Bad Loans

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    • Recently, the Parliament has been informed by the Finance Minister that banks had written off bad loans worth ?10,09,511 crore during the last five financial years.

    More about the news

    • Out of the total ?10.1 lakh crore, only ?1.32 lakh crore has been recovered. 
      • This comes to only about 13% as a percentage of write-offs.

    Background 

    • 2009: The RBI brought out norms that set out categories of NPAs and what banks must do as these bad loans age.
      • The RBI’s master circular in 2009 started off the journey on NPA recognition. 
        • It states that if an asset has been ‘doubtful’ for a certain period, the value of that asset must be provided for in parts, as the asset ages. 
    • 2014-15: India became more stringent in recognising loans as ‘bad’ in the 2014 to 2015 period. 
      • The periodic asset quality review was introduced. 
      • RBI stepped in to prevent evergreening of loans.
        • It means lending more to an already stressed asset in the hope that it could be brought back to its feet. 
    • 2021: There was a revision in 2021 which made recognition far more stringent.
      • Even if the asset is standard and there is no problem with it, banks are expected to make provisions depending on the risk element for that sector. 
      • Like home loans with teaser rates are at greater risk than those that are not. Hence provisions have to be made for such loans.
    • A National Asset Reconstruction Company Ltd. (NARCL) was announced in the Union Budget for 2021-2022 to resolve stressed loans amounting to about ?2 lakh crore in phases.

    What is a Bad loan and NPA?

    • What is a Bad Loan?
      • A bad loan is that which has not been ‘serviced’ for a certain period. 
        • Servicing a loan is paying back the interest and a small part of the principal depending on the agreement between bank and borrower.
      • Bad loans are where there is less certainty that the loan would be paid back in full.
    • What is NPA?
      • A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
      • Types of NPA:
        • Sub Standard:  A sub-standard asset is one that is classified as an NPA for a period not exceeding twelve months.
        • Doubtful: A doubtful asset is one that has remained as an NPA for a period exceeding twelve months.
        • Loss: A loss asset is one where loss has already been identified by the bank or an external institution, but it is not yet completely written off, due to its recovery value, however little it may be.

    What is the need to recognise NPAs?

    • Health of the financial system: In the banking system, the government and regulatory authorities need to have a good view of how healthy the financial system is.
      • A weak financial system can eventually ruin lives and livelihoods.

    Causes and challenges related to Non-Performing Assets (NPA)

    • Lack of SWOT analysis: The bank lends to the corporations/persons etc. whose creditworthiness is not guaranteed and thus taking a lot of high risks.
    • Lack of understandability: The banks are not able to diminish their losses by a complete understanding of the sufficiency of the bank in terms of the loan or capital loss at a specific time frame. 
    • Redirection of funds: The funds are being redirected elsewhere by the promoters of the companies. 
    • Investing in non viable projects: The banks that try to fund projects that are not viable results in high NPAs.
    • Lack of information: Not enough means to collect as well as distribute credit information in between the commercial banks. 
    • Non-efficient recovery of the debts from the overdue borrowers.
    • Delay in legal procedures: Even if an NPA is fully recognised in a particular year, the fastest of legal processes may not resolve for full repayment. 
    • Delays in post-haircut payments: Not only do banks take significant haircuts when it comes to recovery but the amount to be repaid post-haircut may be delayed. 
    • Provisioning: The bad loans lead to banks having to save a part of their operating revenue to account for bad loans which is called Provisioning. 
    • Downfall in the share markets: Any reduction in the perceived valuation of the banks might lead to loss of share value of the banks, leading to general downfall in the share markets. This could result in wiping out shareholders’ wealth from the financial markets.

    Impact of NPAs on Financial Operations 

    • This reduces the profits of the banks.
    • This reduces a bank or financial institution’s capital adequacy. 
    • The banks have become averse to giving loans and taking risks of zero percent. Thus, the creation of fresh credit is debarred. 
    • The banks start concentrating on the management of credit risk instead of the bank becoming profitable. 

    Way forward

    • The transparent recognition of NPAs caused a rise in the percentage for gross loans from 4.1% in 2014 to 11.46% in 2018.
    • The government’s strategy of recognition, resolution, recapitalisation and reforms has helped NPAs to decline to 5.9% by 2022.
    • Taking a person/corporation’s CIBIL score before lending a loan or finance to the person/corporation. 
    • Usage of mechanisms for alternative dispute resolution mechanisms for receiving the settlements faster like the usage of Debt Recovery Tribunals and Lok Adalats. 
    • The defaulters’ information should be actively circulated so that they cannot opt for any other loans/finances from elsewhere. 
    • Using the Asset Reconstruction Company’s services. 
    • Taking strict action against large NPAs. Legal reforms like the implementation of the Insolvency and Bankruptcy Code to be used.
    • Other Steps:
      • Proper implementation of Indradhanush plan. 
      • Strengthening of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI Act) and Debt Recovery Tribunals
      • Setting up of dedicated Stressed Asset Management Verticals (SAMVs) in banks for large-value NPA accounts etc.

    Source: TH