This article is written by Nishit Paul.

Introduction

The looming crisis related to the COVID pandemic has shaken the economic system and has paralyzed the Credit market in a drastic way. The RBI has to realise special funds for the Banks and relax the Lending Rate so that the Banks and other credit companies can sustain by delivering more credit into the economy.

The measures are taken by the RBI for both the Creditors and Borrower whereby, it lowered the Lending Rate for the Banks and also gave a six-month moratorium[1] for the customers so that they are relaxed deferred payment in the lockdown period.

However, the action is not simple as it sounds, there is a constant fear among the debtors that because of their bad business and the non-payment of the constant agitation and judgement by the Supreme Court of India directing RBI to extend the moratorium period for the Borrowers for giving them the relief so that their accounts are not be declared Non-Performing Asset (NPA).

So, what is this NPA that has put fear among the borrower and let them petition before the Hon’ble Supreme Court in safeguarding them from such declaration?

This article describes what NPA means and how Banks or Creditors define NPA in the first place against a defaulting borrower.

Definition of non-performing asset (NPA)

First, understand the meaning of asset because the acronym ‘non-performing’ is appended to the word asset and it is defining a particular category of an asset.

An asset is a property whether tangible or intangible in nature which has a value of its own and its value increases or decreases with time, which means it has a positive or a negative outcome against the time value of money.

In a business of lending, the creditor lends money to the borrower with the promise that the borrower will pay interest annually or monthly on the money lent. Therefore, from this perception for the creditor, his business of lending becomes an asset for the creditor which is earning from the interest on the money lent.

The moment the borrower starts defaulting on the payment of interest on the principal amount, the asset becomes a burden on the books of the creditor because it is not earning any value out of it. Thus, the term Non-Performing is appended for such assets because the borrower is not performing his part of interest payment to the Lender.

• Definition in SARFAESI Act

However, the Non-Performing Asset[2] or NPA is defined under Section 2(o) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

As per the said provision “non-performing asset” means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset —

1. in case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body;
2. in any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank.

Therefore, from the above reference, the provision classifies those assets which the Bank or financial institute as standard, sub-standard and doubtful assets which has been discussed later in the article. Further, the asset classification is in-depth to be described by a statutory authority or RBI.

• Definition as per RBI circular

The RBI in its Master Circular[3] defines the NPA as a non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or instalment of principal has remained ‘past due’ for a specified period of time.

Herein, the term specified period of the RBI is 2 quarters in one financial year ending on 31st March.

This is the definition of the NPA but when such NPA is declared by credit institutes and what are the criteria for such declaration.

When NPA is declared by the creditor?

After the borrower starts defaulting on payment of instalments, the bank or the financial institute then moves on to the next step for declaration of NPA.

The NPA is declared on the basis of non-payment of instalment for a particular period of time and the RBI has classified it for different types of credit offered by the Banks.

The RBI has classified according to the number of days the last instalment was made in the account of the borrower.

So where,

1. interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan,
2. the account remains ‘out of order’ for a period of more than 90 days, in respect of an Overdraft/Cash Credit (OD/CC),
3. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
4. interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes, and
5. any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

The bank has to declare their NPA every year at the end of each financial year i.e on 31st March.

What are the classifications of NPAs?

The RBI master circular has classified the assets into four categories[4] of assets to be recognized by the banks, these are:

• Sub-Standard asset: This kind of asset is declared NPA for a period less than and equal to 18 months from its date of declaration. Also, the assets worthiness has decreased because of the loss of net worth of the borrower or the secured asset charged against such debt. This asset signifies that it has credit weakness if liquidation happens and it will be certain that the bank will suffer loss.
• Doubtful asset: This kind of asset is declared NPA for a period in excess of 18 months from its date of declaration. The type is in addition to the sub-standard asset wherein, the characteristic of its weakness is such that, it is highly improbable or questionable to make full recovery during its liquidation.
• Loss asset: The loss on the asset is ascertained by the Bank which is calculated by the internal auditors or the external auditors of the RBI but it has not been written off wholly from the books. The amount of recovery is considered uncollectible or is of such value is not warranted, although some amount can be recoverable.

On whom NPA is declared?

An NPA is declared upon the asset owned by the Bank or the financial institute. All the loan accounts where the above criteria for classifying it as non-performing may apply will be declared as NPA.

The borrower, however, has a liability to pay the loss suffered by the Bank on its books because of the NPA.

The Banks create a charge on the borrower to recover the loss by using legal methods or through a transfer of the NPA to the asset reconstruction companies registered under the SARFAESI Act, 2002.

What are the consequences in the declaration of the asset as NPA?

The declaration of an asset by the Bank as Non-performing sets the stage for the Bank or financial institution for recovery of the debt by the Banks. This also creates a burden on the Banks because of the loss of income which further may lead to dilution of the lending business of the Bank.

However, the law is implemented for the recovery of the debts and the payment of the debts through legal actions instituted by the Banks. Some of the methods used by the Banks for ensuring recovery.

• Institution of civil suit or application before debt recovery tribunal

A recovery suit is filed by the bank before any court of law having jurisdiction for the recovery of the loan.

The recovery action is then governed as per Section 58 to 104 and Section 130 to 137 of the Transfer of Properties Act, 1882.

However, if NPA is declared for an asset amounting to more than INR 20 Lakhs then the Bank can file an Original Application before the Debts Recovery Tribunal for the recovery of the debts as per the Recovery of Debts and Bankruptcy Act, 1993.

• Recovery through sale of secured asset as per the SARFAESI Act

The Narasimhan Committee report 1991 & 1998 has suggested stringent power to the Lenders which was implemented by the Parliament by enacting the SARFAESI Act, 2002.

This law, however, classified the NPA under the act and also gave stringent powers to the Bank in the auction sale of a secured asset without any intervention of the Courts or DRT.

Although, the law provides protection to the debtor against any illegal action taken by the bank by approaching with a securitization application filed before the Debt Recovery Tribunal.

• Instituting an insolvency or bankruptcy proceedings against the debtor

The new banking reforms bought, the Insolvency and Bankruptcy Code, 2016 whereby a centralized regulation for the insolvency of the bad debts of the corporates to be resolved through an appointment of resolution professionals with the foresight of the National Company Law Tribunal or the Debt Recovery Tribunal.

The Act gave power to the Banks or consortiums of creditors of every spectrum of the lending market to resolve their debt issues by instituting an Insolvency proceeding before the Adjudicating Authority.

The act aims for the resolution of the debts within 180 days from the filing of the resolution application before the Adjudicating Authority.

However, if the debts are not resolved by then lenders have the power for liquidation of assets of the company for the recovery of the debts.

Consequence on the debtor

The debtor or borrower will lose its borrowing credibility in the market. This will affect the credit score or CIBIL score of the borrowing.

It will be hard for the borrower to approach any lender from sanctioning any new loan or granting guarantee for any economic activity in the market.

Consequences on the creditor 

The creditor or the Bank will hit by losing its part of the business because of non-payment of the interest over the principal amount. The Banker either has to restructure its assets because of the increasing burden of NPA on the Books of the bank.

The Banking Companies tend to lower the function in lowering its Net NPA growth rate in their Books. This is because in a Banking company the less growth of Gross or Net NPA then it is presumed the Bank is performing good in the market.

The Bank generally settles debts through different mediums by offering One Time Settlement scheme to the Borrowers. This helps to lower the burden to some extent with loans valuing less.

The Government also comes into help by recapitalisation of the Banks which gives the Banks extra liquidity to spend in the recapitalisation of the bad debs and the issue of new loans to better customers.

Conclusion

Declaring NPA will be bad for both borrowers as well as the Banking/Lending Industry. In the midst of the COVID-19 pandemic and the disruption of the financial institution the Banks, as well as the RBI, are growing with the sentiment of kick-starting the economy.

On the other side, the borrowers are aware of the loss of business happening, where the consumer demand is at the all-time low and no investment is happening, this also brings burden on the Borrower in the timely repayment of the interest on their borrowing.

Though the borrower have been saved by the intervention of the Hon’ble Supreme Court but the burden is still creeping because of the implementation of the moratorium, this will adversely affect both the borrower and the Banks at the end. As for now, the Hon’ble Supreme Court has directed the RBI not to declare any new NPA till the further orders[5] which can be saver for the Borrowers.

References

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11902&Mode=0

[2] https://corporatefinanceinstitute.com/resources/knowledge/finance/non-performing-asset/

[3] https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx%3FId%3D449

[4] https://www.fdi.finance/blog/what-is-npa-and-types-of-npa/

[5] https://www.business-standard.com/article/economy-policy/don-t-declare-accounts-npa-till-further-orders-says-supreme-court-120090400033_1.html

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