Banking News

Bad Loans (NPA) in Banks:Why do we have this state of affairs?


When a borrower defaults to make repayment of loan interest and or principal for more than 90 days, the bank and financial institutions classify such loan accounts as non-performing assets (NPAs). The NPA account causes multiple damages to the bank. It ceases to generate income to the bank. It reduces the recycling of funds for fresh loans. Also, banks need to make provision on NPA for possible capital loss. Therefore, NPA is considered as a double-edged razor to the banks; damaging their profit, weakening the capital structure, as well reducing the rating of the bank.

Public sector banks are the worst victims of NPAs:

As per ‘Quarterly BSR-1 released by RBI’, the Small borrowal accounts each with the credit limit up to ₹ 0.2 million, constituting three-fourth of total numbers of borrowal accounts, had  only a share of 7.3 percent in total outstanding credit in December 2014. From the above report, we may infer that it is the large borrowers who have been heavily damaging banking industries in India by loading on them the enormous amount of NPAs and not the small borrowers  responsible for the present state of affairs. From the various other reports, we may observe that five main sectors run by large borrowers of commercial banks namely infrastructure, iron and steel, textiles, mining and aviation that are major contributors to NPAs. The above five sectors contribute aggregate 54 percent. Within infrastructure credit, power generation, oil & gas enterprises (58%), transport (21%), Tele -communication (10%) are accounted for NPAs of banks.  The data available from RBI as of December 2014 reveals that the gross NPAs (non-performing assets) of the Public Sector banks stood at Rs 2,60,531 crore and the total value of loans writtenoff by the  banks in the last five years amounts to Rs.161018 crore. There were 2897 defaulting large borrowers having outstanding of Rs 10 crore and above at the end of September 2014. The total amount of NPA from the large borrowers stood at Rs 1.60 lakh crore. According to newspaper reports, the finance ministry has quoted 4845 cases of fraud over the past four years, costing 25 nationalized banks a whopping Rs.12660 crore. The above figures of NPAs is expected to be further increased in the current financial year, as the steel companies with Rs.196000 Crore and State electricity boards with Rs.53000 Crore stare at default in July 2015.

Why does NPAs growing in banks?

There are many opinions on real causes of swelling NPAs in the banking sector. The assumption in some quarters, which is currently gaining currency, is that the NPAs are bred mainly due to sweet deals between the bankers and the large borrowers. This view has gained currency because of hot revelations of possible corruption in banks at the highest level.  However, it is not correct to make allegations on all on the basis of such revelations of corruption by a few unscrupulous elements. It is unfair to cast aspersion on the entire community of bankers and business- men for NPAs. The deterioration of loan recovery in commercial banks can be on numerous reasons. A borrower may suffer losses due to various genuine reasons like prevalent business atmosphere, political, legal developments, cost and time overrun due to delay in getting certain permissions etc.  It is not easy to foresee such eventualities all the times either by the borrower or by the bank officials at the time of credit appraisal. The growing non-performing assets (NPAs) of whatever cause have carried enormous disrepute and distress to the banking sector and the concerns remain over the continued weakness in their asset quality.

Why banks are bending  too much and offer concession and write-offs to large borrowers:

In the cases of NPA accounts, the promoters always threaten the banks/financial institutions that the business would be brought to ground unless the bank makes the concessions, keeping the business alive. Let us study, why a promoter of the business entity should insist for banks to compensate his business losses, despite he is having own resources to cover the losses. If the same promoter able to earn fat profit from the business, whether the loss-making bank can ask him to pay the higher rate of interest for money borrowed by him. He does not agree. In that case, the question is why the bank should share his losses in his business?

Another pertinent question is, when the banks can recover dues from small borrowers where banks seize the hard collateral that is available if the borrower defaults, why it can’t possible to recover from the large borrowers. It is well known to public that none of the large promoters of business enterprises have lost their homes or have had to curb their lifestyles despite having offered their personal guarantees for the loans which ultimately turned into NPAs.

The reasons are not difficult to answer. The most palpable reason for the high level of NPAs in banking sector seems to be our judicial system. Banks and financial institutions have two major tools to recover their NPA dues. They are (i) Debt Recovery Tribunals (DRTS) under RDDBFI act 1993 and  (ii) action under SARFAESI act 2002 are two of the most effective tools set up for recovery of NPAs. DRT act has been set up for recovery of banks and financial institutions’ dues speedily without lengthy procedures of civil courts. The law indicates cases before DRT should be disposed-off within 6 months.  The SARFAESI Act provides additional teeth to the banks and financial institutions; it provides taking possession of the secured asset of the NPA borrower and disposal of the asset for realization of dues under NPAs without the intervention of Courts or Tribunals. However, in reality the recoveries of NPA accounts are not that simple. As per the data available, the cases disposed-off at DRT are only around 25% of cases pending at the beginning of the year. The numbers of unresolved cases at DRT are increasing every year and normally it takes minimum 4 to 5 years for DRT to decide a case filed today. Added to this delay in cases disposed-off, judgments of DRTs can be appealed to Debt Recovery Appellate Tribunals (DRATs). Thus it takes long time to decide on these appeals as there are only 5 DRATs in the entire country. Secondly, despite section 18 of RDDBFI Act is intended to prevent higher constitutional courts from intervening routinely in DRT and DRAT judgments. However, the large borrowers who have the wherewithal to hire classy lawyers, go for protracted appeals on the orders of DRT and DRAT.  Various High Courts have been taking up the cases by exercising their jurisdictions under article 226 for passing orders. Thus backlogs and delays are growing year after years with imminent stay orders and appeals at high courts. Meanwhile, as a result of backlogs and delays in obtaining judgments, the value of the money sought under recovery, loses its value. Due to passage of time the value of the assets like stock, plant and machineries etc. which are offered as security to the bank will be considerably reduced or become obsolete. Many a times, the defaulted debt becomes pittance when the recovery actually takes place with such delay. The large borrowers know the predicaments of banks in getting judgments through legal recourse. They simply take the advantage of the situation and in the bargain insist banks to make up their losses in the form of concession and write-offs. Grasping the asymmetry of power in the above situation, banks are tempted to meekly yield in and take the unfair deal the borrower offers.

How to abate this nuisance?

Recently, the Reserve Bank of India introduced Strategic Debt Restructuring scheme which paves way to ensure more ‘skin in the game’ of promoters. In terms of above scheme, JLF/Corporate Debt Restructuring Cell (CDR) may consider the following options when a loan is restructured:

  1. Possibility of transferring equity of the company by promoters to the lenders to compensate for their sacrifices;
  2. Promoters infusing more equity into their companies;
  3. Transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of company. This will enable a change in management control, should lenders favour it.

The introduction of above scheme is a move in the right direction. The restructuring package allow banks both under JLF and CDR mechanism, to stipulate the timeline during which certain viability milestones (e.g. improvement in certain financial ratios after a period of time, say, 6 months or 1 year and so on) would be achieved. The new framework also allows bank to bring strategic international investor in a sector and divest the holdings in the equity of the company in favour of ‘new promoter’ (domestic as well as overseas) as soon as possible.

Secondly, the system also needs professional turn-around agents/ Asset Management Companies of better management capability and capital, to take over distressed enterprise where the promoters do not have the capital and capacity to turnaround the business. Such agents should simply be the liquidators and there shall not be any question of returning the business to old promoters, once taken over by them.

Thirdly, it is worth examining by the Government to amend the laws  in such a way that the promoters should deposit the full judgment amount  ordered by the DRT and DRAT in advance, if they want to go for protracted appeals on the orders of DRT and DRAT. Such amendments of law would certainly reduce routine practice of frivolous appeals to delay the payment.

The Centre is stated to be considering setting up of bankruptcy courts. This is again a positive proposal in reducing the worsening state of NPAs in banking sector. The changes in law are absolutely necessary to create fear in the mind of evading large borrowers. The above steps would prevent or minimize the incidence of new NPA.

Related article: (1) Strategies to reduce NPAs (2) RBI releases Strategic Debt Restructuring Scheme for bad loans

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