This article is written by Pallavi Chandrasekhar, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here she discusses “Management of Non-Performing Assets”.

Meaning of Non-Performing Assets (NPA)

Non-Performing Assets or NPA are like a cancer worm that has been destroying the banking system of India slowly and steadily. NPA are bad loans with banks or other financial institutions whose interests and or principal amounts are overdue for a long time. This time is usually 90 days or more. Like any other business, banks also must run on profits, but NPA eats into that margin for banks.

The Reserve Bank of India (RBI) has a more detailed definition of NPA. According to the RBI Master Circular on NPA the following are classified as NPA:

“An asset, including a leased asset, becomes non- performing when it ceases to generate income for the bank.  A non ­performing asset (NPA) is a loan or an advance 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’, 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. the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
5. the instalment of principal or interest thereon remains overdue for one crop season for long duration crops,
6. the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.”^[i]

Types of NPA

• Substandard NPA: Those NPA that have remained overdue for a period of less than or equal to12 months.
• Doubtful NPA: Those NPA that have remained in the substandard category for a period of equal to or less than 12 months.
• Loss Assets: This occurs when the NPA has been recognized as a loss by the bank, or the internal or external auditor or on Reserve Bank of India (RBI) inspection but the loan has not been forgiven completely.

Provisioning Norms

These are rules set by the RBI for all banks to set aside a certain amount for their bad assets or NPA.  They vary according to the category of the NPA as follows:

• 10 percent of allowances for the total unpaid amount without making any budget for securities or other government guarantee cover.
• The NPA under substandard category would have another 10 per cent cover making it a total of 20 per cent on the outstanding amount.
• The provisional requirement for unsecured or doubtful NPA is 100 percent.

Factors contributing to NPAs

• Banks’ lending to persons/corporations etc. who are not creditworthy and taking high risks.
• Banks are not diminishing their losses by understanding their bank’s sufficiency on capital and loan loss reserves at a given time;
• Promoter of Companies redirecting their funds elsewhere;
• Banks trying to fund non-viable projects;
• In the initial part of the 1990s, Public Sector Banks started experiencing acute capital shortage and losses. The targets set for their operation did not project the utmost need for these corporate goals;
• The banks had very little autonomy to price their products; offer products to preferred sectors or spend money for their own profits. For example, Banks were forced to lend to priority sector namely agriculture due to political pressure;
• Deficient means to collect and distribute credit information amongst commercial banks; and
• Efficient recovery from evasive and overdue borrowers was impeded due to weaknesses in the existing process of debt recovery, ineffective legal provisions on and bankruptcy and problems in foreclosure the execution of court orders.

Impact of NPAs on Operations

• It reduces the bank’s profits.
• It has an effect on the bank’s capital adequacy.
• The Banks thus become averse to giving loans and take zero percent risk. Thus fresh credit is not created.
• The Banks start concentrating on credit risk management instead of making the bank more profitable.
• Funds cost more due to NPA.

Current status of NPA

The RBI expects the asset value of banks to worsen by September 2020.^[ii] As stated by the RBI in its Financial Stability Report, it is projected that the gross NPA ratio for commercial banks could worsen to 9.9 per cent by September 2020 from 9.3% in the first half of the financial year.^[iii] Furthermore, the Gross NPA ratios for public sector banks may increase to 13.2 percent by September 2020 from 12.7 percent in September 2019.^[iv] Also given the current pandemic over COVID-19, the latest projections would be even worse as the Indian economy along with the world economy would move towards an economic slowdown. 

Corrective Action Plan to Arrest increasing NPAs

• Banks must identify early that there is going to be a non-payment and report it to the Central Repository of Information on Large Credits (CRILC).
• Before a loan account turns into an NPA, Non-Banking Finance Companies (NBFCs) must recognize emergent stress in the account by creating a sub-asset category i.e. ‘Special Mention Accounts’ (SMA) with the three sub-categories as given in the table, as per the RBI’s Prudential Framework for Resolution of Stressed Assets dated June 7^th, 2019^[v]:

Special Mention Accounts (SMA) Category	Basis of Categorization Principal or interest payment or any other amount wholly or partly overdue between
SMA-0	1-30 days
SMA-1	31-60 days
SMA-2	61-90 days

Preventive Measures

• Taking a person/corporation’s Credit Information Bureau (India) Limited (CIBIL) score into consideration before lending.
• Compromise or use various settlement schemes.
• Use alternative dispute resolution mechanisms for faster settlement of dues such as use Lok Adalats and Debt Recovery Tribunals.
• Actively circulate information of defaulters.
• Take strict action against large NPAs.
• Use Asset Reconstruction Company.
• Legal Reforms such as implementation of the Insolvency and Bankruptcy Code have already taken place.
• Corporate Debt Restructuring (CDR).
• Propose guidelines on wilful defaults/diversion of funds.
• Special Mention Accounts – Additional Precaution at the Operating Level.

Latest Measures by RBI

The main proposals are:

• Lenders’ Committee with strict timelines for a resolution plan must be formed early.
• Lenders must be given incentives to agree to collectively and quickly plan– if a resolution plan is already under way, then there must be better regulatory treatment; if no agreement can be reached, then accelerated provisioning must be done.
• Improvement in current restructuring process: large value restructurings must be independently evaluated mandatorily, with a focus on viable plans and a fair sharing of losses (and future possible upside) between promoters and creditors.
• Future borrowing for non-cooperative borrowers with lenders must be made more expensive in resolution.
• Asset sales must be given more liberal regulatory treatment.
• If loss is fully disclosed, lenders must be allowed to spread their losses on sale for over two years.
• It will not be construed as restructuring if takeout financing/refinancing is made possible over a longer period.
• If specialized entities are acquiring ‘stressed companies’, leveraged buyouts must be allowed.
• Steps must be taken to facilitate better functioning of Asset Reconstruction Companies.
• Sector-specific Companies/Private equity firms must be helped to play an active role in the stressed assets market.
• Formation of Joint Lenders’ Forum: If an account is reported to Central Repository of Information on Large Credits (CRILC) as SMA-2, all lenders should form a lenders’ committee to be called Joint Lenders’ Forum (JLF) under a convener and frame a joint Corrective Action Plan (CAP) for early resolution of the stress in the account. This would also include: Rectification; Restructuring; Recovery of the asset.

Settlement Scheme

The Banks are autonomous to design and implement their own policies for recovery and write off loans, incorporate compromise and negotiate settlements with approval of its board. After the implementation of the Insolvency and Bankruptcy Code of 2016 (IBC), debts as small as Rs. One Lakh can be brought before the National Company Law Tribunal (NCLT).

• Lok Adalats: They can deal with small NPA upto Rs. 20 lakhs. They ensure speedy recovery and also have a veil of authority. Lok Adalats are not harsh no defaulters, are cheaper and easier means of resolving loan disputes.
• NCLT and the National Company Law Appellate Tribunal (NCALT) have replaced the Board of Industrial and Finance Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR) under the IBC. This was done because the BIFR could not meet its objective of preventing sick industries.  Under the IBC, not only financial creditors, but even an operational creditor can file an application for liquidation before the NCLT. The IBC also stipulates that the entire resolution process including litigation must be completed within 330 days.
• Sale of NPA to other banks: An NPA can be sold to other banks only if it has remained an NPA in the books of the selling bank for more than two years. Further, the NPA must be held in the purchasing bank for more than 15 months before it can be sold to other banks. But it cannot be sold to the bank which originally sold the NPA.

Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act) 

The SARFAESI Act ensures the security interests in movable (tangible or intangible assets including accounts receivable) and immovable property without the court’s intervention.  A Bank or a Financial Institution can send a legal notice to the borrower to pay back her liabilities within 6 days from the date of notice.  If the borrower is unable to do so, the Bank or Financial Institution (FI) can exercise all its rights under the SARFAESI Act.  The Bank or FI can also seize the management of the secured assets.  Any aggrieved person can appeal to the Debt Recovery Tribunal (DRT) within 45 days after depositing 75% of the amount claimed in the notice. 

Insolvency and Bankruptcy Code, 2016

Bad loan recovery in the 2018 fiscal year under the IBC was almost Rs. 70,000/- crores.  This was almost posting a 43% recovery rate and was double the amount recovered from DRT or the Lok Adalats, according to a report from ratings firm Crisil.^[vi] Crisil also said that IBC has shifted the balance of power from the borrower to the creditor because under IBC the borrower faces a real chance of losing her assets.^[vii] Under the Code, any financial or operational creditor can file an application for recovery of debt against a company or partnership before the NCLT.  The NCLT then appoints a Resolution Professional to take over the management of the defaulting debtor.  The Resolution Professional tries to ensure that the defaulting debtor continues to operate while also looking for raising funds and realizing debts during the Corporate Insolvency Resolution Process (CIRP). If the debts are not able to be realized during the CIRP, liquidation process is initiated.  The entire process of resolution including litigation must be completed within 330 days.^[viii]

Factors affecting the Acceptance of Negotiation Proposal by Bank

• Bank’s Documentation.
• The value of the security value and sale value realized.
• The Bank’s ability to sell.
• The ability & source of the borrower.
• The ability & source of the guarantor.
• The vulnerability of the borrower/guarantor.
• Time frame.
• The bank’s field staff’s strength and zeal.
• The message sent by the bank.
• The Bank’s Policy.
• The Bank’s success rate.

In conclusion it can be said that by taking preventive measures such as considering the corporate body’s credit score before lending; banks can go a long way in reducing their NPAs.  Furthermore, after the advent of current legislations such as IBC, the existing one SARFAESI, along with RBI’s recommendations, after the loans have become an NPA, banks also have a post facto redressal mechanism which is speedier than regular long drawn recovery process in the courts.

References

^[i] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9009#CT4

^[ii] https://www.bloombergquint.com/business/fsr-rbi-expects-bank-npas-to-rise-to-99-by-september-2020

^[iii] Ibid.    

^[iv] Ibid

^[v] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

^[vi] https://www.livemint.com/news/india/npa-recoveries-via-ibc-in-2018-19-at-rs-70-000-crore-crisil-1557900274477.html

^[vii] Ibid.

^[viii] https://economictimes.indiatimes.com/small-biz/legal/procedure-for-creditors-to-file-under-ibc-insolvency-and-bankruptcy-code/articleshow/70920647.cms?from=mdr

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