DR.

RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY,

LUCKNOW

BANKING AND INSAURANCE LAW

FINAL DRAFT ON

NON-PERFORMING ASSETS: ITS REGULATION AND ROLE OF RBI

SUBMITTED TO: SUBMITTED BY :

 TABLE OF CONTENTS

1. INTRODUCTION................................................................................................................... 1

2. DEFINITION OF NON-PERFORMING ASSETS ...................................................................... 2

3. CLASSIFICATION OF NON-PERFORMING ASSETS .............................................................. 5

4. REGULATION AND RECOVERY OF NON-PERFORMING ASSETS ........................................ 6

4.1. MEASURES INITIATED BY RBI AND GOVERNMENT FOR REDUCTION OF NPAS .......... 6

4.2. DRT ACT ..................................................................................................................... 8

4.3. CIRCULATION OF INFORMATION ON DEFAULTERS ........................................................ 9

4.4. SARFAESI ACT .......................................................................................................... 9

4.5. LOK-ADALATS ............................................................................................................. 9

4.6. ASSET RECONSTRUCTION COMPANY.......................................................................... 10

4.7. CORPORATE DEBT RESTRUCTURING .......................................................................... 10

5. PREVENTION/ REDUCTION ............................................................................................... 14

6. SUPREME COURT ON NON-PERFORMING ASSET ............................................................ 16

6.1. SALIM AKBARALI NANJI V. UNION OF INDIA: ON WRITING OFF NPAS...................... 16

6.2. ICICI BANK LTD. V. APS STAR INDUSTRIES LTD. ..................................................... 17

7. CONCLUSION .................................................................................................................... 19

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 1. INTRODUCTION

All advances given by banks are termed “assets”, as they generate income for the bank by
way of interest or instalments. Banks give loans and advances to borrowers which may be
categorised as: (i) standard asset (any loan which has not defaulted in repayment) or (ii) non-
performing asset (NPA), based on their performance. However, a loan turns bad if the interest
or instalment remains unpaid even after the due date and turns into a nonperforming asset, or
NPA, if it remains unpaid for a period of more than 90 days.1 NPAs are loans and advances
given by banks, on which the borrower has ceased to pay interest and principal repayments.

In recent years, the gross NPAs of banks have increased from 2.3% of total loans in 2008 to
4.3% in 2015. The increase in NPAs may be due to various reasons, including slow growth in
domestic market and drop in prices of commodities in the global markets. In addition, exports
of products such as steel, textiles, leather and gems have slowed down.2 The increase in non-
performing assets affects the credit market in the country. This is due to the impact that non-
repayment of loans has on the cash flow of banks and the availability of funds with them.3
Additionally, a rising trend in non-performing assets may also make banks unwilling to lend.
This could be because there are lesser chances of debt recovery due to prevailing market
conditions.4 For example, banks may be unwilling to lend to the automobile sector if
companies in this sector are making losses and defaulting on current loans. Non-performing
assets impact the economy in the following ways:

1. Profitability: NPA affects current profit but also future stream of profit, which may lead
to loss of some long-term beneficial opportunity. Another impact of reduction in
profitability is low ROI (Return on Investment), which adversely affect current earnings
of bank.

2. Liquidity: Money gets blocked, decreased profit lead to lack of enough cash at hand
which lead to borrowing money for shortest period of time which lead to additional cost

1
Sandeep Singh, Meaning Non-Performing Assets (Indian Express, February 10, 2016), available at
http://indianexpress.com/article/explained/meaning-non-performing-assets/.
2
‘Non-Performing Assets of Financial Institutions’, 27th Report of the Department-related Standing Committee
on Finance, available at http://164.100.47.134/lsscommittee/Finance/16_Finance_27.pdf.
3
Bankruptcy Law Reforms Committee, November 2015, available at
http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf.
4
Vatsal Khullar, The Rise of Non-Performing Assets in India (PRS India, May 11, 2016), available at
http://www.prsindia.org/theprsblog/?p=3652.

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 to the company. Difficulty in operating the functions of bank is another cause of NPA due
to lack of money, routine payments and dues.

3. Involvement of Management: Time and efforts of management is another indirect cost

which bank has to, bear due to NPA. Time and efforts of management in handling and
managing NPA would have diverted to some fruitful activities, which would have given
good returns. Now day s banks have special employees to deal and handle NPAs, which
is additional cost to the bank.

4. Credit Loss: Banks which are facing problem of NPA are adversely affected in terms of
market credit. They lose goodwill and brand image and credit which have negative impact
to the people who are putting their money in the banks.5

Hence, we can see that increase in number of Non-Performing Assets s detrimental for the
financial health of the country and hence strong measures are required to regulate NPAs.
Hence, RBI has released a Master Circular titled “Prudential norms on Income Recognition,
Asset Classification and Provisioning pertaining to Advances” to define and regulate NPAs.
The following project-work further elaborates upon the issue and explains the definition of
NPAs as well as the regulatory and recovery mechanisms concerning NPAs.

2. DEFINITION OF NON-PERFORMING ASSETS

The assets of the banks which don’t perform are called Non-Performing Assets (NPA) or bad
loans. Bank’s assets are the loans and advances given to customers. If customers don’t pay
either interest or part of principal or both, the loan turns into bad loan. According to RBI,
terms loans on which interest or instalment of principal remain overdue for a period of more
than 90 days from the end of a particular quarter is called a Non-performing Asset. However,
in terms of Agriculture / Farm Loans; the NPA is defined as under: For short duration crop
agriculture loans such as paddy, Jowar, Bajra etc. if the loan (instalment / interest) is not paid
for 2 crop seasons, it would be termed as a NPA. For Long Duration Crops, the above would
be 1 Crop season from the due date. In India, the definition of non-performing assets has
changed over time. According to the Narasimham Committee Report (1991), those assets

5
Amit Kumar Srivastava, Non-Performing Assets & its' Role in Indian Perspective
(A Study of Public, Private & Foreign Sector Banks), available at
http://www.indianmba.com/Faculty_Column/FC1576/fc1576.html.

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(advances, bills discounted, overdrafts, cash credit etc.) for which the interest remains due for
a period of four quarters (180 days) should be considered as non-performing assets.
Subsequently, this period was reduced, and from March 1995 onwards the assets for which
the interest has remained unpaid for 90 days were considered as non-performing assets.6

According to Section 2(o) of the SARFAESI Act, 2002, a "non-performing asset" means an
asset or account of a borrower, which has been classified by a bank or financial institution as
sub-standard, doubtful or loss asset,--

(a) in case such bank or financial institution is administered or regulated by any

authority or body established, constituted or appointed by any law for the time being
in force, in accordance with the directions or guidelines relating to assets
classifications issued by such authority or body;

(b) in any other case, in accordance with the directions or guidelines relating to assets
classifications issued by the Reserve Bank;7

The Master Circular issued by the Reserve Bank of India further defines the term ‘non-
performing assets’. According to ¶ 2.1., an asset, including a leased asset, becomes non-
performing when it ceases to generate income for the bank. It further states that a non-
performing asset is a loan or an advance where;

 interest and/ or instalment of principal remain overdue for a period of more than 90
days in respect of a term loan,

 the account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of
an Overdraft/Cash Credit (OD/CC),

 the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,

 the instalment of principal or interest there on remains overdue for two crop seasons
for short duration crops,

 the instalment of principal or interest there on remains overdue for one crop season
for long duration crops,

6
Srinivas KT, A Study On Non-Performing Assets Of Commercial Banks In India, available at
http://www.abhinavjournal.com/images/Management_&_Technology/Dec13/10.pdf.
7
§2(o), The Securitisation And Reconstruction Of Financial Assets And Enforcement Of Security Interest Act,
2002.

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  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.

 in respect of derivative transactions, the overdue receivables representing positive

mark-to-market value of a derivative contract, if these remain unpaid for a period of
90 days from the specified due date for payment.

Banks should, classify an account as NPA only if the interest due and charged during any
quarter is not serviced fully within 90 days from the end of the quarter.

‘Out of Order’ status: An account should be treated as 'out of order' if the outstanding
balance remains continuously in excess of the sanctioned limit/drawing power. In
cases where the outstanding balance in the principal operating account is less than the
sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the
date of Balance Sheet or credits are not enough to cover the interest debited during the same
period, these accounts should be treated as 'out of order'.

‘Overdue’: Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid
on the due date fixed by the bank.

Non-Performing Asset means an asset or account of borrower, which has been classified by a
bank or financial institution as sub- standard, doubtful or loss asset, in accordance with the
directions or guidelines relating to asset classification issued by RBI. An amount due under
any credit facility is treated as "past due" when it has not been paid within 30 days from the
due date. Due to the improvement in the payment and settlement systems, recovery climate,
up gradation of technology in the banking system, etc., it was decided to dispense with past
due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non per
forming asset (NPA) shall be an advance where. With a view to moving towards international
best practices and to ensure greater transparency, it has been decided to adopt the '90 days
overdue' norm for identification of NPAs, Non-Performing Asset means an asset or account
of borrower, which has been classified by a bank or financial institution as sub- standard,
doubtful or loss asset, in accordance with the directions or guidelines relating to asset
classification issued by RBI. An amount due under any credit facility is treated as "past due"
when it has not been paid within 30 days from the due date. Due to the improvement in the
payment and settlement systems, recovery climate, up gradation of technology in the banking

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system, etc., it was decided to dispense with 'past due' concept, with effect from March 31,
2001.

3. CLASSIFICATION OF NON-PERFORMING ASSETS

Standard Assets: Standard assets are the ones in which the bank is receiving interest as well
as the principal amount of the loan regularly from the customer. Here it is also very important
that in this case the arrears of interest and the principal amount of loan do not exceed 90 days
at the end of financial year. If asset fails to be in category of standard asset that is amount due
more than 90 days then it is NPA and NPAs are further need to classify in sub categories.

Non-Performing Assets: Banks are required to classify non-performing assets further into
the following three categories based on the period for which the asset has remained non-
performing and the realisability of the dues:

a. Sub-standard Assets: With effect from 31 March 2005, a substandard asset would be
one, which has remained NPA for a period less than or equal to 12 months. In such
cases, the current net worth of the borrower/ guarantor or the current market value of
the security charged is not enough to ensure recovery of the dues to the banks in full.
In other words, such an asset will have well defined credit weaknesses that jeopardise
the liquidation of the debt and are characterised by the distinct possibility that the
banks will sustain some loss, if deficiencies are not corrected.

b. Doubtful Assets: With effect from March 31, 2005, an asset would be classified as
doubtful if it has remained in the substandard category for a period of 12 months. A
loan classified as doubtful has all the weaknesses inherent in assets that were
classified as substandard, with the added characteristic that the weaknesses make
collection or liquidation in full, – on the basis of currently known facts,
conditions and values – highly questionable and improbable.

c. Loss Assets: A loss asset is one where loss has been identified by the bank or internal
or external auditors or the RBI inspection but the amount has not been written off
wholly. In other words, such an asset is considered uncollectible and of such little

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 value that its continuance as a bankable asset is not warranted although there may be
some salvage or recovery value.

4. REGULATION AND RECOVERY OF NON-PERFORMING ASSETS

There are various legislative mechanisms available with banks for debt recovery. These
include: (i) Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (DRT Act)
and (ii) Securitisation and Reconstruction of Financial Assets and Security Interest Act, 2002
(SARFAESI Act). The Debt Recovery Tribunals established under DRT Act allow banks to
recover outstanding loans. The SARFAESI Act allows a secured creditor to enforce his
security interest without the intervention of courts or tribunals. In addition to these, there are
voluntary mechanisms such as Corporate Debt Restructuring and Strategic Debt
Restructuring. These mechanisms allow banks to collectively restructure debt of borrowers
(which includes changing repayment schedule of loans) and take over the management of a
company.8 Among the various channels of recovery available to banks for dealing with bad
loans, the SARFAESI Act and the Debt Recovery Tribunals (DRTs) have been the most
effective in terms of amount recovered.

4.1. Measures Initiated By RBI And Government Of India For Reduction Of NPAs
Compromise settlement schemes: The RBI / Government of India have been constantly
inciting the banks to take steps for arresting the incidence of fresh NPAs and have also been
creating legal and regulatory environment to facilitate the recovery of existing NPAs of
banks. The broad framework for compromise or negotiated settlement of NPAs advised by
RBI in July 1995 continues to be in place. Banks are free to design and implement their own
policies for recovery and write-off incorporating compromise and negotiated settlements with
the approval of their Boards, particularly for old and unresolved cases falling under the NPA
category. The policy framework suggested by RBI provides for setting up of an independent
Settlement Advisory Committees headed by a retired Judge of the High Court to scrutinize
and recommend compromise proposals.

Specific guidelines were issued in May 1999 to public sector banks for onetime non-
discretionary and non-discriminatory settlement of NPAs of small sector. The scheme was

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operative up to September 30, 2000. [Public sector banks recovered Rs. 668 crore through
compromise settlement under this scheme.] Guidelines were modified in July 2000 for
recovery of the stock of NPAs of Rs. 5 crore and less as on 31 March 1997. [The above
guidelines which were valid up to June 30, 2001 helped the public sector banks to recover Rs.
2600 crore by September 2001]

An OTS Scheme covering advances of Rs.25000 and below continues to be in operation and
guidelines in pursuance to the budget announcement of the Hon’ble Finance Minister
providing for OTS for advances up to Rs.50,000 in respect of NPAs of small/marginal
farmers are being drawn up. 9

Advantages

i) Saves money, time and manpower

Banks are mainly concerned with recovery of dues, to the maximum possible extent, at
minimum expense. By entering into compromise settlements, the objective is achieved. Also,
a lot of executive time is saved because most of the usual problems / delays associated with
court action are avoided.

ii) Projects a helpful image of the Bank

A well-concluded compromise settlement, which results in a ‘WIN-WIN’ for the Bank as

well as the borrower, is a strong positive propaganda for the Bank. The impression generated
is that the Bank is capable not only of sympathy, but also empathy.

iii) Expedites recycling of funds

Compromise settlements aim at quick recovery. Recovery means funds becoming available
for recycling and, additional interest generation.

iv) Cleanses Balance Sheet

With the NPA level going down, and the additional funds becoming available for recycling as
fresh advances, the asset quality of the Bank is bound to go up. Improved asset quality
signifies higher profits by reduced provisions and increased interest income. With additions
to the reserves, the capital position also improves, improving the Capital Adequacy position.

8
Vatsal Khullar, The Rise of Non-Performing Assets in India (PRS India, May 11, 2016), available at
http://www.prsindia.org/theprsblog/?p=3652.
9
http://www.slideshare.net/parneetwalia/project-report-on-npas#!

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Disadvantages

i. Compromise involves loss, since full recovery is not possible. In fact, full
recovery is not even envisaged, but sacrifice is.

ii. It may be viewed as a reward for default, especially if chronic default cases are
settled by negotiations.

iii. It may have a demonstrative effect, and so may vitiate the culture of repayment

iv. There is also the possibility of misuse or, even, malafides, since assessment of
situation is highly subjective.

Practical aspects of compromise settlements

Every compromise proposal needs to be looked at individually, evaluated strictly on merits,

and negotiated properly for maximization of benefit to the Bank. Hence, a straightjacket
approach is not possible, neither is it desirable, to give strict guidelines for compromise
settlements. 10

4.2. DRT Act

Recovery of Debts Due to Banks and Financial Institutions (DRT) Act provides setting
up of Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate
Tribunals (DRATs) for expeditious and exclusive disposal of suits filed by banks / Financial
Institutions for recovery of their dues in NPA accounts with outstanding amount of Rs. 10 lac
and above. Government has, so far, set up 33 DRTs and 5 DRATs all over the country.11
Provisions for placement of more than one Recovery Officer, power to attach defendant’s
property/assets before judgment, penal provisions for disobedience of Tribunal’s order or for
breach of any terms of the order and appointment of receiver with powers of realization,
management, protection and preservation of property are expected to provide necessary teeth
to the DRTs and speed up the recovery of NPAs in the times to come. RBI on its part has
suggested to the Government to consider enactment of appropriate penal provisions against
obstruction by borrowers in possession of attached properties by DRT receivers, and notify
borrowers who default to honour the decrees passed against them. 12

10
http://www.slideshare.net/parneetwalia/project-report-on-npas#!
11
Banking System in India- Non-Performing Assets (July 5, 2014), available at
http://www.insightsonindia.com/2014/07/05/banking-system-india-non-performing-assets/
12
http://www.slideshare.net/parneetwalia/project-report-on-npas#!

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 4.3. Circulation of Information on Defaulters
The RBI has put in place a system for periodical circulation of details of wilful defaults of
borrowers of banks and financial institutions. This serves as a caution list while considering
requests for new or additional credit limits from defaulting borrowing units and also from the
directors /proprietors / partners of these entities. RBI also publishes a list of borrowers (with
outstanding aggregating Rs. 1 crore and above) against whom suits have been filed by banks
and FIs for recovery of their funds, as on 31st March every year. It is our experience that
these measures had not contributed to any perceptible recoveries from the defaulting entities.
However, they serve as negative basket of steps shutting off fresh loans to these defaulters. I
strongly believe that a real breakthrough can come only if there is a change in the repayment
psyche of the Indian borrowers.13

4.4. SARFAESI Act

The Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interest (SARFAESI) Act, 2002 – The Act empowers Banks / Financial Institutions to
recover their non-performing assets without the intervention of the Court, through acquiring
and disposing of the secured assets in NPA accounts with outstanding amount of Rs. 1 lakh
and above. The banks have to first issue a notice. Then, on the borrower’s failure to repay,
they can:
 Take possession of security and/or
 Take over the management of the borrowing concern.
 Appoint a person to manage the concern.

4.5. Lok-Adalats
Section 89 of the Civil Procedure Code provides resolution of disputes through ADR
methods such as Arbitration, Conciliation, Lok Adalats and Mediation. Lok Adalat
mechanism offers expeditious, in-expensive and mutually acceptable way of settlement of
disputes. Government has advised the public sector banks to utilize this mechanism to its
fullest potential for recovery in Non-performing Assets (NPAs) cases. Lok Adalat
institutions help banks to settle disputes involving accounts in “doubtful” and “loss”
category, with outstanding balance of Rs.5 lakh for compromise settlement under Lok
Adalats. Debt Recovery Tribunals have now been empowered to organize Lok Adalats to
decide on cases of NPAs of Rs.10 lakhs and above. The public sector banks had recovered

13
Id.

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Rs.40.38 crore as on September 30, 2001, through the forum of Lok Adalat. The progress
through this channel is expected to pick up in the coming years particularly looking at the
recent initiatives taken by some of the public sector banks and DRTs in Mumbai. 14

4.6. Asset Reconstruction Company

An Asset Reconstruction Company with an authorized capital of Rs.2000 crore and initial
paid up capital Rs.1400 crore is to be set up as a trust for undertaking activities relating to
asset reconstruction. It would negotiate with banks and financial institutions for acquiring
distressed assets and develop markets for such assets. Government of India proposes to go in
for legal reforms to facilitate the functioning of ARC mechanism

4.7. Corporate Debt Restructuring

Corporate Debt Restructuring mechanism has been institutionalized in 2001 to provide a
timely and transparent system for restructuring of the corporate debts of Rs.20 crore and
above with the banks and financial institutions. The objective of the Corporate Debt
Restructuring (CDR) framework is to ensure timely and transparent mechanism for
restructuring the corporate debts of viable entities facing problems, outside the purview of
BIFR, DRT and other legal proceedings, for the benefit of all concerned. In particular, the
framework aims at preserving viable corporates that are affected by certain internal and
external factors and minimize the losses to the creditors and other stakeholders through an
orderly and coordinated restructuring programme.

Scope: The CDR Mechanism has been designed to facilitate restructuring of advances of
borrowers enjoying credit facilities from more than one bank / Financial Institution (FI) in a
coordinated manner. The CDR Mechanism is an organizational framework institutionalized
for speedy disposal of restructuring proposals of large borrowers availing finance from more
than one banks / FIs. This mechanism will be available to all borrowers engaged in any type
of activity subject to the following conditions :

a) The borrowers enjoy credit facilities from more than one bank / FI under multiple
banking / syndication / consortium system of lending.
b) The total outstanding (fund-based and non-fund based) exposure is Rs.10 crore or
above.

CDR system in the country will have a three tier structure :

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  CDR Standing Forum and its Core Group
 CDR Empowered Group
 CDR Cell

CDR Standing Forum: The CDR Standing Forum would be the representative general body
of all financial institutions and banks participating in CDR system. All financial institutions
and banks should participate in the system in their own interest. CDR Standing Forum will be
a self-empowered body, which will lay down policies and guidelines, and monitor the
progress of corporate debt restructuring. The Forum will also provide an official platform for
both the creditors and borrowers (by consultation) to amicably and collectively evolve
policies and guidelines for working out debt restructuring plans in the interests of all
concerned.

The CDR Standing Forum shall comprise of Chairman & Managing Director, Industrial
Development Bank of India Ltd; Chairman, State Bank of India; Managing Director & CEO,
ICICI Bank Limited; Chairman, Indian Banks' Association as well as Chairmen and
Managing Directors of all banks and financial institutions participating as permanent
members in the system. Since institutions like Unit Trust of India, General Insurance
Corporation, Life Insurance Corporation may have assumed exposures on certain borrowers,
these institutions may participate in the CDR system. The Forum will elect its Chairman for a
period of one year and the principle of rotation will be followed in the subsequent years.
However, the Forum may decide to have a Working Chairman as a whole-time officer to
guide and carry out the decisions of the CDR Standing Forum. The RBI would not be a
member of the CDR Standing Forum and Core Group. Its role will be confined to providing
broad guidelines.

CDR Empowered Group: The individual cases of corporate debt restructuring shall be
decided by the CDR Empowered Group, consisting of ED level representatives of Industrial
Development Bank of India Ltd., ICICI Bank Ltd. and State Bank of India as standing
members, in addition to ED level representatives of financial institutions and banks who have
an exposure to the concerned company. While the standing members will facilitate the
conduct of the Group's meetings, voting will be in proportion to the exposure of the creditors
only. The CDR Empowered Group would be mandated to look into each case of debt
restructuring, examine the viability and rehabilitation potential of the Company and approve

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the restructuring package within a specified time frame of 90 days, or at best within 180 days
of reference to the Empowered Group. The CDR Empowered Group shall decide on the
acceptable viability benchmark levels on the following illustrative parameters, which may be
applied on a case-by-case basis, based on the merits of each case :

 Return on Capital Employed (ROCE),

 Debt Service Coverage Ratio (DSCR),
 Gap between the Internal Rate of Return (IRR) and the Cost of Fund (CoF),
 Extent of sacrifice.

CDR Cell: The CDR Standing Forum and the CDR Empowered Group will be assisted by a
CDR Cell in all their functions. The CDR Cell will make the initial scrutiny of the proposals
received from borrowers / creditors, by calling for proposed rehabilitation plan and other
information and put up the matter before the CDR Empowered Group, within one month to
decide whether rehabilitation is prima facie feasible. If found feasible, the CDR Cell will
proceed to prepare detailed Rehabilitation Plan with the help of creditors and, if necessary,
experts to be engaged from outside. If not found prima facie feasible, the creditors may start
action for recovery of their dues. All references for corporate debt restructuring by creditors
or borrowers will be made to the CDR Cell. It shall be the responsibility of the lead
institution / major stakeholder to the corporate, to work out a preliminary restructuring plan
in consultation with other stakeholders and submit to the CDR Cell within one month. The
CDR Cell will prepare the restructuring plan in terms of the general policies and guidelines
approved by the CDR Standing Forum and place for consideration of the Empowered Group
within 30 days for decision. The Empowered Group can approve or suggest modifications but
ensure that a final decision is taken within a total period of 90 days. However, for sufficient
reasons the period can be extended up to a maximum of 180 days from the date of reference
to the CDR Cell.

Eligibility criteria: 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 of corporate borrowers engaged in any type of activity
with outstanding fund-based and non-fund based exposure of Rs.10 crore and above by banks
and institutions.

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Reference to CDR system: Reference to Corporate Debt Restructuring System could be
triggered by (i) any or more of the creditor who have minimum 20% share in either working
capital or term finance, or (ii) by the concerned corporate, if supported by a bank or financial
institution having stake as in (i) above.

Though flexibility is available whereby the creditors could either consider restructuring
outside the purview of the CDR system or even initiate legal proceedings where warranted,
banks / FIs should review all eligible cases where the exposure of the financial system is
more than Rs.100 crore and decide about referring the case to CDR system or to proceed
under the new Securitisation and Reconstruction of Financial Assets and Enforcement of
Securities Interest Act, 2002 or to file a suit in DRT etc.

Legal Basis: CDR is a non-statutory mechanism which is a voluntary system based on

Debtor- Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA). The Debtor-
Creditor Agreement (DCA) and the Inter-Creditor Agreement (ICA) shall provide the legal
basis to the CDR mechanism. The debtors shall have to accede to the DCA, either at the time
of original loan documentation (for future cases) or at the time of reference to Corporate Debt
Restructuring Cell. Similarly, all participants in the CDR mechanism through their
membership of the Standing Forum shall have to enter into a legally binding agreement, with
necessary enforcement and penal clauses, to operate the System through laid-down policies
and guidelines. The ICA signed by the creditors will be initially valid for a period of 3 years
and subject to renewal for further periods of 3 years thereafter. The lenders in foreign
currency outside the country are not a part of CDR system. Such creditors and also creditors
like GIC, LIC, UTI, etc., who have not joined the CDR system, could join CDR mechanism
of a particular corporate by signing transaction to transaction ICA, wherever they have
exposure to such corporate.

The Inter-Creditor Agreement would be a legally binding agreement amongst the creditors,
with necessary enforcement and penal clauses, wherein the creditors would commit
themselves to abide by the various elements of CDR system. Further, the creditors shall agree
that if 75 per cent of creditors by value and 60 per cent of the creditors by number, agree to a
restructuring package of an existing debt (i.e., debt outstanding), the same would be binding
on the remaining creditors. Since Category 1 CDR Scheme covers only standard and sub-
standard accounts, which in the opinion of 75 per cent of the creditors by value and 60 per
cent of creditors by number, are likely to become performing after introduction of the CDR
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package, it is expected that all other creditors (i.e., those outside the minimum 75 per cent by
value and 60 per cent by number) would be willing to participate in the entire CDR package,
including the agreed additional financing.

5. PREVENTION/ REDUCTION

Banks and other financial institutions shall take a number of measures so that the number of
non-performing assets does not increase. Following are some prudential measures which a
bank or financial institution ought to follow.

1. Early Recognition of the Problem: Invariably, by the time banks start their efforts to get
involved in a revival process, it too late to retrieve the situation- both in terms of
rehabilitation of the project and recovery of banks dues.

2. Identifying Borrowers with genuine intent: Identifying borrowers with genuine intent
from those who are non- serious with no commitment or stake in revival is a challenge
confronting bankers. Here the role of frontline officials at the branch level is paramount
as they are the ones who have intelligent inputs with regard to promoters sincerity, and
capability to achieve turnaround. Based on this objective assessment, banks should decide
as quickly as possible whether it would be worthwhile to commit additional
finance. "Special Investigation" In this regard banks may consider having of all financial
transaction or business transaction, books of account in order to ascertain real factors that
contributed to sickness of the borrower. Banks may have penal of technical experts with
proven expertise and track record of preparing techno-economic study of the project of
the borrowers.

3. Timeliness & Adequacy of response: Longer the delay in response, grater the injury to
the account and the asset. Time is a crucial element in any restructuring or rehabilitation
activity. The response decided on the basis of techno-economic study and promoter s
commitment, has to be adequate in terms of extend of additional funding and relaxations
etc. Under the restructuring exercise. The package of assistance may be flexible and bank
may look at the exit option.

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4. Focus on Cash flows: While financing, at the time of restructuring the banks may not be
guided by the conventional fund flow analysis only, which could yield a potentially
misleading picture. Appraisal for fresh credit requirements may be done by analyzing
funds flow in conjunction with the Cash Flow rather than only on the basis of Funds
Flow.

5. Management Effectiveness: The general perception among borrower is that it is lack of

finance that leads to sickness and NPAs. But this may not be the case all the time.
Management effectiveness in tackling adverse business conditions is a very important
aspect that affects a borrowing unit s fortunes. A bank may commit additional finance to
angling unit only after basic viability of the enterprise also in the context of quality of
management is examined and confirmed. Where the default is due to deeper malady,
viability study or investigative audit should be done – it will be useful to have consultant
appointed as early as possible to examine this aspect. A proper techno- economic viability
study must thus become the basis on which any future action can be considered.

6. Multiple Financing: During the exercise for assessment of viability and restructuring, a
Pragmatic and unified approach by all the lending banks / FIs as also sharing of all
relevant information on the borrower would go a long way toward overall success of
rehabilitation exercise, given the probability of success/failure.

7. Conservatism: Banks need to be more conservative in granting loans to sectors that have
traditionally found to be contributors in NPAs. Infrastructure sector is one such example.
NPAs rise predominantly because of long gestation period of the projects. Therefore, the
infrastructure sector, instead of getting loans from the banks can be funded from
Infrastructure Debt Funds (IDFs) or other specialized funds for infrastructural
development in the country. 15

8. Improving Processes: The credit sanctioning process of banks needs to go much more
beyond the traditional analysis of financial statements and analysing the history of
promoters. For example, banks rely more on the information given by credit bureaus.
However, it is often noticed that several defaults by some corporate are not registered in
their credit history.

15
Banking System in India- Non-Performing Assets (July 5, 2014), available at
http://www.insightsonindia.com/2014/07/05/banking-system-india-non-performing-assets/

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9. Relying less on restructuring the loans: Instead of sitting and waiting for a loan to turn
to a bad loan, and then restructure it, the banks may officially start to work to recover
such a loan. This will obviate the need to restructure a loan and several issues associated
with it. One estimate says that by 2013 there will be Rs 2 trillion worth of restructured
loans.

10. Expanding and diversifying consumer base by innovative business models: Contrary
to popular perceptions, the NPA in non-corporate sector is less than that in the corporate
sector. Hence, there is a need to reach out to people in remote areas lacking connectivity
and accessibility. More and more poor people in rural pockets should be brought under
the banking system by adopting new technologies and electronic means. Innovative
business models will play a crucial role here. Otherwise, the NPAs may increase instead
of decreasing. 16

6. SUPREME COURT ON NON-PERFORMING ASSET

6.1. Salim Akbarali Nanji v. Union of India17: On Writing Off NPAs.

In the above case the petitioner had challenged that the respondent bank and RBI had
wrongfully written off certain loans worth Rs. 120 crore, which became non-performing
assets. However the Supreme Court dismissed the petition by concluding that such exercise
of writing off was perfectly within the powers of the bank. The Supreme Court also
commented on NPAs and role of RBI. It was explained that write-off is an internal
accounting procedure to clean up the balance sheet of the Bank. Such write-off is resorted to
even in cases where the Bank has not exhausted all the avenues for recovery of dues. Such
write-off does not affect the right of the Bank to proceed against the borrowers to collect the
dues. The legal proceedings initiated by the Bank to recover the loans or to enforce the
security against the borrowers may continue. The write-off does not bar the Bank from
following up recoveries. Further recoveries, if any, in these accounts are credited to the
income account, in turn improving the net worth of the Bank. The Court also commented the
following:

16
Banking System in India- Non-Performing Assets (July 5, 2014), available at
http://www.insightsonindia.com/2014/07/05/banking-system-india-non-performing-assets/
17
Salim Akbarali Nanji v. Union of India, (2006) 5 SCC 302.

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 “No doubt, Reserve Bank has been vested with wide powers to control and regulate
the functioning of banks. If need be, those powers may be exercised by Reserve Bank.
In the instant case, we are only concerned with the writing-off of non-performing
assets.

It is no doubt true that amounts advanced by banks must be recovered. Such debts
should not be permitted to become non-performing assets. However, one cannot lose
sight of the realities of the situation. Having regard to the nature of banking business,
it is possible that the Bank may commit an error of judgment in advancing funds to a
particular party or industry. It may be that on account of other factors beyond its
control, or even beyond the control of the borrowers, it may become difficult, or even
impossible to recover the loan advanced in accordance with the schedule of
repayment, or to recover the loan at all. These are risks inherent in the banking
business, though a wise banker with foresight and anticipation may reduce such risks
to the minimum level. One cannot however, jump to the conclusion that only because
some of the debts have become bad, there is lack of proper management of the Bank,
or that the conduct of the Bank is dishonest or mala fide. In a given case, there may
be evidence of such mismanagement or dishonest conduct, but in the absence of any
such accusation one cannot draw an adverse inference against the Bank. In the
instant case, though some of the debts have to be written-off, with little chance of
substantial recovery, we cannot lose sight of the fact that the Bank has generated
considerable operating profits and has built up a substantial general reserve over the
years, against which the debts written-off have been adjusted.”

6.2. ICICI Bank Ltd. v. APS Star Industries Ltd.18

The short question which arose in this batch of cases was “Whether inter se transfer of non-
performing assets (“NPA”, for short) by the banks is illegal under the Banking Regulation
Act, 1949 (“the BR Act, 1949”, for short) as held by the Gujarat High Court in the impugned
judgment?” Hence, the court also had to decide the validity of RBI guidelines dated 2005
which permitted such transfer. The court on perusal of the Banking Regulation Act
determined the following:
“The impugned guidelines show that RBI considers inter se NPA assignment between
banks to be a tool for resolving the issue of NPAs and in the interest of banking policy

18
ICICI Bank Ltd. v. APS Star Industries Ltd., (2010) 10 SCC 1.

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 under Section 21 of the BR Act, 1949. The object is to minimise the problem of credit risk.
The corporate debt restructuring is one of the methods for reducing NPAs. Thus, such
restructuring as a matter of banking policy cannot be treated as “trading”. One has to
keep in mind the object behind enactment of the BR Act, 1949. Thus, the said guidelines
fall under Section 21 of the 1949 Act. These guidelines are a part of credit appraisal
mechanism. Thus, in our view the impugned guidelines are not ultra vires the BR Act,
1949. Dealing in NPAs as part of the credit appraisal mechanism and as a part of
restructuring mechanism falls within Section 21 read with Section 35-A of the Act.
Hence, it cannot be said that “transfer of debts/NPAs” inter se between banks is an
activity which is impermissible under the 1949 Act. The BR Act, 1949 is an Act enacted
to consolidate and amend the law relating to banking. Thus, while interpreting the Act
one needs to keep in mind not only the framework of the banking law as it stood in 1949
but also the growth and the new concepts that have emerged in the course of time.”
The Supreme Court in course of the discussion also elaborated upon the meaning and
possible negative impacts of NPA:
“At the outset one needs to know what is NPA? When a borrower who is under liability to
pay to secured creditors, makes default in repayment of secured debt or any instalment
thereof, the account of borrower is classified as non-performing asset (NPA). Such NPAs
cannot be used for any productive purpose. Continuous growth in NPAs threatens the
repayment capacity of the banks. They have an adverse impact on the financial strength
of the banks which in the present era of globalisation are required to conform to
international standards. Thus, NPA means an asset or account receivable of a borrower,
which has been classified by banks or financial institutions in terms of the RBI Guidelines
as substandard, doubtful, etc. These guidelines are issued to improve quality of assets of
the banks. The 2005 Guidelines of RBI are not to eliminate NPAs but to restructure.”

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 7. CONCLUSION

It can be concluded that though the definition of NPAs is very elaborate, NPAs basically
mean assets which fail to generate any revenue or profits for the creditor/ bank. Hence assets
which remain unpaid even after ninety days of the due date technically qualify as non-
performing assets. Many internal and external factors are responsible for creation of NPAs.
Non-performing assets are harmful for the particular bank which initially lent the asset but for
the larger economy as well. A large presence of NPAs in the market leads to decline in
market credibility as well as general financial health of the country. Sometimes NPAs are
impossible to recover and hence banks have to write off a number of debts. Hence, the
legislature has enacted the DRT Act in order to help banks and other creditors recover their
unpaid loans by taking recourse to proceedings before the Debt Recovery Tribunal. Another
legal recourse to recover debt has been provided under the Securitization and Reconstruction
of Financial Assets and Enforcement of Securities Interest Act, 2002 which prescribes easy
relief in an extra-judicial manner. The Banks are free to choose the means which suits them
the best. Apart from this, the Reserve Bank of India plays an important role in regulating
NPAs by virtue of powers under Section 21 and 35 of the Banking Regulation Act. The RBI
under the various circulars issued to banks has prescribed guideline for identification of
NPAs, their classification and various mechanisms to deal with them. Yet the circulars issued
by the RBI permit a lot of discretion and freedom to banks and financial institutions. The RBI
has also permitted banks to enter into Corporate Debt Restructuring schemes which can only
be entered into with industrial companies. The CDR is a voluntary mechanism which uses
consent and compromise as against coercion to help banks recover debts. The CDR scheme is
in order to revitalize and revive the non-performing asset so that it can be generate profits and
be of use to the creditor again. Hence, we can see that the RBI plays an important role in
regulation of NPAs.

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