BANKING CONTENT

The Banking sector has been considered as backbone of the economy and has an important
role to play in the growth of a nation. The persistent increase in Non-Performing Assets
(Hereinafter referred as NPAs) of the Indian banking sector now has become a cause for
concern for the economy. It adversely affects the profitability and has potential to affect the
operational efficiency of the banks leading to deterioration in asset quality. As a result,
management of NPAs is necessary amongst the various desirable characteristics of a well-
functioning financial system. Further, NPAs above certain level has always been a cause of
concern for everyone involved as credit is important for economic development and rise in
NPAs disrupt the smooth credit flow. Bank raise resources not only from depositors but also
through recycling of funds received from the borrowers and when a loan becomes non-
performing, it affects both recycling of credits and credit creation.

Banks raise resources not just on fresh deposits, but also by recycling the funds received from
the borrowers. Thus, when a loan becomes non-performing, it affects recycling of credit and
credit creation. Apart from this, NPAs affect profitability as well, since higher NPAs require
higher provisioning, which means a large part of the profits needs to be kept aside as
provision against bad loans. Therefore, the problem of NPAs is not the concern of the lenders
alone but is, indeed, a concern for policy makers as well who are involved in putting
economic growth on the fast track. In India due to the social banking motto, the problem of
bad loans did not receive priority from policy makers initially.

However, with the reform of the financial sector and the adoption of international banking
practices the issue of NPAs received due focus. Thus, in India, the concept of NPA came into
the reckoning after reforms in the financial sector were introduced on the recommendations
of the Report of the Committee on the Financial System (Narasimham, 1991) and an
appropriate accounting system was put in place. Broadly speaking, NPA is defined as an
advance where payment of interest or repayment of instalment of principal (in case of term
loans) or both remains unpaid for a certain period2. In India, the definition of NPAs has
changed over time. According to the Narasimham Committee Report (1991), those assets
(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 NPAs. 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 NPAs. Though the NPA issue has received
considerable attention in the post reform period, academic work on the subject is not
adequate (Ghosh, 2005, Mor and Sharma, 2003, Rajaraman et al, 1999). This paper attempts
to provide an overview of the NPA problem in India concentrating on the various dimensions
involved.
The banking industry plays a critical role in the economy of our country. It grew in leaps and
bounds and so is the complexity associated with it. Now a day’s Loans measurement from
time to time and recovery mechanism of NPA is a significant role in the banking industry.
The asset quality in banks, especially the Public Sector Banks (PSUs) is constantly
deteriorating and thus causing intolerable stress to the banking sector, regulators, and the
Indian economy.
NPA are those loans dispersed by banks or financial institutions which borrowers default in
making payment of principal amount or interest. When a bank is not able to recover the loan
given or not getting regular interest on such a loan, the flow of funds in the banking industry
is affected. The issue of Non Performing Assets has been discussed at length for the financial
system all over the world. The dilemma of NPAs is not only distressing the banks but also the
entire wealth of the country. In fact, the level of NPAs in Indian banks is nothing but a
reflection of the state of health of the industry and trade. Providing credit for economic
activities is the prime duty of banking. Lending is generally encouraged because it has the
effect of funds being transferred from the system to productive purposes, which results in
economic growth.
However, lending also carries a risk called credit risk, which arises from the failure of a
borrower. Non-recovery of loans along with interest forms a major hurdle in the process of
the credit cycle. These loans affect the bank's profitability on a large scale. Though complete
elimination of such losses is not possible; banks can always aim to keep the losses at a low
level. In this situation, there is a need of the researcher to address how the non-performing
assets of the banks affect the bank’s profitability, growth and development. For this, the
present study is going to discuss this issue.
1. Introduction
The banking sector is a keystone of any financial system. The smooth functioning of the
banking sector ensures the healthy condition of an entire economy. In the process of
accepting deposits and lending, loans banks create credit. The funds received from the
borrowers by way of interest on loan and repayments of principal are recycled for raising
resources. However, building up of non-performing assets (NPAs) disrupts this flow of credit.
It hampers credit growth and affects the profitability of the banks as well. NPAs are
the leading indicators to judge the performance of the banking sector. As per Reserve Bank
of India (RBI) reports on November 2018, the gross amount of poor quality loans is in excess
of Rs 9 lakh crores, which shows the severe impact it has on lending practices of banks and
their liquidity positions. This growth is a result of quadrupling during the past five years,
which shows the poor practice of banks with regard to lending.
The main source of income of banks is through the interest earned on loans and advances
and repayment of the principal. If such assets fail to generate income, then they are
classified as non-performing assets (NPA). According to the Reserve Bank of India, NPA is
defined as a credit facility in respect of which the interest and/or instalment of principal is
“past due” for a specified period. Generally, if the loan payments have not been made for a
period of 90 days, the asset is classified as non-performing asset. On the basis of how long
the asset has been non-performing, banks are required to sort the non-performing assets in
one of the following categories:
_ sub-standard asset: If an asset has been non-performing for less than 12 months;
_ doubtful asset: If an asset has been non-performing for more than 12 months; and
_ loss assets: Assets where losses have been identified by the bank, auditor or
inspector and have not been fully written off.
The generation of poor loans in the books of banks is not a favourable event for the banking
industry as it affects the size and soundness of the balance sheet. There is an unfavourable
impact on the level of return on assets as well. Large amount of profits have to be
provisioned against the doubtful and bad loans, which reduces profitability. Banks are even
burdened with the increasing level of carrying costs of NPA accounts, which could have
been used for any other profitable purpose. The financial institutions are also desired to
maintain a certain capital adequacy level to strengthen their net worth. Though this issue is
bad news for the banking industry, in recent times from the newspaper reports, it is evident
that this problem has taken a serious toll on the banking space. The RBI has been taking
measures to control the NPA menace. Some legal measures such as debt recovery tribunals
(DRTs), Lok Adalats, the SARFAESI (Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest) Act and the Insolvency and Bankruptcy Code, 2016
have been introduced for the resolution of NPAs. Recapitalisation of public sector banks,
setting up of stressed asset management verticals are some other steps taken by the RBI.

NPA NORM
Though the issue of NPA was given more importance after the Narasimham Committee
Report (1991) and highlighted its impact on the financial health of the commercial banks and,
subsequently, various asset classification norms were introduced, the concept of classifying
bank assets based on its quality began during 1985-86. A critical analysis to monitor credit
comprehensively and uniformly was introduced in 1985-86 by the RBI by way of the Health
Code System in banks. This system, inter alia, provided information regarding the health of
individual advances, the quality of the credit portfolio and the extent of advances causing
concern in relation to total advances. It was considered that such information would be of
immense use to banks for control purposes. The RBI advised all commercial banks
(excluding foreign banks, most of which had similar coding system) on November 7, 1985, to
introduce the Health Code System indicating the quality (or health) of individual advances
under the following eight categories, with a health code assigned to each borrowal account
(source: RBI):
1. Satisfactory - conduct is satisfactory; all terms and conditions are complied with; all
accounts are in order and safety of the advance is not in doubt.
2. Irregular- the safety of the advance is not suspected, though there may be occasional
irregularities, which may be considered as a short-term phenomenon.
3. Sick, viable - advances to units that are sick but viable - under nursing and units for which
nursing/revival programmes are taken up.
4. Sick: nonviable/sticky - the irregularities continue to persist and there are no immediate
prospects of regularisation and the accounts could throw up some of the usual signs of
incipient sickness
5. Advances recalled - accounts where the repayment is highly doubtful and nursing is not
considered worthwhile and where decision has been taken to recall the advance.
6. Suit filed accounts - accounts where legal action or recovery proceedings have been
initiated.
7. Decreed debts - where decrees (verdict) have been obtained.
8. Bad and Doubtful debts - where the recoverability of the bank's dues has become doubtful
on account of short-fall in value of security, difficulty in enforcing and realising the securities
or inability/unwillingness of the borrowers to repay the bank's dues partly or wholly
Under the above Health Code System, the RBI classified problem loans of each bank into
three categories: i) advances classified as bad and doubtful by the bank (Health Code No.8)
(ii) advances where suits were filed/decrees obtained (Health Codes No.6 and 7) and (iii)
those advances with major undesirable features (Health Codes No.4 and 5). The Narasimham
Committee (1991) felt that the classification of assets according to the health codes was not
in accordance with international standards. It believed that a policy of income recognition
should be objective and based on the record of recovery rather than on subjective
considerations.
In addition, before the Indian banks complied with the capital adequacy norms, their assets
had to be revalued on a more realistic basis of their realisable value. Thus, the Narasimham
Committee (1991) believed a system of income recognition and provisioning is fundamental
to preserve the strength and stability of the banking system. The international practice is that
an asset is treated as non-performing when interest is due for at least two quarters. In respect
of such nonperforming assets, interest is not recognised on accrual basis but is booked as
income only when it is actually received. The committee suggested that a similar
practice be followed by banks in financial institutions in India and recommended that interest
on NPAs be booked as income on accrual basis.
With the introduction of international norms for income recognition, asset classification and
provisioning in the banking sector, managing NPAs has emerged as one of the major
challenges facing Indian banks. Banks today are judged not only on the basis of number of
branches and volume of deposits but also on the basis of quality of assets. Non-performing
assets constitute a major portfolio of the Banks portfolio and hence are an inevitable burden
on the banking industry. NPAs adversely affect the profitability, liquidity and solvency of the
banks.

The last decade has seen many positive developments in the Indian Banking sector. The
policy makers who comprise the Reserve Bank of India (RBI), Ministry of Finance and
related government and financial sector regulatory entities have made several notable efforts
to improve regulation in the sector which compares favorably with banking sector in the
region on metrics like growth and profitability. However, NPAs remain a cause for worry.
This study evaluates and compares the NPA of public and private sector banks during the
recent years and makes some suggestions for NPA management.

NPAs threaten a country’s banking system; they erode the fiduciary role of banks, affect
safety of depositors’ funds, and beyond a certain point rapidly increase the risk of a run on
bank deposits.

The high level of NPAs in banks and financial institutions has been a
matter of grave concern to the public as bank credit is the catalyst to the
economic growth of the country and any bottleneck in the smooth flow of
credit, the main cause of which is the mounting NPAs, is bound to create
adverse repercussions in the economy. NPAs are not, therefore, the concern
of lenders only, but all beneficiaries of the financial system. The level of NPAs
is recognised as a critical indicator for assessing banks’ credit risk, asset
quality and efficiency in allocation of resources to productive sectors. Hence,
there is need for a concerted effort of all to recover bad loans and arrest fresh
accretion of NPAs. The biggest challenge that the banking industry now faces
is management of NPAs

3. NPA RECOVERY MECHANISM

The Government of India felt that the usual recovery measures like issue of notices for
enforcement of securities and recovery of dues was a time-consuming process. Thus, in order
to speed up the recovery of NPAs, the government constituted a committee under the
chairmanship of late Shri Tiwari in 1981. The committee examined the ways and means of
recovering NPAs and recommended, inter alia, the setting up of ‘Special Tribunals’ to
expedite the recovery process. Later the Narasimham Committee (1991) endorsed this
recommendation, and, suggested setting up of the Asset Reconstruction Fund (ARF). It was
suggested that the Government of India, if necessary, should establish this fund by special
legislation to take over the NPAs from banks and financial institutions at a discount and
recover the dues owed by the primary borrowers. Based on the recommendations of the
Tiwari and the Narasimham Committees, Debt Recovery Tribunals were established in
various parts of the country. An Asset Reconstruction Company was also established. The
various measures taken to reduce NPAs include rescheduling and restructuring of banks,
corporate debt restructuring and recovery through Lok Adalats, Civil Courts, Debt Recovery
Tribunals and compromise settlement.
In addition, some legal reforms were introduced to speed up recovery.
1. SARFAESI ACT
The legal mechanism for recovery of default loans was so far cumbersome and time-
consuming. Thus, it was felt that banks and financial institutions should be given the power
to sell securities to recover dues. In this regard, the Government of India appointed a
committee under the chairmanship of Shri T R Andhyarujina, senior Supreme Court advocate
and former Solicitor General of India, in 1999 to look into these matters. The Committee
submitted four reports. One of them is related to securitisation. Based on the
recommendations of the Andhyarujina Committee, The Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, was passed
on December 17, 2002. The act provides enforcement of the security factor without recourse
to civil suits. This act was passed with the aim of enabling banks and financial institutions to
realise long- term assets, manage the problem of liquidity, reduce asset liability mismatches
and improve recovery by taking possession of securities, selling them and reducing NPAs.
The ordinance also allows banks and financial institutions to utilise the services of ARCs/SCs
for speedy recovery of dues from defaulters and to reduce their NPAs. The ordinance
contains provisions that would make it possible for ARCs/SCs to take possession directly of
the secured assets and/or the management of the defaulting borrower companies without
resorting to the time-consuming process of litigation and without allowing borrowers to take
shelter under the provisions of SICA/BIFR. In addition to passing the SARFAESI Act,
certain other legal reforms were also introduced to speed up the loan recovery process.
2. OTHER LEGAL REFORMS
One of the important factors responsible for the ever-increasing level of NPAs in the Indian
banking industry is the weak legal system. According to an international rating agency called
FITCHIBCA, “The Indian legal system is sympathetic towards the borrowers and works
against the banks’ interest. Despite most of their loans being backed by security, banks are
unable to enforce their claims on the collateral when the loans turn non-performing, and
therefore, loan recoveries have been insignificant.” However, efforts have been made to
rectify these problems through the judicial process as well as by enacting laws. In 1999, a
standing committee under the aegis of Industrial Development Bank of India (IDBI) was
constituted to initiate a co-ordinated approach to the recovery of large NPA accounts and for
institutionalising an arrangement between banks and financial institutions for the systematic
exchange of information in respect of large borrowers (including defaulters and NPAs).
Moreover, as mentioned above, in 2002 the SARFAESI Act was passed and it empowered
the creditors to foreclose non-performing loans and the underlying collateral without going
through a lengthy judicial or tribunal process (Basu, 2005). All these efforts improved the
recovery of NPAs by commercial banks, which in turn has helped in reducing the NPA level.
The total worth of NPAs recovered through various channels was around Rs 4,039 crore
during 2003-04, which increased many fold to Rs 20,578 crore during 2004- 05.

Measures to reduce NPA: -

Following are some of the measures to reduce NPA.s.
Insolvency and Bankruptcy Code (IBC), 2016.
Through this banks either revive the businesses or liquidate them.
. Selling NPAs is the immediate solution. Since April 2017, this is how banks are reacting to
NPAs.
. The top 20 businesses, among all defaulters, were responsible for NPAs worth Rs. 1.54 lakh
crore. Hence concentration on them may eliminate the need for governments to rescue banks.
. Thorough inspection of the enterprise before sanctioning loans.
. Display of names of Defaulters publicly, will cause fear and shall act as a deterrent.
. After yielding loan, banks should constantly observe the company.s repaying capacity. In
case they assess that the business is heading towards bankruptcy, banks may decide to sell the
assets before the loans turns into an NPA.
. Forming „bad bank. and transferring NPAs to it. This will clear the NPAs from the bank on
papers and relieve the stress from the banking system.

The position of NPAs continues to haunt Indian banking Sector. Several experiments have
been tried to curb NPAs (viz., BIFR/SICA, lok adalats, DRTs, OTS, SARFAESI etc) but
nothing has hit the mark in tackling NPAs. The validity of both DRT/ Securitization act was
challenged and still hangs in dilemma, which has dampened the spirits of bankers.

The problem of NPA is greater in the public sector banks as compared to private and foreign
banks in India. Similarly, the problem of NPAs is more in non-priority sector than priority
and public sector. Further, SSI sector has largest share in the total NPA of priority sector. As
a result of this, financial health of banks has been affected adversely. Hence, banks in India
must apply the basic principles of financial management to solve the problems of mounting
NPA.

CROSS COUNTRY COMPARISON

India has a large population and land-size, a diverse culture and extreme disparities in income
which are marked among its regions. There are high levels of illiteracy in a large segment of
its population but, at the same time, the country has a large reservoir of managerial and
technologically advanced talents. About 35 percent of the population resides in metro and
urban areas and the rest is spread over several semi urban and rural centers. These features
have left the Indian banking sector with strengths and weaknesses. A big challenge facing
Indian banks is how to attain operational efficienc suitable for modern financial
intermediation under the current ownership structure. While it has been relatively
The banking system in India is significantly different easy for the public sector banks to
recapitalize given from that in other Asian countries because of the country the increase in
NPAs, as their Government dominated specific geography socio-economic characteristics.

Indian banking sector is going through a tough phase where the GNPA (gross Non-
performing assets) are all time high and there seem to be no respite in this coming quarter, at
least. An asset is classified as NPA (Non-Performing Assets) which ceases to generate
income for a bank. The gross Non-performing asset ratio stood at 11.5% in March, 2018 and
this could reach to 12.2% by March 2019 (RBI financial stability report). There seems to be
some respite on this increase where GNPA declines from 11.5% in March 2018 to 10.8% in
September, 2018 (RBI financial stability report). India has seen various debt resolution
mechanism namely BIFR (Board for Industrial and Financial Reconstruction), CDR
(Corporate debt restructuring), SARFAESI (Securitization and reconstruction of financial
assets and Enforcement of Securities Interest) Act, 2002 to IBC (Insolvency and Bankruptcy
Code) in 2016. Insolvency and bankruptcy code (IBC) 2016 was enacted in India in May
2016 with the intent of providing a solution which is efficient and time bound. The code has a
time frame of 180 day and extension of 90 days which makes a total of 270 days for a
company to “resolve or liquidate”. Immediately after passing resolution of IBC in Parliament
in May, 2016,

6. Conclusion
The overall findings point to a worrisome situation for the banking sector as a whole.
An analysis of the growth rate in the NPA level shows that the problem is evident not
only with small-sized banks but also with big names in the banking space. Hence, the
entire sector is gripped in the crisis. The poor asset for the banks is a problem
because as per the guidelines, given by the RBI, banks are required to keep some
amount as provision depending on their asset quality thereby leading to declining
profitability of the banks. Hence, it impacts not only the profitability level of these
banks but also affects the shareholders’ wealth. Thus, the time is apt that the RBI has
been coming up with very stringent norms so that the growth in these assets can be
put under control. The Insolvency and Bankruptcy Code of 2016 is playing an
important role with regard to recovery of assets of those creditors whose case has
been filed with the National Company Law Tribunal. In fact, figures are given by the
RBI point to a declining phase in the NPA growth rate, which is a positive
development. But, there is still a lot to be done. Only time will say how successful has
the RBI been in controlling the NPA growth in the sector. It is necessary to pull the
trigger hard as these poor loans are having a severe impact on the liquidity position of
banks and even the banks have been asked to go slow with regard to lending, which
is ultimately having an impact on the economic growth, which has been slow during
the past few quarters.

Because of the hazardous impact of economic slowdown, plenty of projects/Industries are

under stress and as an outcome banking system of India has seen significant rise in the level
of Gross and Net NPA in the recent past.
The government in developing countries such as India push for financial inclusion, leading to
increase in the risk associated with bank’s asset.
Banking system is the most crucial sector of the economy. A robust and sound banking sector
is very indispensable for overall economic development of a nation. Non-Performing Assets
is a serious ailment associated with the banking system of India.

With this backdrop, this paper has been designed to analyze the problem of NPAs in the
Indian banking system.