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What happens when a loan becomes a Non-Performing Asset?

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An NPA is basically a Non-Performing Asset. When loans which have been borrowed by a person from either an Indian Bank or any financial institutions and when the interests and the loan amount has been overdue for a long period.

A long period is basically when it has been more than 90 days. Being a Non-Performing Asset takes a toll on any banks’ margin. 

In the banking sector, Non-Performing Asset is not such a desirable happening as it is indirectly destroying the overall banking system that India has.

RBI has even listed in their Master Circular about NPA. During a term loan, when the installment or the interest is overdue and crosses the 90-day mark,

Points given below are counted under Non-Performing Asset in Banking.

  1. When an account is ‘out of order’ with respect to Overdraft/Cash Credit.
  2. When there is an outstanding bill for more than a period of 90 days.
  3. The installments and the interest would remain overdue in two crop seasons if the seasons have crops growing for a short duration.
  4. When the installments or interest is overdue for a crop season having a long duration.
  5. When the liquidity amount which has been outstanding for a continuous period of 90 days.

In normal standards, the period might be 90 days but depending on the terms and conditions, the period might either be shorter or longer of the loan. The loan can be considered or named as a Non-Performing Asset either during the term of the loan or at its maturity. 

Carrying a Non-Performing Asset can also become a huge financial burden for the lender. NPA can indirectly affect the budgets and decrease the earnings which will also affect the lender’s cash flow.

The funds which are set aside for potential losses which are known as Loan Loss Provisions in turn reduces the capital which is available to provide the subsequent loans to the other borrowers. 

These are written off against the earnings of the lender. Having a huge amount of NPAs can put the bank at risk as it will affect the balance sheet over a period and play as an indicator of regulating and not having a proper financial fitness.

The Assets can be categorized by the Banks or the lenders, depending on what type of NPA they are.

1) Standard Assets:

These are assets which have been due for anywhere from 90 days to a year which has a normal risk level.

2) Sub-Standard Assets:

This is the asset which crosses the one-year mark and also has higher level of risk which gets combined with the borrower who also has a bad credit. Banks usually reduce the market value of the assets because there is no certainty of the borrower repaying the loan amount.

3) Doubtful Debts:

The assets from this category have been due for more than 18 months. The Bank is always really doubtful whether the borrower will repay the loan and this also results in putting the bank’s own profile at risk.

4) Loss Assets:

The assets having an extended period of non-payment comes under this category. This happens when there is nothing that can be done and the Bank has accepted that there will be no repayment of the loan and hence it is tagged as a loss on the balance sheet. Lenders or Banks consider before hand the factors when the borrowers are late on their payments even after giving them an extended period or a grace period.

Until a considerable amount of time hasn’t passed of non-payment, a loan wouldn’t be classified as a NPA. It is only at the end of the grace period when the loan becomes a Non-Performing Asset.

Reasons behind Non-Performing Assets

  • When there is a diversification of funds directed to unrelated business or for a fraud.

  • The losses which happen in a Business due to change in the business or in the regulatory environment.

  • When there is either a Regional, National or Global financial crisis which erodes the margins and profits of the Businesses. This starts stressing their balance sheets resulting in non-servicing of interest and loan payments.

  • When the entire economy becomes slow resulting in a faster growth of NPAs.

  • When a specific sector becomes slow and that’s when it affects the businesses in that sector which leads to them becoming an NPA.

  • When there isn’t a proper assessment of a particular loan application which will gauge if the loan applicant will be able to repay the loan or not, then it turns out to be an improper credit appraisal. This becomes a reason to convert into an NPA.

  • Recession in a specific industry can also be a reason how NPAs get formed. 

  • When the customers don’t make their payments on time, the recovery rate of the receivable tends to fall and cause a problem

Impact of NPAs

When a certain loan turns into a Non-Performing Asset when there isn’t any kind of non-payment of a loan. In such situations, there are repercussions which Banks and Lenders have to face.

The Lenders start suffering a profit margin which keeps on lowering. There is a stress which gets developed in the banking sector when there aren’t enough funds available for other projects. 

This in return creates a negative impact on the national economy. To maintain the profit margins, the interest rates are made higher by the banks.

The Lenders have to redirect their funds from the good projects to the bad ones. Because the investments have gotten stuck, this can also result in unemployment.

When it comes to a bank from the public sector, having a bad health leads to bad returns for the shareholders. This means the dividend that the Government of India gets, would be less. 

This will also disrupt the deployment of funds for social and infrastructure development. This then becomes a social and political costs. The rightful returns that the Investors should get, they don’t get it.

There is a term called ‘Balance Sheet Syndrome’ which means when Banks and corporate sectors have a stressed balance sheet resulting in halting their investment-led development process.

Having cases on NPAs can also pile up and create more stress to the Indian judiciary as they already have a lot of pending cases.

Various Reforms to tackle Non-Performing Assets –

Non-Performing Assets have been a trouble for the Lenders, for the Banks, and the Government. So the Government of India have taken several steps with regards to legal, financial, policy level reforms. Narsimham Committee recommended these reforms to tackle NPAs smoothly. But only some of them had been implemented.

• Debt Recovery Tribunals (DRTs) – 1993

India passed a law which was Recovery of Debt Due to Banks and Financial Institutions Act, 1993, so that they could decrease the time which was committed in settling cases. Since the number was insufficient, they suffered from a time lag and a lot of cases got pended in many areas for more than 2-3 years.

• Credit Information Bureau – 2000

This reform was created to be a good system of information which will help in preventing falling of loans into the wrong hands and thus, preventing NPAs. This reform helps in maintaining and sharing data of the people who are either individual defaulters or willful defaulters.

• Lok Adalats – 2001

The purpose of this reform was to help to tackle and recover the small loans which are limited to 5 lakh rupees as per the RBI guidelines which had been issued in 2001. This is helpful as they avoid more cases to get piled up in the legal system.

• Compromise Settlement – 2001

This reform was formed because it provides a simple but proper mechanism to recover the NPAs for advances which are less than 10 crore rupees. This reform basically covers the lawsuits with the courts and also the Debt Recovery Tribunals even if the willful defaulters and fraud cases have been excluded.

• SARFAESI Act – 2002

An Act called Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 was passed which allows the Banks or Financial Institutions to recover the NPAs without involving any legal boy like the Court. The method they use is to acquire and dispose the secured assets of NPA accounts who have an outstanding of 1 Lakh rupees and above. This can only be done if the borrower ignores the notice that had been sent by the bank. Then, the bank can take measures like taking the ownership of security or taking control of the management of the borrowing concern or by appointing someone to manage the concern.

This Act got amended last year so that the enforcement gets faster.

• Asset Reconstruction Companies (ARC)

After the SARFAESI Act, 2002 got amended, the RBI gave license to 14 new ARCs. The ARCs consist of companies that had been created to unlock the value from the stressed loans. Before the law had been passed, the lenders had the option of enforcing their security interests only with the help of courts which consumed a lot of their time.

• Corporate Debt Restructuring – 2005

To reduce the burden of the debts of the company, this reform was created to decrease the rates which were being paid and to increase the time given to the company to pay the obligation back.

• 5:25 Rule – 2014

This rule was proposed so that the cash flow is maintained of the companies who have a long project timeline and who don’t get their money recorded in their books for a long time. Implementing this rule gives the companies the requirement of loans of every 5-7 years and hence, they can refinance for their long-term projects. This rule is also known as Flexible Structuring of Long-Term Project Loans to Infrastructure and Core Industries.

• Joint Lenders Forum – 2014

This forum was mainly created with the purpose of including all the Public Sector Banks who have a lot of stressed loans. It is present so that no loan issued by any other bank to the same individual or company. This is such a situation when an individual takes a loan from one bank to pay off the loan of another bank can be prevented.

• Mission Indradhanush – 2015

The goal of this mission to revamp the functioning of Public Sector Banks so that they are able to compete with the Private Sector Banks. So that the economic growth gets revived by reducing the political interference in the functioning of Public Sector Banks in order to improve their credit.

Mission Indradhanush follows ABCDEFG.

A – Appointments –

So that Public Sector Banks are treated equally as Private Sector Banks, Chief Executive Officers and Managing Directors are appointed so that they overlook if the banks are functioning smoothly.

B – Bank Boards Bureau 

This Bureau will replace the Appointments board to advice the banks in matters such as raising funds, mergers and acquisitions etc. The Bureau will also hold the bad assets of the Public Sector Banks. The Bureau plays the role of a middleman between the Public Sector Banks and the Government.

C – Capitalization 

Due to high NPAs, there was an induction of 70000 crore rupees was planned by capitalizing the banks.

D – De-stressing 

By strengthening the ARCs through solving the issues which arise in the infrastructure sector in order to check the stressed assets in the banks. To have a better developed vibrant debt market for the Public Sector Banks.

E – Employment 

Keeping the commercial and organizational interests in mind, the Government of India has decided that the Government and Banks wouldn’t interfere in any independent decisions. Giving the liberty of flexibility and autonomy to the Public Sector Banks for hiring employees.

F – Framework of Accountability 

There are few key performing indicators which will help the bank assess such as Quantitative Parameters in which will include an NPA management, diversification, growth, return of capital and financial inclusion and Qualitative Parameters like improvement of quality of the assets, initiatives of human resources etc.

G – Governance Reforms

Gyan Sangam which is also known as Banker’s Retreat is a conference between the bankers and the Government officials to resolve the issues happening in the banking sector and also deciding the course of action to be taken in the future.

• Strategic Debt Restructuring (SDR) – 2015

In this scheme, the banks gets the right to convert the loans that have been given to borrowers into equity shares in the loan taken company. This is to ensure the more stake of promoters who revive the stressed accounts, providing the banks by enhancing the capability to initiate the change of ownership in cases which are appropriate.

• Asset Quality Review – 2015

This review is done so there is a classification of stressed assets, provisioning them so that the future of the banks is secure and there is an early identification of the assets to prevent the assets from becoming stressed by taking the right action.

• Sustainable structuring of stressed assets (S4A) – 2016

This is an optional framework so that the largely stressed accounts get resolved. This mainly involves the determining of the sustainable level for a stressed borrower. 

There is also a bifurcation of the debt which is outstanding into the sustainable debt and equity or quasi-equity instruments which are expected in providing an upside to the lenders when the borrowers steps back.

• Insolvency and Bankruptcy code Act – 2016

To tackle an Economic Survey called the Chakravyuaha Challenge of the exit problem of India. The purpose of this law was to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders by consolidating and amending the laws related to reorganization. 

Resolving the insolvency of individuals, partnership firms and corporate people in a proper time-bound manner. In order to maximize the value of assets of such people and any matters connected therewith or incidental thereto.

• Public ARCs vs. Private ARCs

The point of Public ARCs being fully funded and administered by the Government whereas Private ARCs is being advocated by the Deputy Governor of RBI at that time. 

An Economic Survey considers this as PARA which is Public Asset Rehabilitation Agency and the recommendations are based on basically a similar agency being used during the East Asian crisis of 1997 which was quite a success.

• Bad Banks – 2017

The idea is basically of forming a bad bank which will take care of all the stressed loans, tackling it according to the rule flexibility and mechanism. This will ease the balance sheet of the Public Sector Banks which will help them invest in other new projects, helping them to continue funding of development projects.

Conclusion:

In Conclusion, Non-Performing Assets shouldn’t be a stage which a person should reach. There are different options when people have trouble repaying their loans. They can talk to their Lender or their Banks or contact a company like SingleDebt which will advise you and help you make a Debt Management Plan.  

This is the asset which crosses the one-year mark and also has higher level of risk which gets combined with the borrower who also has a bad credit. Banks usually reduce the market value of the assets because there is no certainty of the borrower repaying the loan amount.

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