Economic Analysis of NPA’s in the Indian Banking Industry
1. Economic Analysis of NPA’s in the Indian Banking
Oindrilla Dutta Roy
3. Gross NPA and Net NPA
• Gross NPA is a advance which is considered
irrecoverable, for bank has made provisions, and which
is still held in banks‘ books of account.
• Net NPA is obtained by deducting items like interest
due but not recovered, part payment received and kept
in suspense account from Gross NPA.
• The problem of high gross NPAs is simply one of
• Historically, Indian public sector banks have been poor
on credit recovery, mainly because of very little legal
provision governing foreclosure and bankruptcy,
lengthy legal battles, sticky loans made to government
public sector undertakings, loan waivers and priority
• Net NPAs are comparatively better on a global basis
because of the stringent provisioning norms prescribed
for banks in 1991 by Narasimham Committee.
4. There are several challenges that Indian banks
will have to face as they look to compete in a
globalize environment. They are:
• Risk Management & Basel II
• Overseas Expansion
• Government Reforms
• Non Performing Assets (NPAs)
• Skilled Manpower
• Consumer Protection
5. Impact of NPAs on Banking Operations
1. The NPAs have destructive impact on the return on
assets in the following ways.
2. The interest income of banks reduced it is to be
accounted only on receipt basis.
3. The current profits of the banks are eroded because the
providing of doubtful debts and writing it off as bad
debts and it limits the recycling funds.
4. The capital adequacy ratio is disturbed and cost of
capital will go up.
5. The economic value addition (EVA) by banks gets upset
because EVA is equal to the net operating profit minus
cost of capital.
6. Causes responsible for increasing NPAs
• One of the main causes of NPAs in the banking sector is
the Directed loans system under which commercial banks
are required to supply 40% percentage of their credit to
• Most significant sources of NPAs are directed loans
supplied to the “micro sector” are problematic of
recoveries especially when some of its units become sick
or weak. PSBs 7 percent of net advances were directed to
• Poverty elevation programs like IRDP, RREP, SUME, SEPUP,
JRY, PMRY etc., failed on various grounds in meeting their
objectives. The huge amount of loan granted under these
schemes was totally unrecoverable by banks due to
political manipulation, misuse of funds and non-reliability
of target audience of these sections.
8. Preventive Management
Preventive measures are to prevent the asset
from becoming a non performing asset. Banks
has to concentrate on the following to
minimize the level of NPAs.
1. Early Warning Signals
2. Financial warning signals
3. Management related warning signals
4. Banking related signals
5. Watch-list/Special Mention Category
6. Willful Defaulters
9. Curative Management
The curative measures are designed to
maximize recoveries so that banks funds locked
up in NPAs are released for recycling.
The Central government and RBI have taken
steps for controlling incidence of fresh NPAs
and creating legal and regulatory environment
to facilitate the recovery of existing NPAs of
banks. They are:
1. One Time Settlement Schemes
2. Lok Adalats
3. Debt Recovery Tribunals (DRTs)
4. Securitization and SARFAESI Act
10. Asset Reconstruction Company (ARC)
• This empowerment encouraged the three major players in Indian
banking system, namely, State Bank of India (SBI), ICICI Bank Limited
(ICICI) and IDBI Bank Limited (IDBI) to come together to set-up the first
• Arcil was incorporated as a public limited company on February 11, 2002
and obtained its certificate of commencement of business on May 7,
2003. In pursuance of Section 3 of the Securitization Act 2002, it holds a
certificate of registration dated August 29, 2003, issued by the Reserve
Bank of India (RBI) and operates under powers conferred under the
Securitization Act, 2002. Arcil is also a "financial institution" within the
meaning of Section 2 (h) (ia) of the Recovery of Debts due to Banks and
Financial Institutions Act, 1993 (the "DRT Act").
• Arcil is the first ARC in the country to commence business of resolution
of non-performing assets (NPAs) upon acquisition from Indian banks and
financial institutions. As the first ARC, Arcil has played a pioneering role
in setting standards for the industry in India.
11. A. Unlocking capital for the banking system and the economy
B. Creating a vibrant market for distressed debt assets / securities in
India offering a trading platform for Lenders
C. To evolve and create significant capacity in the system for quicker
resolution of NPAs by deploying the assets optimally
16. • Corporate Debt Restructuring (CDR) framework is to ensure
timely and transparent mechanism for restructuring of the
corporate debts of viable entities facing problems, outside
the purview of BIFR, DRT and other legal proceedings, for
the benefit of all concerned.
CDR system in the country will have a three-tier structure:
A. CDR Standing Forum
B. CDR Empowered Group
C. CDR Cell
17. The Mechanism of the CDR
• CDR mechanism will be a voluntary system based on
debtor-creditor agreement and inter-creditor agreement.
The scheme will not apply to accounts involving only one
financial institution or one bank.
• The CDR mechanism will cover only multiple banking
accounts / syndication / consortium accounts with
outstanding exposure of Rs.20 crore and above by banks
• However, as an interim measure, permission for corporate
debt restructuring will be made available by RBI on the
basis of specific recommendation of CDR "Core-Group", if a
minimum of 75 per cent (by value) of the lenders
constituting banks and FIs consent for CDR, irrespective of
differences in asset classification status in banks/ financial
institutions. There would be no requirement of the account
/ company being sick NPA or being in default for a specified
period before reference to the CDR Group.
18. Circulation of Information of Defaulters
The RBI has put in place a system for
periodical circulation of details of willful
defaulters of banks and financial institutions.
The RBI also publishes a list of borrowers
(with outstanding aggregate rupees one crore
and above) against whom banks and financial
institutions in recovery of funds have filed
suits as on 31st March every year. It will serve
as a caution list while considering a request
for new or additional credit limits from
defaulting borrowing units and also from the
directors, proprietors and partners of these
19. Credit Information Bureau
The institutionalization of information sharing
arrangement is now possible through the newly
formed Credit Information Bureau of India Limited
(CIBIL) It was set up in January 2001, by SBI, HDFC,
and two foreign technology partners. This will
prevent those who take advantage of lack of system
of information sharing amongst leading institutions
to borrow large amount against same assets and
property, which has in no measures contributed to
the incremental of NPAs of banks.
20. Solutions proposed by RBI
• Restructured standard account provisioning has been increased to 5%
making it easier for banks to go for restructuring. On the flip side, this
has the potential to enhance tendency of evergreening of loans
• RBI has directed banks to give loans by looking at CIBIL score and is
encouraging banks to start sharing information amongst themselves.
This is to deal with cases of information asymmetry. RBI has directed
banks to report to Central Repository of Information on Large Credit
(CRILC) when principle/interest payment not paid between 61-90 days
• RBI has asked banks to conduct sector wise/activity wise analysis of
• SEBI has eased norms for banks to convert debt of distressed
borrowers into equity
• 5/25 scheme
• For existing and new projects greater than 500 crores and also for
existing projects which have been classified as bad debt or
stressed asset, bank can provide longer amortization periods of
25 years with the option of restructuring loans every 5 or 7 years
• The advantage of this scheme is that it provides for longer
lending period with inbuilt flexibility. Shorter lending periods
leads to companies stretching their balance sheet to pay back
• From bank’s point of view it is helpful as freshly restructured
asset is considered as bad debt and requires 15% provisioning by
banks against such loans leading to erosion of profitability for
28. under-recognition of NPAs
• There’s been an increase in divergences in classifying stressed corporate loans as
non-performing loans. (A loan on which a debtor has not made the scheduled
payment within its allotted time of 90 days is called a non performing loan or
NPL. A NPL is usually in default or close to being in default. Once a loan becomes
a NPL, the chances of it being repaid are usually slim.)
• So far still only 10–20% of steel loans are impaired for most banks. This number
could easily go up as steel has been a highly stressed sector because of the
global com oddities slow down.
• The majority of “House of Debt” groups’ stress is still neither NPL or restructured.
(House of Debt is a Credit Suisse report where it evaluated top 10 Indian
corporates, including companies owned by several billionaires such as Anil
Ambani, Anil Agarwal, Gautam Adani amongst others, and found that a steep
growth in borrowings had stretched the financials of these companies. Many of
those loans are yet to be restructured or declared as NPLs.)
29. Reasons for rising npas
As per the government, the main reasons for rise in NPAs are :
• sluggishness in the domestic growth in the recent past,
• slow recovery in the global economy
• continuing uncertainty in global markets leading to lower exports of
various products such as textiles and leather.
• careless lending practices.
• Wilfull defaulter
• Of all this, the biggest reason is the lack of autonomy in operations.
30. How has the NPA story evolved
• In just three months, banks have reported an additional Rs 2 lakh
crore bad loans.
• The intriguing question is how come banks did not disclose these
hidden NPAs all these years and why are they doing it all of a sudden?
• The answer lies in the March, 2017 target the RBI has given to banks
to clean up their balance sheets (to disclose the entire stock of bad
• This also shows the tendency of the banking system to hide bad loans
and show a healthier-than-real balance sheet to the investor.
31. Turning point
• One of the turning points in Indian banks’ NPA story is governor Rajan’s drive to
dig out the dirt from bank balance sheets. If left unattended, the NPAs possess
the potential to drive the Indian economy to a bottomless chasm at some point.
• Banks merrily pushed loans to the restructured loan basket at the first sign of
trouble and retained them as standard assets. Cronies thrived in these technical
adjustments since they were still eligible to borrow even more from the same
banks or other bank unless tagged as defaulters. It was Rajan who insisted that
banks shouldn’t postpone today’s problem to tomorrow and worsen it.
• Rajan also insisted banks recognise stress in their portfolio early and classify them
into special mention accounts (SMAs) depending on the period of repayment
delay. Banks were asked to form Joint Lenders’ Forum and address the problem
as a group. In effect, the RBI forced banks to have a clear roadmap to clean up
their balance sheets. He set a deadline of March 2017 for banks to clean up their
32. impact of NPAs on the profitability of the
• reduces earning capacity of the assets and as a result of this return on assets get
• Blocks capital: NPA’s carry risk weight of 100% (to the extent it is uncovered). Therefore
they block capital for maintaining Capital adequacy. As NPA’s do not earn any income,
they are adversely affecting “Capital Adequacy Ratio” of the bank.
• While calculating Economic Value Added (EVA =Net operating Profit after tax minus cost
of capital) for measuring performance towards shareholders value creation, cumulative
loan loss provisions on NPAs s considered as capital. Hence, it increases cost of capital
and reduces EVA.
• Low yield on advances: Due to NPAs, yield on advances shows a lower figure than actual
yield on “standard Advances”. The reasons that yield are calculated on weekly average
total advances including NPAs
• Affect on Return on Assets: NPAs reduce earning capacity of the assets and as a result of
this, ROA gets affected
33. Impact of npa on banks
• Banks profitability is affected adversely because of the provision of
doubtful debts and consequent write off as bad debts.
• Return on investment is reduced.
• The cost of capital will go up
• Banks cost of raising funds go up
• They result in reduced interest income
• The capital adequacy ratio is hindered as NPAs are entering into the
• Drain of profit
• Bad effect on goodwill
• Credit ratings gets affected
• A nonperforming asset (NPA) refers to a classification for loans on the
books of financial institutions that are in default or are in arrears on
scheduled payments of principal or interest. In most cases, debt is
classified as nonperforming when loan payments have not been made
for a period of 90 days.
35. Sale of npa to other banks
• A npa is eligible for sale to other banks only if it has a remained a NPA
for atleast 2 years in the books of the selling bank.
• The npa must be held by the purchasing bank at least for a period of
15months before it is sold to other banks but not to bank which
originally sold the npa.
• The bank may purchase/sell npa only on without recourse basis.
• If the sale is conducted below the net book value the shortfall shuld
be debited to P&L ac and if it is higher the excess provision will be
utilized to meet the loss on account of sale of other npa.