be implemented for a better and safer banking system and to make the industry more reliable.[5] This would ensure that there is some kind of safeguard present for the banks and they can enjoy some kind of autonomy and at the same time maintain enough power to take action as and when required.
Conclusion
The NPA’s have a big and deep impact on the Banking industry as they are used to determine the health of the industry in any country. The NPA’s are responsible for the losses that are suffered by the banks and they reduce the trust of the individuals from the industry. They are the most harmful thing that can happen in the industry and immediate steps should be taken to reduce its impact and to spread knowledge regarding its harmful impacts.
The banks are heavily regulated but some level of autonomy should be provided to them so that they can operate with the changing environment and can take corrective action as and when required. This would ensure the survival of the bank and make the industry much more viable to operate in.
Refereces:
[1] Gurusamy Karunanithi, Impact of Non-Performing Assets in Banking Sector, Research Gate (September, 2020), https://www.researchgate.net/publication/351391290_IMPACT_OF_NON-PERFORMING_ASSETS_IN_BANKING_SECTOR (Last visited Oct 28, 2021)
[2] Namita Rajput Anu Priya Arora Baljeet Kaur, Non-performing assets in Indian public sector banks: an analytical study, Banks and Bank Systems (08 February 2012), https://www.businessperspectives.org/images/pdf/applications/publishing/templates/article/assets/4383/BBS_en_2011_04_Rajput.pdf (Last Visited on Oct 28, 2021)
[3] Abhishek Sikdar, NPAs and its effects on banks’ profitability, Times of India (December 22, 2020), https://timesofindia.indiatimes.com/blogs/economic-update/npas-and-its-effects-on-banks-profitability/ (Last Visited on Oct 27, 2021)
[4] K.hafsal Anandarao Suvvari and S. Raju Sethu Durai, Efficiency of Indian banks with non-performing assets: evidence from two-stage network DEA, Springer Open (July 16, 2020), https://fbj.springeropen.com/articles/10.1186/s43093-020-00030-z (Last Visited on Oct 27, 2020)
[5] Varuna Agrawala, Nidhi Agrawala, A critical review of the non-performing assets in the Indian banking industry, Rajgiri Management Journal (December 13, 2019), https://www.emerald.com/insight/content/doi/10.1108/RAMJ-08-2019-0010/full/html (Last Visited on October 29, 2021)
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