What is NPA?
The Non-Performing Asset is the asset of the banks on which payment of principal or interest is due for more than ninety days. The NPA stops generating any income to the bank and are on the verge to default and the loans given by banks becomes stressed assets for the banks.
In India, as of March 2018, about 11.6% of loans forwarded by banks are classified as NPAs. This a serious problem and needs to be addressed.
How the NPA problem occurred?
There was a boom period in the Indian economy from 2002 to about 2008, in which the economy was growing at 9 to 10 per cent. There was a surge in borrowing by the companies from the banks during that period to finance their infrastructure projects like steel, power, telecommunication etc. Banks have lent heavily to companies during that period.
But then the Global Financial crisis of 2008 occurs, which results in a fall in demand in all the sectors of the economy. Due to slowdown, companies which have lent money from the banks cut their production and their revenues started decreasing. There was a situation when the interest coverage ration of these companies was less than one, means they were not earing enough to pay even interest on their loans.
All this situation lead to a debt servicing problem for the companies banks started to do evergreening to loans (to give a new loan to pay interest or principle of the previous loan) which ultimately worsed the situation.
Twin Balance sheet problem is a situation when companies don’t earn enough to pay dues of loans taken from banks and banks are not giving further loans to companies due to default on previous loans, as a result, companies have not enough capital to boost production process which will lead to losses and banks assets turn to NPA. Thus a situation when bank balance sheet and companies balance sheet both are stressed is called twin balance sheet problem.
Classification of bank’s assets
There are a number of categories depending on what period there is no income from loans forwarded by banks, shown in the figure:
Special Mention Accounts (SMA)?
For the early detection of stressed assets, before these turn into NPA, RBI has set up a repository where banks and NBFCs which have forwarded loans to companies or firms of an amount greater than or equal to 5 crore rupees have to register it in RBI’s repository. This special mention account is divided into three categories depending upon the time period as:
- SMA 0: If principal or interest is due for 1 to 30 days
- SMA 1: If principal or interest is due for 31 to 60 days
- SMA 2: If principal or interest is due for 61 to 90 days
If multiple lenders report SMA for a single company, then a Joint Lenders Forum is formed and corrective action plan with majority voting is taken. There is a lack of consensus in the Joint Lenders Forum, hence decentralised decision making is not working. For this economic survey advocate that we need a bad bank name as PARA (Public Sector Asset Rehabilitation Agency) to short out bad loans from banks.
How to solve the NPA issue?
To short out the distressed assets of banks RBI came up with a 3-R framework, called Rectification, Restructuring and Recovery. The government has also enacted an act called Insolvency and Bankruptcy Code, 2016 to deal with mounting NPA. Read about Insolvency and Bankruptcy code at IBC, 2016.