NEGATIVE IMPACT OF NPA ON INDIAN ECONOMY: AN ANALYSIS

Abstract

Any asset which stops giving returns to its investors for a specified period of time is known
as Non-Performing Asset (NPA). Indian Banking industry is seriously affected by Non-
Performing Assets. More than Rs. 7 lakh crore worth loans are classified as Non-Performing
Loans in India. This is a huge amount. The figure roughly translates to near 10% of all loans
given. This means that about 10% of loans are never paid back, resulting in substantial loss
of money to the banks. When restructured and unrecognised assets are added the total stress
would be 15-20% of total loans. NPA crisis in India is set to worsen. Restructuring norms are
being misused.

This bad performance is not a good sign and can result in crashing of banks as happened in
the sub-prime crisis of 2008 in the United States of America. Also, the NPA problem in India
is worst when comparing other emerging BRICS Economies. In India banking sector has
played pivotal role in our nation building. After Liberalisation of the economy the banking
sector has faced severer challenges, but due to its solid foundation and management it has
withered all the subsequent challenges including 2008 sub-prime crisis.

The Public Sector Banks (PSBs) continue to be under stress, on account of aggressive
lending in the past. NPA is one of the major concerns for the banking system around the
globe and the Indian banking system is not an exception to this universal phenomenon. The
problem which was largely hidden earlier has now come to the forefront in recent years.

But the recent problem has been grave. In the case of public sector banks, the bad health of
banks means a bad return for a shareholder which means that government of India gets less
money as a dividend. Therefore it may impact easy deployment of money for social and
infrastructure development and results in social and political cost. NPAs related cases add
more pressure to already pending cases with the judiciary one. In this paper it has been
discussed in details with best possible solutions.

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INTRODUCTION

Objective and research methodology: The objective of this paper is to discuss why NPA is
threat to the banking system in India and its possible solution.. This paper is explorative by
nature and secondary sources have been used as the source of information.

History of Indian banking System:

Although the banking system in India has around 300 years old history but the real growth
happened after independence. We can also divided this into three parts .First period is just
after independence, second period is after nationalization of banks andthe last period is after
introduction of Liberalisation of the Indian economy.

Immediately after independence banking system in India was limited to only few privilege
classes. Mass had to depend on land lords and village sahukars. And also to expand the
industrial activities private investment was needed. But private banks were unable to provide
these investment needs due to various reasons. Also high rate of interest were charged.
Therefore industrial base was not developed in India due to lack of cheap capital. This had
prompted the then government to nationalise all the private sector banks in 1969 and then in
1984.

Nationalisations of banks createda wave of development in our country. Government has

entrusted various function to the banks for eradication of poverty, for entrepreneurships, for
development of agricultures. Lead bank system and priority sector banking were some of the
programme of the governments. But the real value addition of these programmes was
negligible compared to the cost involved with it. A lot of public money were got wasted. It
prompted the government to think after the priority of banking sectors. The watershed period
of banking sector was introduction of Liberalisation by then government. A committee was
formed under former RBI Governor M. Narsimham in August 1991 to look into all aspects of
the financial system of India. The report of this committee had comprehensive
recommendations for financial sector reforms including the banking sector and capital
markets. The key recommendations with respect to the banking sector were as follows:

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(1) Reduction in the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)

(2)Redefining the priority sector

(3) Deregulation

Many of the recommendations of the committee were acceded to by the government. The
government also enacted Recovery of Debts Due to Banks and Financial Institutions
(RDDBFI) Act, 1993 Debt Recovery Tribunals with an appellate Tribunal at Mumbai for
quicker recovery of bad debts. In 1995, Banking Ombudsman scheme was launched with an
objective to provide quicker solutions to customers’ complaints

What is Non-Performing Assets (NPAs)

You may note that for a bank, the loans given by the bank is considered as its assets. So if the
principle or the interest or both the components of a loan is not being serviced to the lender
(bank), then it would be considered as a Non-Performing Asset (NPA).

Any asset which stops giving returns to its investors for a specified period of time is known
as Non-Performing Asset (NPA).

Generally, that specified period of time is 90 days in most of the countries and across the
various lending institutions. However, it is not a thumb rule and it may vary with the terms
and conditions agreed upon by the financial institution and the borrower.

Major causes for increase in Non Performing Assets (NPAs) of Banks

The banking sector has been facing the severe problems of the rising NPAs. But the problem
of NPAs is more in public sector banks when compared to private sector banks and foreign
banks.

 Willful Defaulters: we have seen an upsurge in mal-administration by the corporates

in the country in terms of willful defaults by showing lack of morale to repay loans.

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 There are borrowers who are competent to pay back loans but are intentionally or
unintentionally refrain from repayment.

“We do not punish the defaulters and wrong- doers unless he is small and weak.. No one
wants to go after the rich and well-connected wrong-doer, which means they get away with
even more.”

-Raghuram Rajan, Former RBI Governor and Indian Economist.

 Bad lending practices: A non transparent way of providing loans has led to increase in
NPAs of the banks. The diversification of funds to business frauds, due to poor credit
appraisal system, the bank gives advances to those who are not able to repay it back.
Thus, unplanned expansion of credit during the boom period led to enormous rise in
NPAs.
 Over-expectation of economic growth: Due to over-expectation of economic growth
in future, made the Indian banking sector to disburse more credit during the boom
period of the business cycle. But the economy is unable to achieve its specified
targets because of implementation of demonetization and GST. The high expectation
of growth does not materialise and bad loans accumulate as borrowers are unable to
repay.
 Natural hazards: Every year India is hit by major natural calamities in one or other
part of the country. Thus, making the borrowers unable to pay back there loans.
Irregularities of rain fall and other event reduces production, the farmers are not able
to repay the loans. The bank has to make large amount of provisions in order to pay
damages to those loans, hence they end up with a reduced profit.
 Severe Competition: Severe competition in any particular market segment leads to
rise in NPAs. In the anxiety to attain business targets the rules and procedures for
prudent
 Misgovernance: Misgovernance and policy paralysis hampers the timeline and
working of the banks. Political interference in the functioning of the public sector

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 banks and providing huge loans to their known has major impact on rising NPAs.
Political pressure in selection of Chairman and heads of the banks by the Government
is also a cause of concern.
 General slowdown of Industrial sector: After 2011 there was a slowdown in the
Indian economy which resulted in faster growth of NPAs. The banks that finance
those industries ultimately end up with a low recovery of their loans reducing their
profit and liquidity.
 Ineffective recovery tribunal: Although vigilance mechanisms exist, but lack of
penalties enforcement means that wrongdoing is neglected. The Govt. has set
recovery tribunals, which works for recovery of loans and advances, due to their
carelessness and ineffectiveness in their work and the perception of „wait and watch‟
makes the bank suffers the consequence of non-recovery, their by reducing
profitability.
 Financial Burden: The execution of any government‟s scheme fall over public sector
banks. Banks continued to be the primary source of long-term big-ticket investment
projects in India, from roads and ports to power and steel. This increases the financial
burden on banks. The Infrastructure sector is facing this problem.
 Lack of Management information system: There seems to be lack of Management
information system (MIS), which makes the decisions on real time basis poor. Proper
MIS and financial accounting system is not implemented in the banks, which leads to
poor credit collection and allocation.

Impacts of NPA

Unplanned expansion of corporate houses during boom period and loan taken at low rates
later being serviced at high rates, therefore, resulting into NPAs.The problem of NPAs in the
Indian banking system is one of the foremost and the most formidable problems that had
impact the entire banking system. Higher NPA ratio trembles the confidence of investors,
depositors, lenders etc.

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It also causes poor recycling of funds,which in turn will have deleterious effect on the
deployment of credit. The non-recovery of loans effects not only further availability of credit
but also financial soundness of the banks. Profitability: NPAs put detrimental impact on the
profitability as banks stop to earn income on one hand and attract higher provisioning
compared to standard assets on the other hand. On an average, banks are providing around
25% to 30% additional provision on incremental NPAs which has direct bearing on the
profitability of the banks. Asset (Credit) contraction:

The increased NPAs put pressure on recycling of funds and reduces the ability of banks for
lending more and thus results in lesser interest income. It contracts the money stock which
may lead to economic slowdown. Liability Management: In the light of high NPAs, Banks
tend to lower the interest rates on deposits on one hand and likely to levy higher interest rates
on advances to sustain NIM. This may become hurdle in smooth financial intermediation
process and hampers banks’business as well as economic growth. Capital Adequacy: As per
Basel norms, banks are required to maintain adequate capital on risk-weighted assets on an
ongoing basis. Every increase in NPA level adds to risk weighted assets which warrant the
banks to shore up their capital base further.

Capital has a price tag ranging from 12% to 18% since it is a scarce resource. Shareholders’
confidence: Normally, shareholders are interested to enhance value of their investments
through higher dividends and market capitalization which is possible only when the bank
posts significant profits through improved business. The increased NPA level is likely to
have adverse impact on the bank business as well as profitability thereby the shareholders do
not receive a market return on their capital and sometimes it may erode their value of
investments.

As per extant guidelines, banks whose Net NPA level is 5% & above are required to take
prior permission from RBI to declare dividend and also stipulate cap on dividend payout.
Public confidence: Credibility of banking system is also affected greatly due to higher level
NPAs because it shakes the confidence of general public in the soundness of the banking
system. The increased NPAs may pose liquidity issues which is likely to lead run on bank by

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depositors. Thus, the increased incidence of NPAs not only affects the performance of the
banks but also affect the economy as a whole. In a nutshell, the high incidence of NPA has
cascading impact on all important financial ratios of the banks viz., Net Interest Margin,
Return on Assets, Profitability, Dividend Payout, Provision coverage ratio, Credit contraction
etc., which may likely to erode the value of all stakeholders including Shareholders,
Depositors, Borrowers, Employees and public at large.

Our banking system is robust and based on strong foundation.. The Reserve Bank of India as
a central bank of India doing great job. In 2008 sub-prime crisis when banking system in rest
of the world is in danger of collapse, our domestic banking system was secured. It was due to
solid foundation of our banking system. But the situation has changed a lot. As economy has
slowed down due to global slowdown and structural problem, it has indirect impact on credit
disbursement. When mining sector was in boom, a lot of iron industries were open up in
India. So other ancillaries industries were also mushroomed as a result. Banking sector has
invested a lot in these industries, but due to crash in global commodity market and
subsequent slowdown in the economy has affected the credit worthiness of the bank.

There are other industries like aviation sectors, infrastructure sectors , telecom sectors which
has shown early promise but slowdown in the market has negative impact on these sectors as
a result banks cannot recover their due and it became a NPA.

Established and willful defaulters like Vijaya Mallya have created tremendous loss to the
banking sector. Another reason is debt written off by successive state governments and
central government on agricultural loan and industrial loans. It has very bad effect on fiscal
discipline of state finance and major reason of increasing NPAs.

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CASE STUDY

 Punjab & Maharashtra Cooperative (PMC) Bank Crisis

About the Punjab & Maharashtra Cooperative (PMC) Bank

This bank was established on February 13, 1984 as a single branch cooperative Bank. Punjab
& Maharashtra Cooperative (PMC) Bank is a Scheduled Urban Co-operative Bank with its
area of operation in the States of Maharashtra, Gujarat, Delhi,Goa, Karnataka, Madhya
Pradesh and Andhra Pradesh.

The commencement of the banking business of PMC taken place on February 13,1984. It
operated nicely and within a time of 35 years, the Bank has a wide network of 137 branches
across six states.

PMC has 1814 number of employees and now this bank stands among top 10 co-operative
banks of the country.

At the time of its establishment PMC was a cooperative bank but in 2000 it got the status of
Schedule Commercial Bank by the the Reserve Bank of India. PMC is the youngest bank to
achieve the ‘Scheduled Bank’ status.

Detail of the Bank fraud

The crux of this bank fraud is that the higher management of the PMC bank has given huge
loan to the Housing Development and Infrastructure Ltd (HDIL) and its group entities. This
fraud case is related to transfer of 70% of the total credit facilities of the PMC bank to HDIL
and its associated companies. If I talk about the total amount of the bank fraud then it was Rs
4,355 cr. Now the total NPA of the bank has grown to 73%.

The PMC bank allegedly favoured to the promoters of Housing Development and
Infrastructure Ltd (HDIL) and allowed them to operate password protected ‘masked
accounts’.

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It is found that around 21,049 bank accounts were opened by bogus names to conceal 44 loan
accounts. The bank's software was also tampered to conceal these loan accounts.This bank
fraud case is busted by a bunch of women employees of the credit department of the PMC
bank. These employees told to the RBI that they were aware of the ghost accounts. When this
case came in the light; then customers of the PMC bank rushed to the PMC bank to withdraw
their hard earned money but they were refused to give their deposited money and withdrawal
limit is set by the bank.

Now the Enforcement Directorate (ED) has sealed the assets of Rs 3,500 cr of the HDIL
group and the HDIL chief Rakesh Wadhawan and his son Sarang Wadhawan have been
arrested by the Mumbai Police.

Now it the need of the hour that the central government need to make some strict policies to
prevent such banking frauds in the country. The most important measure I would suggest is
to restrict the political intervention in the functioning of the Indian banks.

 Infrastructure Leasing & Financial Services (IL&FS) Crisis

Infrastructure Leasing & Financial Services (IL&FS) is a non-banking financial company

(NBFC), or 'shadow bank'. Established over 30 years ago, the conglomerate funds
infrastructure projects across India. Some of the projects it has helped develop are 9-km
Chenani-Nashri tunnel (India’s longest road tunnel), Delhi-Noida Toll Bridge, Ranchi-
Patratu Dam Road, Baleshwar-Kharagpur Expressway, Tripura Power Project, and Gujarat
International Finance Tech-City (GIFT).

Among IL&FS shareholders are LIC, SBI, Japan's Orix Corporation, HDFC and CBI. The
subsidiaries of IL&FS include transportation network subsidiary IL&FS Transportation
Networks Ltd (ITNL), engineering and procurement company IL&FS Engineering and
Construction Co Ltd and financier IL&FS Financial Services Ltd.

IL&FS crisis: What went wrong for the shadow banker

IL&FS Financial Services fell short of cash and defaulted on several of its obligations. Even
as new infrastructure projects dried up, IL&FS' running construction projects faced cost
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overruns amid delays in land acquisition and approvals. It defaulted on repayment of bank
loans (including interest), term and short-term deposits and also failed to meet commercial
paper redemption obligations. It reported that it had received notices for delays and defaults
in servicing some of the inter-corporate deposits accepted by it. Following the defaults,
rating agency ICRA downgraded the ratings of its short-term and long-term borrowing
programmes. The defaults also jeopardised hundreds of investors, banks and mutual funds
associated with IL&FS, and sparked panic among equity investors, even as several non-
banking financial companies faced turmoil amid a default scare.

The IL&FS group operates over a hundred subsidiaries and is sitting on a debt of Rs 94,000
crore.

IL&FS's new board

In October 2018, the government constituted a new board as the old one was deemed to have
failed to discharge its duties. Kotak Mahindra Bank Executive Vice-Chairman and Managing
Director Uday Kotak, Tech Mahindra Vice-Chairman, Managing Director and CEO Vineet
Nayyar, former Sebi chief G N Bajpai, former ICICI Bank chairman G C Chaturvedi, former
IAS officers Malini Shankar and Nand Kishore were made members of the board. In the first
few weeks of taking over, the board appointed its nominees on key subsidiaries,
initiated austerity measures, began a full audit of standalone and consolidated
accounts, formed a core operating committee under Nayyar and started to work towards a
resolution plan.

The board, thereafter, appointed Arpwood Capital and J M Financial as financial as

transaction advisors. It also roped in Alvarez & Marsal to maintain strict liquidity controls,
manage stakeholders and help develop a resolution plan.

Investigation in the IL&FS case

Serious Fraud Investigation Office (SFIO) started a probe as there were huge procedural
lapses at the NBFC. On April 2, 2019, former vice-chairman of IL&FS, Hari Sankaran, was

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arrested by SFIO in Mumbai for granting loans to entities that were not creditworthy and
thereby causing loss to the company and its creditors.

The initial SFIO probe also revealed that there were major lapses in Deloitte's audit of the
IL&FS. SFIO investigation found it guilty of painting a rosy picture of IFIN despite being
aware of the poor financial health of the company, triggering the ministry to seek a ban on
the auditors.

On August 16, 2019, the Enforcement Directorate (ED) filed its first chargesheet in the so-
called IL&FS money laundering case.

The prosecution complaint was filed in a special court of the Prevention of Money
Laundering Act (PMLA), charging former senior management personnel of IL&FS — Ravi
Parthasarathy, Ramesh Bawa, Hari Sankaran, Arun Saha, and Ramchand Karunakaran —
along with Aircel founder C Sivasankaran.

The ED also made provisional attachment of bank accounts and immovable property to the
tune of Rs 570 crore held by these people. The chargesheet pointed out that the senior
management had falsified the accounts and indulged in circuitous transactions. This was
done ostensibly to maintain the credentials of IFIN, in order to continue receiving high
remuneration and to artificially boost the balance sheet of IL&FS group. However, these
activities led to further losses.

SOLUTIONS

The Reserve Bank of India has identified growing NPAs is the major problem of our
economy. The then Governor of the RBI Raghuram Rajan has taken a number of steps to
cleared the NPAs. The public sector banks has twin balance sheet problem. Therefore the
RBI has clearly directed the banks to clear off old NPAs. It was expected that
demonetization would solved the NPAs problem of banks. But the result has not been so

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success full. Another solution is recapitalization of banks and merger of the banks. But it
requires huge capital and the government has not that fiscal ability. Merger of the banks are
although passed by the cabinet, it will take sometimes to be fruitful.

Therefore from our above analysis it was proved that NPAs are detrimental to our economy.
There are different solution tried by the government, but it couldn’t solve the main problem.
So a strong political will the all-round effect of all these steps can solve NPAs problem.

The terms of bank chairpersons must be elongated in order to effect meaningful changes and
to hold them accountable. The Punjab National Bank fraud demonstrates the extent of
operational and risk management failures in PSBs. Improvements to HR practices can help
mitigate behaviour like frauds.

The banks should follow the principle of diversification of risk based on the famous maxim
“do not keep all the eggs in one basket”, which means that the banks should not grant
advances to a few big farms only or to concentrate them in few industries or in a few cities. If
a latest big customer meets misfortune or certain traders or industries affected adversely, the
overall position of the bank will be affected

Indian law treats an individual and his company as two different entities. So if company has
borrowed loan and defaults, at best bank can seize properties of the company, but cannot
seize property of individual. There are many companies which have defaulted but their
promoters/owners have properties worth billions of dollars. In such cases, govt. can pass
laws and see if it is feasible to make the owners pay for the default. Willful defaulters will
have to be dealt with a heavy hand, but political interference is a huge issue

Banks should examine the balance sheet which shows the true picture of business. When
banks give loan, they should examine the purpose of the loan. To make sure safety and
liquidity, banks should grant loan for productive purposes. Bank should examine the
profitability, viability, long term acceptability of the project while financing.

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In today‟s era of globalization, the role of banking sector is not limited to providing financial
resources to the needy sectors but the banks act as agents of financial intermediation and also
plays a major role in the fulfillment of social agendas of the Government.

However, a steady rise in the NPA‟s of banks affects not only the banking sector but the
country‟s economy as a whole. Some experts have suggested creating a single „bad loan‟
bank, under which all bad loans will be consolidated, so that they can be resolved with
simpler and faster decision-making while keeping in mind sectoral complexities and
multiplicity of lenders. However, creating a bad bank remains a politically volatile idea and
is difficult to implement. Privatization of PSBs is not the solution. In the recent past we have
seen many private banks such as Global Trust Bank and other private banks run in the co-
operative sector going bust and thereafter either being wound up or merged with some other
bank.

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References:

 Non Performing Assets of Indian Banking System and its Impact on Economy Pro.
D.S. Rathore1, Dr.Sangeeta Malpani2 , Sunita Sharma,OSR Journal of Economics
and Finance (IOSR-JEF) e-ISSN: 2321-5933, p-ISSN: 2321-5925.Volume 7, Issue 6
Ver. III (Nov. - Dec. 2016), PP 21-26 www.iosrjournals.org
 Dramatic rise in NPAs in India after 2015 in one chart, and it‟s not Modi‟s fault By:
Pragya Srivastava |

 (PDF) The Problem of Rising Non-performing Assets in Banking Sector in India:

Comparative Analysis of Public and Private Sector Banks.
 www.researchgate.net
 B. Ravi Kumar1,B.V.S.S. Subba Rao2,G.D.V. Kusuma3(2018) Genesis for Increase
of NPAs in Indian Banks An Empirical Analysis Journal of Banking and Finance
Management, Vol:1
 www.orfonline.org › Research › Development › Indian Economy

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