What are NPAs?
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.
There are three types of NPAs
- Sub-standard– If a period of 90 days to 1 year has elapsed from the due date of repayment of loan.
- Doubtful– If a period of 1 year to 3 years has elapsed from the due date of repayment of loan
- Loss– If a period of 3 years or more has elapsed from the due date of repayment of loan
It is to be noted that Public sector banks are more prone to face the problems of NPAs than the private sector banks. This may be due to a range of issues ranging from poor managerial control to defective lending practices.
Causes that are internal to the banking system
- Defective lending practices. Laxity is observed while doing the background checks of the companies. In addition, there is no SWOT analysis done by the banks. Therefore, the problems persist.
- The technology used in the public-sector banks are obsolete in the present scenario of high tech banking. The Management Information System and Financial accounting apparatus is inefficient.
- Poor credit appraisal system.
- Managerial deficiencies.
- There is hardly any follow-up of the project by the bank management, after the loan is sanctioned. This indicates lack of responsibility and accountability on the part of the bank management.
Causes that are beyond the control of banking system
- The SARFESI act has failed to create an efficient recovery framework.
- The recovery tribunal system is ineffective as it takes years to establish an entity as a wilful defaulter. In the meantime, the value of defaulter’s assets depreciates to a great extent. So that, even if banks sell off the assets, it gets too little too late.
- The corporates suffer from various issues that lead them to be unable to pay back loans. These range from industrial sickness, lack of reserves and technology to fall in demand and increasing costs. They also are a victim of change in government policies.
- Overall slowdown in economy and decline in the growth of core sector.
- Priority Sector Lending leaves less liquidity to the banks to lend to others.
The twin balance-sheet problem
In Twin Balance Sheet (TBS) problem, on one side there are overleveraged and distressed companies and on the other side the rising NPAs in Public Sector Bank balance sheets. Both the banking and corporate sectors are under stress as due to loss corporate couldn’t repay the loan and due to higher NPA banks couldn’t lend money to economy.
Solution to the NPA problem
Initiatives by the government
- Recapitalization– Rs. 2.11 lakh crore to be spent on recapitalization of public sector banks.
- Reduction in government’s equity in public sector banks. The government expects to raise Rs. 58000 crores out of the above figure by selling of its stake in public sector banks.
- The government intends revive economy by making huge investments in building infrastructure. e.g. Bharatmala project, Sagarmala project, National waterways, port development etc.
- The new Insolvency and Bankruptcy code.
- Indradhanush mission for banks
- Mergers of banks
- Amendments in SARFESI
Suggestions by the RBI
- Independent and objective credit appraisal of the corporates is required before extending loan to them.
- A proper analysis of the project shall be done. An assessment shall be made regarding the future prospects of the project.
- Asset Reconstruction reforms are required.
- Strategic Debt Restructuring shall be in place. A plan to convert loans to equity and an effective Asset reconstruction mechanism is required.
- BASEL III norms– RBI advised that these norms shall be implemented by March 2019.
Evaluation of the government initiatives
- Recapitalisation of banks strengthen the banking system. This, in turn will increase the value of the government equity in these banks. Now, when the government sells off a part of its equity in future, it is likely to get a better deal. The Nayak committee had recommended the government to reduce its stake to less than 51% in the public-sector banks.
- One of the criticisms of the recapitalisation move is that it will not initiate efficiency, transparency and accountability in the public-sector banks. Along with recapitalisation, restructuring of the banks is required.
- Government rescuing the banks out of this stress is an example of rewarding them for bad performance. The banking sector is unlikely to improve its risky and defective lending practices.
- Additionally, the international experience of recapitalisation shows that it only stimulates larger banks and is helpful for big corporates. This is in divergence of government’s claim that recapitalisation will stimulate small banks and MSMEs.
- Government investment in infrastructure shall give a signal to private sector, which right now is hesitant to invest in infrastructure, to follow the lead.
- Infrastructure building will create jobs as well as improve connectivity.
- However, the effort is likely to create more inequality among the citizens and regions as the focus is not on hinterland connectivity and regional development as a whole.
- Recapitalisation and restructuring shall go hand in hand.
- Government equity shall be reduced to less than 51%.
- A more balanced and equitable infrastructure development shall be executed.
- The overall effect of recapitalisation me still be positive as most of the money is not coming from the government budget. Out of Rs. 2.11 lakh crore, Rs. 18000 will b spent as a budgetary support, Rs. 58000 will be raised by selling of government equity and the rest will be raised by issuing bonds. This might act as a stimulus to revive economy