Case Study

Managing Non-Performing Assets

in Indian Banking Industry
Koya Raghunath* and Manish Agarwal**

The case discusses the issue of high Non-Performing Assets (NPAs) in the Indian banking
system in the first two decades of the 21st century. It covers in detail the various steps
taken by the central bank of India and the Government of India (GoI) to bring down the
NPAs, and how Gross Non-Performing Assets (GNPAs) went down by 1 tn in the financial
year 2019 when compared with the previous financial year. Although the GNPAs had
gone down by close to 1 tn in FY19, bad loans were still very high. Some experts opined
that the high number of bad loans would continue as long as the Public Sector Banks
(PSBs) remained under the shadow of the government. They commented that the RBI and
the GoI should take more stringent steps to clean up the balance sheet of banks.

The important thing that concerns RBI when it comes to financial sector
intermediation in general and banks in particular, is risk management. If banks get
this right, most of the problems are not likely to be there.1
– N S Vishwanathan, Deputy Governor of the Reserve Bank of India, November
2019

Introduction
In July 2019, Nirmala Sitharaman (Sitharaman), Union Finance Minister of India, stated that
the bad loans in the Indian banking industry had gone down in FY19 compared to FY18. The
Gross Non-Performing Assets (GNPAs) had decreased from 10.5 tn in FY18 to 9.24 tn in
FY19. Similarly, Non-Performing Assets (NPAs) had also come down from 5.27 tn in FY18
to 3.52 tn in FY19. Experts stated that various factors such as bad loan write-offs by banks,
change in the credit culture, prohibiting willful defaulters from raising funds from the market,

* Associate Professor, IBS Hyderabad (Under IFHE – A Deemed to be University u/s 3 of the UGC Act,
1956), Hyderabad, Telangana, India. E-mail: koyaraghunadh@ibsindia.org
** Assistant Professor, IBS Hyderabad (Under IFHE – A Deemed to be University u/s 3 of the UGC Act,
1956), Hyderabad, Telangana, India. E-mail: manish.agarwal@ibsindia.org

1
“RBI Mulling New Rules on Corp Governance; Wants Banks to Disclose More”, www.livemint.com/industry/
banking/rbi-mulling-new-rules-on-corp-governance-wants-banks-to-disclose-more-11574445891485.html
November 22, 2019.

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and enactment of the Insolvency and Bankruptcy Code (IBC) in 2016 by the Reserve Bank
of India2 (RBI) and the Government of India (GoI) had resulted in the reduction in GNPAs
and NPAs.
Although GNPAs had gone down by close to rupees 1 tn in FY19, bad loans were still
very high. Some experts opined that the high number of bad loans would continue as long
as the Public Sector Banks (PSBs) remained under the shadow of the government They
commented that ever since the nationalization of banks in 1969, successive governments
had used these banks to fulfill their populist schemes. The RBI and the GoI had to take more
steps to clean up the balance sheet of the banks, they added.

Indian Banking Industry

An indigenous banking industry had prevailed in India since ancient times, with some
communities being traditionally involved. These communities mostly ran huge businesses
apart from their small banking business. They dealt mainly in money lending, did not accept
deposits from customers, and discouraged savings.
The Western type of banks came into the picture in the late 18th century in India when the
Bank of Hindustan was established in 1770 in Calcutta (now Kolkata) in eastern India. Calcutta
became the center of banking activities mainly due to the trading activities of the British
Empire. In the 19th century, the major development in the Indian banking industry was the
establishment of three presidency banks3 by the British East India Company. In 1935, the RBI
was established under the provisions of the Reserve Bank of India Act, 1934.
The Indian banking industry saw a major expansion after India gained independence from
British Rule in 1947. The major development came in 1949 with the nationalization of the
RBI and the enactment of the Banking Regulation Act, 1949. This act authorized the RBI to
regulate, control, and inspect the banks in India. Over the next one or two decades, the
banking sector became one of the major growth engines of the Indian economy and one of the
major job providers in the country.
In a major step, the GoI nationalized 20 of the largest commercial banks in two stages – 14
banks4 in 1969 and six banks5 in 1980. The objectives of nationalization included the expansion
of banking—especially into rural areas in India—social welfare, controlling of private

2
Reserve Bank of India (RBI) is the central bank of India.
3
The first presidency bank was Bank of Calcutta, set up in 1806. This was renamed as Bank of Bengal in 1809.
The second and third presidency banks were Bank of Bombay, set up in 1840, and Bank of Madras set up in
1843 respectively. In 1921, these three presidency banks were amalgamated to create the Imperial Bank of India
which later became the State Bank of India in 1955.
4
These 14 banks were Central Bank of India, Bank of India, Punjab National Bank, Bank of Baroda, United
Commercial Bank, Canara Bank, Dena Bank, United Bank, Syndicate Bank, Allahabad Bank, Indian Bank,
Bank of Maharashtra, Indian Overseas Bank, and Union Bank. At that time, these banks had 70% of the nation’s
deposits. In 1993, New Bank of India was merged with Punjab National Bank, which reduced the number of
nationalized banks from 20 to 19.
5
The six banks were Andhra Bank, Corporation Bank, New Bank of India, Vijaya Bank, Oriental Bank of
Commerce, and Punjab & Sind Bank.

472 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
monopoly, and reduction in regional imbalances. Nationalizing the banks helped to fulfill
some of these objectives. It helped to improve bank penetration in India as the number of
bank branches increased to 57,699 (33,014 in rural India) in 1989 from 7,000 (1,833 in rural
India) in 1969.6
Another major development in the Indian banking industry took place when the Indian
Government adopted its liberalization policy in the early 1990s. The M Narasimham
Committee, 1991, on banking reforms suggested several reforms for the Indian banking industry,
including reduction in the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR),
reduction in mandatory priority sector lending, setting up of an Assets Reconstruction Fund
(ARF), ending of credit allocation under government direction, establishment of special tribunals
for quick recovery of debts, and deregulating of interest rates. The RBI accepted the various
recommendations of the Narasimham Committee such as reduced SLR and CRR and introduced
a risk-weighted assets ratio system—the Capital Adequacy Ratio; SBI and some other banks got
permission to tap the capital market; new private banks were started, etc. In 1992, new norms
were introduced with regard to income recognition, classification of assets, and provisioning
of bad and doubtful debts.
After 1994, banking licenses were provided to new private sector banks7 – Axis Bank
Limited8, Centurion Bank Ltd.9, Global Trust Bank (India)10, Kotak Mahindra Bank, Times
Bank11, and YES Bank Limited.12 The nationalization of the commercial banks and the entry
of the new private banks redefined the Indian banking structure, which included PSBs, Old
Private Sector Banks13, Foreign Banks, and Regional Rural Banks14 (RRBs) (See to Exhibit I
for Indian banking structure).
The last two decades of the 20th century and the first decade of the 21st saw revolutionary
changes take place in the Indian banking industry. The industry adopted information technology,
computers, mobile banking, Automated Teller Machines (ATMs), and internet banking. All
these spurred the growth of the industry. The number of branches of Scheduled Commercial
Banks (SCBs) went up from 80,200 on March 31, 2009, to 102,343 by the end of March
2013. The number of ATMs too increased, going up to 114,014 by the end of March 2013.
6
“Revisiting History – From Class Banking to Mass Banking”, www.businessandeconomy.org/28022013/
storyd.asp?sid=7198&pageno=2, February 28, 2013.
7
New Private Sector Banks or New Private Banks are the private banks that came in or after 1994.
8
In 2014, Axis Bank Limited was the third largest private sector bank in India with a balance sheet size of 3.86
tn.
9
Centurion Bank Ltd. was established in 1994. In 2005, it merged with Bank of Punjab to form Centurion Bank
of Punjab Ltd. which ultimately merged with HDFC in 2008.
10
Global Trust Bank (India) came into existence in 1994. After a scam, it was acquired by Oriental Bank of
Commerce.
11
Times Bank Limited, promoted by the Times of India Group, merged with HDFC in February 2000. This was
the first merger of two new generation private sector banks.
12
YES Bank Limited, a Mumbai-based private sector bank, had a balance sheet size of 1.09 tn as of 2014.
13
Old Private Sector Banks or Old Private Banks are the private banks which came into existence before1994.
14
Regional Rural Banks (RRBs) are local level banking entity.

Case Study 473

 Exhibit I: Indian Banking Structure
Reserve Bank of India
(Central Bank and Monetary Authority)

Commercial Regional Cooperative

Banks Rural Banks Banks

Public Sector Private Sector State Cooperative

Banks Banks Banks

Central Cooperative
Indian Foreign Banks

State Bank Other Nationalized

Primary Credit
Group Banks
Societies

SBI Associate Banks

Source: Smriti Chand, “Indian Banking System: Structure and Other Details (with Diagrams)”,
www.yourarticlelibrary.com/banking/indian-banking-system-structure-and-other-details-with-diagrams/23495/

According to the MarketLine15 industry profile published in October 2015, the overall
Compound Annual Growth Rate16 (CAGR) of the Indian banking sector for the period 2010-
14 was 14.8%. The industry grew from $876.6 bn in 2010 to $1.53 tn in 2014. Bank credit
was the largest segment of the Indian banking industry, contributing around 70.4% to the
total value of the banking sector.17 The MarketLine industry profile further mentioned that
the Indian banking industry would grow at a CAGR of 14.1% to take the industry size to $
2.95 tn in the period 2014-19.18 Though this data looked impressive, NPAs in the Indian
banking industry had increased substantially in the last few years of the 20th century and the
first decade of the 21st century. The GNPA which was about 575 bn in FY01, had increased
to 1 tn in FY11. It had further increased by 10.5 tn in FY18 before going down to 9.23 tn
in FY19 (Refer to Exhibit II for aggregate NPA of banking services industry).
15
MarketLine provides data on companies, industries, and countries across the globe.
16
Compound Annual Growth Rate (CAGR) gives us a compounded annual growth rate over multiple time
periods.
17
“MarketLine Industry Profile - Banks in India”, http://360.datamonitor.com, October, 2015.
18
Ibid.

474 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
 Exhibit II: Aggregate NPA of Banking Services Industry (in mn)

Financial Year GNPA NPA

1998-99 31,820.80 6,097.70
1999-00 392,398.50 157,352.80
2000-01 574,871.30 162,016.30
2001-02 685,437.60 196,843.30
2002-03 680,781.90 177,024.00
2003-04 649,130.20 118,117.40
2004-05 614,918.00 210,362.10
2005-06 530,611.30 181,498.30
2006-07 530,529.50 205,512.50
2007-08 581,964.00 248,331.60
2008-09 707,705.90 319,041.30
2009-10 864,859.30 392,783.00
2010-11 1,000,268.80 421,413.90
2011-12 1,444,192.70 656,657.70
2012-13 1,960,580.40 994,271.50
2013-14 2,667,647.20 1,440,658.60
2014-15 3,282,986.10 1,780,297.50
2015-16 6,179,856.60 3,526,708.30
2016-17 7,574,219.00 4,107,501.40
2017-18 10,500,104.20 5,265,851.10
2018-19 9,236,217.90 3,519,168.80
Source: https://industryoutlook.cmie.com/. Accessed on November 15, 2019

NPAs in Indian Banking Industry

In 1996-97, the GNPA in the Indian banking industry was 15.7%. This fell to 2.36% at the
end of financial year 2010-11 due to various reforms introduced by the RBI and GoI, such as
implementation of the reforms suggested by the second M Narasimham Committee on the
banking sector in 1998, enactment of the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 200219 (SARFAESI Act) and the Credit
Information Companies (Regulation) Act, 200520, etc.21, 22
19
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
allowed Indian banks and financial institutions to auction borrower property to recover their debts.
20
The Credit Information Companies (Regulation) Act, 2005, regulates the functions of Credit Information
Companies in India.
21
“Asset Reconstruction and NPA Management in India”, www.rbi.org.in/scripts/BS_SpeechesView.aspx?
Id=974, September 15, 2015.
22
“Banking - Performance Indicators”, http://dbie.rbi.org.in/DBIE/dbie.rbi?site=statistics

Case Study 475

 However, due to various reasons, the total stressed assets, which stood at 9.8% at the
end of March 2012, went up to 11.06% by March 2015 and then to 14.5% by the end of
December 2015.23,24 This affected the growth in the net profit of the SCBs, and led to a fall
in the ROA and the ROE of banks (Refer to Exhibit III).25

Exhibit III: Return on Assets and Return on Equity of SCBs – Bank Group-Wise

Return on Assets (ROA)* Return on Equity (ROE)**

Bank Group
2012-13 2013-14 2014-15 2012-13 2013-14 2014-15
Public Sector Banks 0.80 0.50 0.46 13.24 8.48 7.76

Private Sector Banks 1.63 1.65 1.68 16.46 16.22 15.74

Foreign Banks 1.92 1.54 1.87 11.53 9.03 10.25

All SCBs 1.04 0.81 0.81 13.84 10.69 10.42

Note: * Return on Assets = Net Profit/Average Total Assets; and ** Return on Equity = Net Profit/Average
Total Equity.
Source: “S S Mundra: Asset Quality Challenges in India - Diagnosis and Prognosis”,
www.bis.org/review/r160517a.pdf, April 28, 2016

Analysts opined that Indian banks had a poor record in the recovery of bad debts compared
to banks in developed countries. While the Indian banks were able to recover about 25% of
their bad debts in four years on an average, American banks were able to recover almost 80%
of their bad debts in just two years.26 The PSBs, which had more distress assets than other
banks, wrote off 2.11 tn between 2004 and 2015. Of this, more than half were written off
between 2013 and 2015 (Refer to Exhibit IV for the top 10 banks in writing off bad debts).27 In
the last two quarters of the financial year 2016, Indian banks reported about 3 tn worth of bad
debts, mostly by PSBs.
The GNPAs of all SCBs stood at 4.28% in FY15. They increased to 8.58% in FY17 and
further moved up to 11.22% in FY18.28 Due to the huge NPAs, the PSBs collectively reported
853.70 bn losses in FY18 compared to a profit of 4.74 bn in FY17.29

23
“Asset Reconstruction and NPA Management in India”, www.rbi.org.in/Scripts/BS_SpeechesView.
aspx?Id=974, September 15, 2015.
24
“S S Mundra: Asset Quality Challenges in India – Diagnosis and Prognosis”, www.bis.org/review/
r160517a.pdf, April 28, 2016.
25
Ibid.
26
“Bureaucrats at the Till”, www.economist.com/news/finance-and-economics/21699933-financial-sector-india-
being-improved-rather-overhauled-bureaucrats, June 4, 2016.
27
Utkarsh Anand, “Rs 1.14 Lakh Crore of Bad Debts: The Great Government Bank Write-Off”, http://
indianexpress.com, February 9, 2016.
28
“Gross and Net Non-Performing Assets: By Bank Groups”, https://economicoutlook.cmie.com/. Accessed on
November 15, 2019.
29
“‘Sashakt’ Plan to Resolve NPA will Go Live in a Month: Sunil Mehta”, www.moneycontrol.com/news/
business/sashakt-plan-to-resolve-npa-will-go-live-in-a-month-sunil-mehta-2676491.html, July 5, 2018.

476 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
 Exhibit IV: Top 10 Banks Writing Off Bad Debts in 2015

Bank Bad Debt Write Off (in bn)

State Bank of India 213.13

Punjab National Bank 65.87

Indian Overseas Bank 31.31

Allahabad Bank 21.09

IDBI Bank Ltd. 16.09

Bank of Baroda 15.64

Syndicate Bank 15.27

Canara Bank 14.72

UCO Bank 14.01

Central Bank of India 13.86

Source: Utkarsh Anand, “Rs 1.14 lakh Crore of Bad Debts: The Great Government Bank Write-Off”,
http://indianexpress.com, February 9, 2016

Reasons for High Growth in NPAs

Environmental Factors
There were many environmental factors that were responsible for the high growth of NPAs
in India. One of the main reasons was the US financial crisis in 2008 which had a global
impact. In addition to this, a fall in commodity prices and dumping from China had decreased
the competitiveness of Indian manufacturers, leading to a reduction in the cash flow of the
manufacturers. This had made it tough for them to repay their loans and this in turn resulted in
the growth in NPAs.

Companies’ Carelessness
Several companies had taken massive debts vis-à-vis their capacity to service the debts. They
rushed to the high growth sectors and diversified into unrelated industries. Intent on chasing
profits, these companies overlooked the risks involved.

Willful Defaulters
India had one of the highest numbers of willful defaulters. Willful defaulters had the capacity
to repay the loan but were disinclined to do so. Some willful defaulters had diverted funds to
some other purpose, whereas others had used the funds for personal purposes.

Failure of Banks’ Own System

In many cases, the banks themselves were responsible for the rise in NPAs. While they did
not conduct proper due diligence in some instances, poor credit appraisal became the cause

Case Study 477

of NPAs in others. Weak risk management and lack of proper governance were other reasons
for the NPAs.

RBI’S Policies on NPAs

In September 2013, Raghuram Rajan (Rajan) became governor of the RBI. In his very first speech
as governor, he said, “We have to improve the efficiency of the recovery system, especially at
a time of economic uncertainty like the present [2013]…. I have asked Deputy Governor Dr.
Chakrabarty to take a close look at rising NPAs and the restructuring/recovery process, and we
too will be taking the next steps shortly. RBI proposes to collect credit data and examine large
common exposures across banks. This will enable the creation of a central repository on large
credits, which we will share with the banks. This will enable banks themselves to be aware of
building leverage and common exposures…. The bad loan problem is not alarming yet, but it
will only fester and grow if left unaddressed.”30 Rajan said deep surgery was important to clean
up the balance sheets of banks and for this purpose, the RBI had taken the following steps:
Central Repository of Information on Large Credits
The RBI had set up the Central Repository of Information on Large Credits (CRILC) in 2013.
The objective of CRILC was to gather, store, and distribute data related to large borrowers’
accounts to lenders. The lenders had to report details of all credits which had total fund-based
and non-fund based exposure of 100 mn31 and above to CRILC in the proper classification.
CRILC reporting started from the end of June 2014.32, 33

Guidelines for Better Credit Risk Management

For better credit risk management, the RBI asked lenders not to depend on the credit appraisal
report prepared by outside consultants but to conduct independent credit appraisals. The RBI
also suggested to lenders that they conduct a sensitivity test and measure risk through credit
scoring or credit rating before approving loans. Banks were asked to use the scientific method
for risk pricing. They also had to verify whether the names of directors/promoters were on
the list of defaulters. Lenders had to develop a proactive credit risk management policy
which included industry research at regular intervals, site visits at regular intervals, regular
management review of borrowers with poor credit, etc. The RBI also asked lenders to improve
the post disbursement supervision system and to diversify their portfolio.

Asset Quality Review

An Asset Quality Review (AQR) in Indian banks was started by Rajan in February 2015. The
objective of AQR was to clean up the balance sheets of the banks and make the banks
30
“Statement by Dr. Raghuram Rajan on Taking Office on September 4, 2013”, https://rbi.org.in/scripts/
BS_PressReleaseDisplay.aspx?prid=29479, September 4, 2013.
31
From the quarter ending in June 2014, the threshold limit for reporting large credit had come down to 50 mn
from the earlier 100 mn.
32
www.iba.org.in/Documents/CRILCreporting.pdf, April 10, 2015.
33
“Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders:
Framework for Revitalising Distressed Assets in the Economy”, https://rbidocs.rbi.org.in/rdocs/content/pdfs/
NPA300114RFF.pdf, January 30, 2014.

478 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
stronger in the long run. Rajan asked the banks to recognize troubled loans as bad debts, to
make provisions against bad debts, and to spread them out over the remaining two quarters
of FY16. As a result of AQR, the Indian banking industry witnessed a surge in NPAs and a
fall in the profitability of the banks, especially the PSBs, in the last two quarters of FY16 and
the first quarter of FY17.
S Naganath, President and Chief Investment Officer at DSP BlackRock Investment
Managers Pvt. Ltd.,34 said, “I think what is happening now is good in the long term for the
banking sector and for the economy. The problem is being addressed in a focused manner
and within a defined time period. Once it’s done, the outcomes will be very positive for the
economy.”35 Experts believed this trend would continue till March 2017, Rajan’s deadline
for the banks to clean up their balance sheets. Rajan said, “We hope that over the span of
next year... say by March 2017, a full clean-up will have been done by banks... the idea is
to put the real assets back on track with whatever needs to be done.”36

Strategic Debt Restructuring

The Strategic Debt Restructuring (SDR) scheme was started by Rajan in June 2015 for the
recovery of NPAs. Under this scheme, Joint Lenders’ Forum (JLF) could take the SDR route to
recover loans given to companies. The SDR scheme ensured that lenders could easily acquire
a majority stake in stressed companies, which had failed to recover under Corporate Debts
Restructuring (CDR), by converting part of the outstanding loan into equity. This would help
the banks take control of the debtor company and easily sell off the assets to recover loans. At
a later stage, when things improved, the banks could transfer the stake to new promoters and
upgrade the assets to standard assets. The banks had to ensure that the new promoters had no
connection with the old promoters. They had to transfer the entire 51% stake37 to the new
promoters within 18 months of the reference date.38 According to experts, SDR was useful to
both the lenders and the companies because under the scheme the lenders got the chance to
recover a part of the loan and the borrower got a chance for revival.
Scheme for Sustainable Structuring of Stressed Assets
In June 2016, Rajan came up with the Scheme for Sustainable Structuring of Stressed Assets
(S4A). The S4A was an optional framework for the lenders to deal with NPAs. The objective
of this scheme was to give some relief to companies facing genuine problems in loan
repayment and improve the lenders’ capability to deal with NPAs. Under S4A, the lender
determined the sustainable level for a stressed debtor and divided the outstanding loan into
34
DSP BlackRock Investment Managers Pvt. Ltd. is an assets management company in India.
35
MC Govardhana Rangan and Saloni Shukla, “Why Raghuram Rajan’s NPA Move May Either Bring Indian
Banking to Life, or Push it into a Coma”, http://economictimes.indiatimes.com/industry/banking/ finance/
banking/why-raghuram-rajans-npa-move-may-either-bring-indian-banking-to-life-or-push-it-into-a-coma/
articleshow/51114936.cms, February 24, 2016.
36
“RBI, Government Steps to Help Banks End NPA Woes by March ‘17: Raghuram Rajan”, http://
articles.economictimes.indiatimes.com/2015-12-01/news/68688535_1_rbi-governor-raghuram-rajan-npas-
march-2017, December 1, 2015.
37
The condition of sale of the entire 51% stake to new promoters went down to 26% stake in February 2016.
38
Reference date is the date when JLF took the decision to undertake SDR.

Case Study 479

sustainable debt and equity or quasi-equity.39 The scheme helped the borrower with a flow
of credit and provided good returns to the lender when the borrower achieved a turnaround.
The banks were free to decide how much of the loan could be serviced by the borrower
with the present cash flow. However, a sustainable loan should not be less than half of the
current funded liabilities. The S4A scheme did not allow banks to restructure the terms of
sustainable debts by reducing interest rates, extending the repayment period, etc. The scheme
provided a detailed framework for a resolution plan to be developed with the help of professional
agencies, overseen by the committee formed by the Indian Banks Association (IBA).40

New Disclosure Regarding Divergence in the Asset Classification and

Provisioning
In April 2017, the RBI came up with new disclosure norms for banks. In its notification, it
asked lenders to make suitable disclosures wherever divergence between reported numbers and
the RBI assessed numbers regarding provisions for NPA and GNPA crossed a certain limit. The
banks had to make disclosures in the ‘Notes of Accounts’ of annual financial statements. New
disclosures ensured that the banks acted according to the central bank’s prudential norms on
Income Recognition, Asset Classification, and Provisioning (IRACP). According to the
notification, banks had to make disclosures in any of the following conditions:
• When additional provisioning for NPAs, assessed by the RBI, exceeded 15% of the
net Profit After Tax (PAT) for the reference period.
• In addition to this, the new rule was also applicable in a situation when additional
GNPAs, assessed by the RBI, exceeded 15% of the published incremental GNPAs
for the reference period.
Banks had to report these divergences in a format suggested by the RBI (Refer to Exhibit V
for the prescribed format of RBI).41

Change in Divergence Disclosure Rules in April 2019

In 2017, when the RBI issued disclosure rules, it wanted disclosure from the banks only where
divergences exceeded a certain threshold from the prudential norms. However, over a period
of time, the RBI found that some banks with a low or negative PAT were also disclosing
divergences when the additional provision assessed by the RBI was negligible. So, the
central bank came up with a new notification in April 2019 to make some changes in these
rules. As per this new notification, banks had to report divergence when,
• Additional provisioning for NPAs, assessed by the RBI, exceeded 10% of reported
profit before provisions and contingencies for the reference period.

39
Quasi equity is a form of debt taken by a company which has some qualities of equity. Example: Mezzanine
debt and Junior debt.
40
Indian Banks Association (IBA) is the association of Indian banks and financial institutions.
41
“Disclosure in the ‘Notes to Accounts’ to the Financial Statements- Divergence in the Asset Classification and
Provisioning”, www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10932&Mode=0#Ann1, April 18, 2017.

480 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
 • In addition to this, the new rule was also applicable in a situation when additional
GNPAs, assessed by the RBI, exceeded 15% of the published incremental GNPAs
for the reference period.42

Exhibit V: Format to Report Divergence in Asset Classification and Provisioning for

NPAs ( in thousands)
S. No. Particulars Amount

1. Gross NPAs as on March 31, 20XX* as reported by the bank

2. Gross NPAs as on March 31, 20XX as assessed by RBI

3. Divergence in Gross NPAs (2-1)

4. Net NPAs as on March 31, 20XX as reported by the bank

To be reported by banks
5. Net NPAs as on March 31, 20XX as assessed by RBI

6. Divergence in Net NPAs (5-4)

7. Provisions for NPAs as on March 31, 20XX as reported by the bank

8. Provisions for NPAs as on March 31, 20XX as assessed by RBI

9. Divergence in provisioning (8-7)

10. Reported Net Profit After Tax (PAT) for the year ended March 31, 20XX

11. Adjusted (notional) Net Profit after Tax (PAT) for the year ended March 31,
20XX after taking into account the divergence in provisioning

Note: * March 31, 20XX is the close of the reference period in respect of which divergences were assessed.

Source: “Disclosure in the ‘Notes to Accounts’ to the Financial Statements- Divergence in the Asset
Classification and Provisioning”, www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10932&Mode=0#Ann1,
April 18, 2017

Prudential Framework for Resolution of Stressed Assets, 2019

In June 2019, the RBI came up with a ‘Prudential Framework for Resolution of Stressed
Assets’ to provide a framework for early identification, reporting, and time-bound resolution
of stressed assets. This framework had replaced as many as 28 circulars (including Timelines
for Stressed Assets Resolution, Refinancing of Project Loans, SDR scheme, S4A Framework
for Revitalizing Distressed Assets among others), issued by the RBI between August 23,
2001, and May 5, 2017.43
The prudential directions were applicable to all SCBs, RRBs, various financial institutions
(NABARD, NHB, EXIM Bank, and SIDBI), Small Finance Banks, etc. Now, lenders had to
42
“Disclosure in the ‘Notes to Accounts’ to the Financial Statements - Divergence in the Asset Classification
and Provisioning”, www.rbi.org.in/scripts/NotificationUser.aspx?Id=11521&Mode=0, April 1, 2019.
43
“Prudential Framework for Resolution of Stressed Assets”, www.rbi.org.in/Scripts/
NotificationUser.aspx?Id=11580&Mode=0, June 7, 2019.

Case Study 481

identify stressed assets immediately after default and classify such assets as Special Mention
Accounts (SMA) (Refer to Table 1).

Table 1: Classification of Special Mention Accounts

The Basis for Classification – Principal or Interest Payment or Any

SMA Sub-Categories
Other Amount Wholly or Partly Overdue Between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

Source: “Prudential Framework for Resolution of Stressed Assets”, www.rbi.org.in/Scripts/
NotificationUser.aspx?Id=11580&Mode=0, June 7, 2019

According to an industry expert, the earlier rules were stringent, whereas the new rules
were more practical. Earlier, lenders were supposed to treat an account as an NPA even on
day zero/day one after default. However, with the new rules, banks had a 30-day window to
decide whether the account was an NPA or not.
As per the new framework, lenders had to inform CRILC about the SMA for all borrowers
with exposure to more than 50 mn. The new framework also made the signing of the Inter-
Creditor Agreement mandatory. The framework also covered the implementation of a resolution
plan, rules regarding the 30-day review period, rules for additional provisions, etc.44

SEBI’S Circular on Disclosure of Divergence

In November 2019, the Securities and Exchange Board of India (SEBI), the regulator of the
Indian securities market, issued a circular asking listed banks to disclose any material divergence
in their NPAs as soon as possible but not later than 24 hours after the receipt of the Risk
Assessment Report (RAR) from the RBI. SEBI’s circular stated, “These disclosures in respect
of divergence and provisioning are in the nature of material events/information and hence
necessitate immediate disclosure.”45 Before the November circular, banks used to disclose
such divergences in quarterly results.
The new disclosure rules were applicable in a situation where additional provisioning for
NPAs exceeded 10% of the profit before provisions and contingencies for the reference period.
In addition to this, the new rule was also applicable in a situation where additional GNPAs
exceeded 15% of the published incremental GNPAs for the reference period.46

44
“Prudential Framework for Resolution of Stressed Assets”, www.rbi.org.in/Scripts/Notification
User.aspx?Id=11580&Mode=0, June 7, 2019.
45
“SEBI Asks Banks to Declare NPA Divergences on Continuous Basis”, https://economictimes.indiatimes. com/
markets/stocks/news/sebi-asks-banks-to-declare-npa-divergences-on-continuous-basis/articleshow/
71847214.cms, November 1, 2019.
46
“Disclosure of Divergence in the Asset Classification and Provisioning by Banks”, www.sebi.gov.in/ legal/
circulars/oct-2019/disclosure-of-divergence-in-the-asset-classification-and-provisioning-by-banks_ 44830.html,
October 31, 2019.

482 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
Efforts of GoI to Reduce NPAs
Enactment of Insolvency and Bankruptcy Code, 2016
In May 2016, the Indian parliament passed the long-awaited ‘Insolvency and Bankruptcy
Code, 2016’ (IBC) which gave more powers to the creditors and ensured timely winding up of
unviable projects and faster recovery of money. IBC replaced the old bankruptcy law. The
provisions of this law would be applicable to companies incorporated, limited partnership
firms, partnership firms, and individuals. This law made it easier to do business in India as it
resolved the problem of having to deal with multiple laws that a person who wanted to start
a business in India faced.
The new law ensured the time-bound settlement of insolvency and the faster turnaround of
businesses. This law was also expected to help solve the NPA problem. The new code set the
framework to bring in changes in the debt recovery tribunals. The new code had provisions to
deal with cross-border insolvency with the help of bilateral agreements with other nations.
The new law protected the interests of workers. It clearly defined the time limit for each
procedure so that the result came out in 180 days. The law had also made a provision of a one-
time extension of 90 days for any unexpected event.47
Project Sashakt
Around mid-2018, a high-level committee under the chairmanship of Sunil Mehta, the then
Chairman of Punjab National Bank, on restructuring stressed assets suggested a five-pronged
strategy namely Project ‘Sashakt’ for loans from 0.5 bn, 0.5-5 bn, and 5 bn above. The five-
pronged approach was as follows:
• SME resolution approach loans up to 0.5 bn would be resolved at the bank-level
with the help of a steering committee within 90 days.
• The Bank-Led Resolution Approach (BLRA) was for a loan size of 0.5-5 bn. Under
BLRA, lenders would enter into an inter-creditors agreement which authorized a
lead bank to implement a resolution plan in 180 days. If the lead bank was unable
to resolve the issues within 180 days, then the assets would go to National Company
Law Tribunal (NCLT).
• In the Asset Management Company (AMC)/Alternative Investment Fund (AIF)
led resolution approach, an AMC would be set up for resolution of loans above 5
bn. The name of the AMC would be ‘Sashakt India Asset Management’.48
• The NCLT/IBC approach was for cases already pending with the resolution courts
and not covered in other approaches.
• The asset trading platform was for performing as well as NPAs so that lenders could
trade bunched loan assets.
47
www.indiacode.nic.in/acts-in-pdf/2016/201631.pdf
48
Arjun Manjunadha, “Sunil Mehta Committee Incorporated Sashakt India AMC for Large NPAs Over 500 Crore
Rupees”, www.fresherslive.com/current-affairs/articles/sunil-mehta-committee-incorporated-sashakt-india-amc-
for-large-npas-over-500-crore-rupees-16526, November 19, 2018.

Case Study 483

 While announcing Project Sashakt, Piyush Goyal, the then Acting Union Finance Minister,
said, “The committee has set a five-prong strategy towards resolution of stressed assets.
‘SASHAKT’ stands for strengthening and the whole objective was to strengthen the credit
capacity, credit culture, and portfolio of PSBs.”49

4Rs Strategy
The GoI had implemented a comprehensive 4Rs strategy – recognition, resolution,
recapitalization, and reforms. Sitharaman said, “Over the last four years, the government has
taken comprehensive steps under its 4Rs strategy of recognizing NPAs transparently, resolving
and recovering value from stressed accounts, recapitalizing PSBs, and reforms in banks and
financial ecosystem to ensure a responsible and clean system.”50 Under the 4Rs strategy, the
following measures were taken to reduce the NPAs:
• Change in work culture including change in the relationship between creditors and
borrowers mainly due to the introduction of the IBC, 2016.
• Various initiatives to help the PSBs recapitalize up to 3.12 tn in which 0.66 tn
was mobilized by the PSBs themselves and the remaining 2.46 tn was injected by
the GoI.
• Various reforms were introduced at the PSB level for the timely realization of loans.
These included separation in monitoring and sanction roles, hiring specialized
monitoring agencies for a loan size of more than 2.5 bn, One-Time Settlement
(OTS) and online end-to-end OTS platforms.51

Looking Ahead
Sitharaman, who became the new Union Finance Minister of India on May 31, 2019, asked
banks to follow the circular of the RBI in which the central bank had directed banks to not
declare the stressed loans of Micro, Small and Medium Enterprises (MSMEs) as NPAs till
March 31, 2020.52 Sitharaman said, “We have told the banks that till March 31, 2020, no
stressed-asset MSME will be declared an NPA. We have also requested that the banks should
make an effort to sit with such stressed-asset MSMEs and work it out with them to get them
out of that situation.”53
49
“Project Sashakt: Five-Point Formula for Resolution of Bad Loans at PSU Banks”, www.hindustantimes.
com/business-news/project-sashakt-five-point-formula-for-resolution-of-bad-loans-at-psu-banks/story-
FmOcIeuP7hXv1jpVezT54J.html, July 3, 2018.
50
“Modi Government’s ‘4R’ Strategy to Resolve NPA Crisis Shows Results; Bad Debt Reduces by Rs 89,189
Crore”, www.businesstoday.in/sectors/banks/modi-government-4r-strategy-to-resolve-npa-crisis-shows-results-
bad-debt-reduces-rs-89189-cr/story/358884.html, June 25, 2019.
51
“Comprehensive Steps Taken by the Central Government Under the 4R’s Strategy to Reduce NPAs of Public
Sector Banks”, https://pib.gov.in/Pressreleaseshare.aspx?PRID=1578985, July 19, 2019.
52
“No Stressed MSME Loan to be Declared NPA till March 2020: FM Nirmala Sitharaman”, https://
economictimes.indiatimes.com/industry/banking/finance/no-stressed-msme-loan-to-be-declared-npa-till-march-
2020-fm-niramala-sitharaman/articleshow/71205777.cms, September 19, 2019.
53
“Banks Not to Declare Stressed MSMEs as NPAs as till March 31 Next Year: Sitharaman”, www.sify.com/
finance/banks-not-to-declare-stressed-msmes-as-npas-as-till-march-31-next-year-sitharaman-news-bank-
tjtwbridgadja.html, September 20, 2019.

484 The IUP Journal of Accounting Research & Audit Practices, Vol. 20, No. 4, 2021
 Some experts stated that the various steps taken by the RBI and the GoI would definitely
strengthen the Indian banking system. They suggested that the RBI and the GoI should work on
the root cause of the NPAs, which was connected to capital structure, government intervention
in loan disbursement, loan waiver policies used by various state governments, the high
shareholding of government, and management style of PSBs.

Suggested Readings and References

1. Chiranjivi Chakraborty (2016), “PSBs in Deep Waters! Nine Banks Report Net Losses of
Rs 14,000 Core So Far”, http://economictimes.indiatimes.com/markets/stocks/news/psbs-
in-deep-waters-nine-banks-report-net-losses-of-rs-14000-crore-so-far/articleshow/
52323160.cms, May 18.
2. http://pib.nic.in/newsite/printrelease.aspx?relid=124107, July 31, 2015.
3. “PNB Reports Q4 Loss of Rs 5,367 Crore, Biggest in Indian Banking History”, http://
economictimes.indiatimes.com/markets/stocks/earnings/pnb-reports-q4-loss-of-rs-5367-
crore-biggest-in-indian-banking-history/articleshow/52322501.cms, May 18, 2016.
4. Ravindra Sonavane (2016), “PNB Tops List of Worst Losses in Indian Banking History”,
www.livemint.com/Industry/nyp8yAz9fEXYdkcstG4CEP/PNB-tops-list-of-worst-losses-in-
Indian-banking-history.html, May 18 2016.
5. Remya Nair (2016), “PNB Posts Record Rs5,367 Crore Loss in Q4, Worst May Not be
Over”, www.livemint.com/Companies/djeLHOyRwKoAxXuY6RTuVK/PNB-posts-Rs5367-
crore-loss-in-fourth-quarter.html, May 19.

Reference # 09J-2021-10-32-02

Case Study 485

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