NPA & Stressed Assets

Bank non-performing assets (NPAs) are defaulted loans. The criteria for determining such assets have evolved over time. The RBI adopted the current policy in 2004 in order to follow international best practices and ensure greater transparency. If a loan has not been serviced for one term, it is considered non-performing (i.e., 90 days). This is referred to as the ’90-day’ overdue norm. For agriculture loans, the repayment period is linked to the duration of the crops in question, ranging from two crop seasons to one year past due.  NPAs were classified into three types:

1. Sub-standard: remaining NPAs for less than or equal to 12 months;
2. Doubtful: remaining NPAs for more than 12 months; and
3. Loss assets: where the loss has been identified by the bank or internal/external auditors or the RBI inspection, but the amount has not been written off.

Recent Upsurge

During 2019-20, the banking sector, particularly Public Sector Banks (PSBs), continued to underperform. SCBs’ Gross NPA ratio remained unchanged at 9.1% between March and September 2019, according to the Economic Survey 2019-20. For the SCBs, the size of net NPAs has remained stable at around 12.2%. The public sector banks have been hit the hardest by the NPA crisis, which has slowed the economy’s overall credit expansion. However, banks were able to recover around X1.58 lakh crore through insolvency proceedings by December 2019, but hair cuts in asset valuations were also very high. Though various reasons have been cited for the recent increase in PSB NPAs (as reported in government documents from 2013-14), the major ones are now being considered as follows:

• Global and domestic macro-economic instabilities due to which a slowdown was seen in the economy diluting the capability of the borrowers to service the loans.
• Delays in project approvals result in high-cost over-runs. This dented the loan servicing capability of the borrowers in a big way.
• Aggressive lending by the banks to high corporate leverage.
• High incidences of ‘wilful defaults’.
• Cases of loan frauds.
• Instances of corruption in the banking institutions.

Now, the Government has commenced a multi-pronged policy framework to resolve the NPA crisis faced by the public sector banks.

Resolution of the NPAs

On the one hand, the RBI has taken several steps to resolve the problem, while also attempting to keep NPAs from rising by announcing new guidelines for banks. Since 2014-15, the RBI has implemented a number of schemes to help banks resolve their nonperforming assets (NPAs), which are briefly discussed below:

5/25 Refinancing

This program provided a wider window for the revival of stressed assets in the infrastructure and core industries. Lenders were allowed to extend loan terms to 25 years under this scheme, with interest rates adjusted every five years, to match the long gestation period of the sectors. The scheme aimed to improve borrowers’ credit profiles and liquidity positions while allowing banks to treat these loans as standard in their balance sheets, lowering provisioning costs for nonperforming assets. However, because the interest was spread out over a longer period, the companies faced a higher interest burden, which they struggled to repay, forcing banks to extend additional loans (known as ‘evergreening’). This has exacerbated the original problem.

ARCs (Asset Reconstruction Companies)

Under the SARFAESI Act (2002), ARCs were introduced to India as specialists to resolve the burden of NPAs. However, because the ARCs (most of which are privately held) are having difficulty resolving the NPAs they have purchased, they are now only willing to buy such loans at low prices. As a result, banks have been hesitant to sell them large amounts of loans. Since the ARCs’ fee structure was changed in 2014 (requiring ARCs to pay a greater proportion of the purchase price in cash upfront to the banks), their purchases of NPAs have slowed even more—only about 5% of total NPAs were sold in 2014-15 and 2015-16.

SDR (Strategic Debt Restructuring)

The SDR scheme, introduced by the RBI in June 2015, allows banks to convert the debt of companies (whose stressed assets were restructured but could not finally meet the conditions attached to such restructuring) to 51 percent equity and sell them to the highest bidders, resulting in a change in ownership. Only two such sales had occurred by the end of December 2016, in part because many businesses remained financially unviable because only a small portion of their debt had been converted to equity. AQR (Asset Quality Review): In order to solve the problem of bad assets, you must first recognize them. As a result, the RBI focused on AQR to ensure that banks were evaluating loans in accordance with RBI loan classification rules. Any violations of these rules had to be corrected by March 2016. S4A (Scheme for Long-Term Stressed Asset Structuring): Introduced in June 2016, it requires banks to hire an independent agency to determine how much of a company’s stressed debt is sustainable.’ The remainder (referred to as “unsustainable”) is converted into equity and preference shares. Unlike the SDR arrangement, there is no change in the company’s ownership.

Public Sector Asset Rehabilitation Agency (PARA)

To address the twin problems of ‘balance sheet syndrome’ (in both the banking and corporate sectors), the Economic Survey 2016-17 recommended that the government establish a public sector asset rehabilitation agency (PARA) to handle the largest and most complex cases of the syndrome.’ In the countries affected by the South East Currency Crises in the mid-1990s, such initiatives were successful in addressing the ‘twin balance sheet’ (TBS) issues. According to the survey, the Agency is in charge of resolving the largest and most complex cases. Most of the current roadblocks to loan resolution could be removed with such an approach.

• coordination problem as in this case, the debts would be centralized in one agency;
• it could be set up with proper incentives by giving it an explicit mandate to maximize recoveries within a defined time period; and
• it would separate the loan resolution process from concerns about bank capital.

Seven Reasons to set up PARA

The Survey has outlined seven reasons in support of its suggestion for setting up the PARA which is as given below:

1. It’s not just about banks; it’s about businesses as well. So far, the NPA issues have revolved around the bank’s capital and how to fund it so that it can resume lending. However, the most pressing issue is determining how to resolve the NPAs created by corporations (as to why they are stressed).
2. It’s a business issue, not a morality play. Non-payment of debts has undoubtedly been caused by the diversion of funds (wilful defaults). Unexpected changes in the economic environment, such as miscalculated timetables, exchange rates, and growth rate assumptions, have caused a large number of loan defaults.
3. Large corporations are heavily reliant on stressed debt. TBS could be overcome by solving a relatively small number of cases, which is an opportunity. However, because large cases are inherently difficult to resolve, it poses an even greater challenge.
4. Many of these businesses are unviable at their current debt levels, necessitating debt writedowns. Over the last few years, cash flows in large stressed companies have deteriorated to the point where debt reductions of more than 50% are frequently required to restore viability. The only other option is to convert debt to equity, take over the businesses, and then sell them for a loss.
5. Despite a plethora of schemes to assist them, banks are having difficulty resolving these cases. They face severe coordination problems, among other things, because large debtors have many creditors with varying interests. Large debt reductions granted by PSBs may attract the attention of investigative agencies. Taking over large corporations, however, will be politically difficult.
6. Delay is expensive. Because the banks have been unable to resolve the major cases, they have simply refinanced the debtors, worsening the situation. However, this is costly to the government because bad debts continue to rise, increasing the government’s overall recapitalization bill and causing political difficulties. Delay costs the economy money because troubled banks are cutting back on credit and stressed companies are cutting back on investments.
7. A PARA may be required for progress. In resolving bad debts, ARCs (Asset Reconstruction Companies) have not been any more successful than banks. However, international experience shows that a professionally run central agency with government backing can provide the solution in this regard (albeit with its own set of challenges).

By late February 2017, the government had expressed an interest in PARA. However, before the idea can take shape, the government must resolve a number of related issues, including its funding mechanism, the selection of companies for balance sheet resolution, the recovery mechanism for banks’ nonperforming assets, and so on.