Position of non-performing assets in FY22: A critical analysis

Introduction

The past two years have been significantly challenging for India due to the widespread COVID pandemic situation across the country, but out of the various sectors, the banking sectors are the most suffering section of the Indian Economy.

Whenever a bank lends any loan, it charges interest on the principal amount which is regarded as an asset to the bank. If the payment of this interest or advance becomes overdue for more than ninety days (one quarter), then it becomes a Non-Performing Asset (NPA) for the bank. The number of Non-Performing Assets has increased drastically in India, but with Covid-19 waning, the Indian banks are gradually and steadily strengthening their recovery in the first quarter of the fiscal year 2022-2023

Recently the Reserve Bank of India (RBI) released its Financial Stability Report of June 2022, which injected some sense of relief to the banking sectors. The report said that “The Gross Non-Performing Assets, commonly known as GNPAs, of Scheduled Commercial Banks (SCBs) fell to a six-year low of 5.9% in March 2022 and could fall further to 5.3% by March 2023 which were at 7.4% in March 2021. Further, the Net NPA has also reduced to 1.7% during the same period.”

This article primarily aims at critically analyse the current situation of NPAs in India along with the role of the Insolvency and Bankruptcy Code 2016 in resolving the remaining Non-Performing Assets.

Categorization of NPAs

Once the asset enters the domain of the Non-Performing Assets category, the banks are required to bifurcate them into different categories depending upon the time period for which that specific asset has remained there as non-performing. For the subsequent categorization of NPAs, there exist Three categories which are as follows:

1. Sub-standard Assets

A sub-standard asset is any asset which has remained as an NPA for a period of less than or equal to 12 months. The period for an asset to be classified as a sub-standard asset does not exceed one year. Such assets are at a higher risk level, incorporated with a borrower that has less than ideal credit.

Subsequently, the banks become less certain about the repayment of the full amount of loan or advances landed to the borrower. In order to correct the deficiency and to safeguard the banks from any losses, the banks usually take haircuts to clear such NPAs.

Haircuts: A haircut refers to the shortfall in recovery or lower-than-market value placed on an asset being used as collateral for a loan. In other words, it means the reduction in the market value of an asset.

2. Doubtful Assets

Doubtful assets are non-performing assets which have been past due for more than 12 months. The assets remain sub-standard assets for a period exceeding 12 months.

This category of NPA severely affects the risk capacity of the banks. Any asset classified as a doubtful asset has similar properties as of sub-standard asset along with a few additional elements that the liquidation of a full asset becomes highly questionable and uncertain.

Liquidation: Liquidation is a legal method usually used to pay off debts. It means converting property or non-liquid assets into liquid assets by selling them on the open market.

3. Loss Assets

Loss assets are non-performing assets with an over-extended period of non-payment by the debtor. If the loss has been identified by the bank or internal or external auditors or by the co-operation department or by the RBI inspection but when the amount has been written off wholly or partly.

In simple words, these assets are also recognised as uncollectible or of very little value that their continuance as a standard asset is not worth it even though there may be some recovery value, but the banks are compelled to accept that the loan or advances will never get repaid and it must maintain a record of loss on the bank’s balance sheet.

Balance sheet: The balance sheet displays the company’s total assets and how the assets are financed, either through either debt or equity. It can also be referred to as a statement of net worth or a statement of financial position.

Impact of NPAs on the Indian economy

Constant rate of growing numbers of NPAs has adverse effects on the reliability of the banks which ultimately degrade the whole economy. Since all the sectors are directly or indirectly dependent on each other in an economy, the impact can be seen in every sector including the Industrial sectors as well.

Banks are responsible for providing funds to the industrial sector to escalate its growth. But the continuous downfall of the credit to industries is destructive to not just the industries but the overall economy too.

An increasing number of Non-Performing Assets can impact the whole economy in the following ways:

• Reduction in the profitability of banks.
• Negative impact on the credibility of the banks.
• Destabilize the confidence of depositors, investors, lenders, and shareholders of the concerned bank, which will lead to the withdrawal of their money and subsequently the banking system will collapse.
• The reduction in the availability of funds with the bank is due to direct stress caused by NPA.
• Increase in the normal interest rates on the principal amount to maintain and balance the profit margin.
• Less interest income directly impacts the profitability of a bank, under recovery of principal capital can result in the erosion of the bank’s capital base. The combination of both can potentially hamper the stability of a bank.
• Loss of employment, inflation, bear market, etc. due to a reduction in the availability of working capital with the financial institutions.
• increasing the burden of the judiciary, and affecting the working system of the organization.
• Affecting national development, as a result of a downfall in circulating capital within the economy and a reduction in funds available to the government.
• Distressing companies coupled with rising NPAs of PSBs in holding up investment in the economy.
• Lack of funding for infrastructure, which is a major factor in economic growth, has a massive impact on the Indian economy.
• Unemployment in Food processing and agriculture sectors, as 5.3% of total NPAs is accounted by food processing sectors.

Analysis of RBI’S Financial stability report, 2022

The recent report stated that “The Gross Non-Performing Assets (GNPAs) of Scheduled Commercial Banks (SCBs) fell to a six-year low of 5.9% in March 2022.”

The news explicitly establishes that there is a fall in a number of growing Non-Performing Assets of the scheduled commercial banks in FY22. This report presents a much more positive and satisfactory image of the Indian banking system as the GNPA ratio is one of the most valid factors to check the health of any existing banking system.
According to the stress tests which was recently conducted by RBI, the SCBs GNPA ratio could improve from 5.9 per cent in March 2022 to 5.3 per cent by March 2023 under the baseline scenario driven by higher bank credit growth and a declining trend in the stock of the GNPAs.

The Indian banks have adopted various ways to counter the problem of rising NPAs which have resulted in a better position of the banks in terms of financial stability. Numerous methods implemented by the banks to reduce the number of NPAs are as follows:

1. 4R’s Strategy: This strategy was adopted and started in 2015. The four Rs in this method refer to Recognising the NPAs transparently and effectively, Resolution and recovery of debts, Recapitalizing Public Sector Banks (PSBs) and Reforms in the financial ecosystem and PSBs of the country.

2. EASE (Enhanced Access and Service Excellence): This agenda of EASE for PSB reforms was introduced in 2018 for two separate banking models which are;

• CLEAN Banking, stands for, Clean credit, Leveraging data, Ensuring accountability, Action against defaulters and NPA recovery of the banks.
• SMART Banking, stands for, Speedy, Multi-channel reach, Accessible and affordable, Responsive, and Technologically Enhanced way of reducing NPAs.

3. The Mission Indra Dhanush: It is a seven prolonged program that aims to address and combat the challenges faced by the public sector banks (PSBs) and help them to compete with the private sector banks by reducing the interference of politics in the working system and improved credit of PSBs. The 7 programs involve;

• Framework of Accountability
• Distressing
• Bank Board Bureau
• Governance Reforms
• Empowerment
• Capitalisation
• Appointments

4. Policy Support: Amid the Covid pandemic upsurge, the government and RBI have laid out several policies to strengthen the risk absorption capacity of the Scheduled Commercial Banks such as:

• Amendment in Insolvency and Bankruptcy Code (IBC) 2016: This amendment in IBC provided the Banks with a Pre-Packaged Insolvency Resolution Process (PPIRP) for the corporate MSMEs (Micro, Small and Medium Enterprises).
• Credit Guarantee Scheme: It was launched by the government of India during the Covid-19 pandemic to strengthen the credit delivery system and to provide credit, especially to the MSE sectors, create access to finance for unserved, under-served and underprivileged, making the availability of finance from conventional leaders to new generation entrepreneurs.

5. Progressive normalisation of economic activities: These normalisations helped the banks which were at high risk of collapsing to get a fresh start on the lending cycle and improve their profitability of the banks.

6. Establishment of NARCL and IDRCL: Separate bodies were set up in 2021 to resolve the challenges of NPAs and clear out the bank books from any losses such as National Asset Reconstruction Company Limited (NARCL) and India Debt Resolution Company Limited (IDRCL).

7. Merger of PSBs: Merging of banks consolidates the resources of the merged banks which reduces the over financing and multiple financing by the banks. these mergers indirectly help the banks in reducing the percentage of NPAs.

If these methods of resolution of NPAs continue to give the output in a positive direction and are implemented efficiently and effectively, then the percentage of GNPA may fall to 5.3% by March 2023, the report said.

Challenges for the overall banking system

Even though several reforms and policies have been laid down to counter the problems of NPAs, there are many remaining and emerging challenges left to resolve for the PSBs and the overall banking system. Some of the major challenges are as follows:

• Higher rate of NPAs in PSBs: PSBs being the backbone of the Indian Banking system and the Indian economy, are still at 7.6% of NPA. And in the case of severe stress scenarios, the percentage is expected to rise to 10.5% by the end of FY23.
• Delayed working in NARCL: National Asset Reconstruction Company Limited (NARCL), has missed its March deadline for the acquisition of 15 stressed assets which were worth ₹50,000 crores from the banks. NARCL need to improve its working efficiency to complete and resolve the NPA issue at a faster pace.
• The decline in IBC Resolution process: The amount which is perceived from the resolution is shifting to a lower level than the liquidation value of assets for the very first time in Q4 of FY22 due to the unnecessary delays in the process of resolution of stressed assets under the Insolvency and Bankruptcy Code.
• Lack of competition in PSBs: In comparison to the private sector banks, the Net-Interest Margins, and the ratio of profitability of public sector banks is much lower due to the lack of competitiveness in PSBs.

What is the way forward?

Banking sectors are recognised as the backbone of the economy of every country. During this pandemic period, various challenges such as economic slowdown, increased stressed assets, risk of recession, rising inflation, a decline of ease of doing business, etc. have been recorded in the country. Hence to eradicate these issues the banks and government must take the following steps:

• Amendments in the existing Insolvency and Bankruptcy Code to regulate the National Company Law Tribunals (NCLT) and to resolve unnecessary delays in the resolution process under the IBC.
• To strengthen the financial stability of the economy and tackle the upcoming economic risks, the government should introduce specific banking reforms.
• Changes must be made to maintain asset quality and capital adequacy by following the path of risk aversion.

Conclusion

Once Hendrith Smith quoted that, “A healthy banking system is one of the vital parts of a nation’s foundation.” It is the primary duty of the government to maintain and regulate the banking reforms of the country.

If any factor affects the stability of banks, it leads to the downfall in the reputation and profitability of those banks which ultimately hampers the economic stability of the whole country.

So, the necessity of efficient reforms in improving the current conditions of the banking system is the need of the hour, especially after the Covid-19 period. The high percentage of Non-Performing Assets (NPA) of any bank indicated that the banking policies and working methods of that bank are not much efficacious. Therefore, the banks must take quick and instant action towards reforming of NPAs into profitable assets.

This article has been authored by Priyanshi Parmar, a student at Amity university Madhya Pradesh, Gwalior.