Non-Performing Assets and Twin Balance Sheet Problem

Non-Performing Asset is an asset, including a leased asset, which becomes non-performing

when it ceases to generate income for the bank or a financial institution. A ‘Non-Performing
Asset’ (NPA) was defined as a credit facility in respect of which the interst and/ or instalment
of principal has remained ‘past due’ for a specified period of time. The specified period was
reduced in a phased manner. According to the Narasimham Committee Report in 1991, those
assets for which the interest remains due for a period of four quarters should be considered as
NPAs. Subsequently, this period was reduced, and from March 1995 onwards the assets for
which the interest remains unpaid for ninety days were considered as NPAs. 

The following three categories are considered as NPAs :-

Sub-standard Assets

A sub-standard asset would be one, which has remained NPA for a period less than or equal
to 12 months. In such cases, the current net worth of the borrower/ guarantor or the current
market value of the security charged is not enough to ensure recovery of the dues to the banks
in full.

Doubtful Assets

An asset would be classified as doubtful if it remained in the sub-standard category for 12

months. A loan classified as doubtful has all the weaknesses inherent in assets that were
classified as sub-standard.

Loss Assets

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

Banks in India are not only a source of financial reserves, funding the capital intensive
industries like automobiles, infrastructure, iron and steel etc. but also, are key to
government’s various initiatives (like to boost the economic growth and development) . And
since India is one of the fastest growing economy, credit flow to various sectors is
unavoidable. Conversely, this growth is one of reason that leads to increase of stressed assets
due to excess capacity creation, increased inflation, less write-offs and liquidity. The credit
growth during growing years till 2008 (Financial Crisis) is in excess of 22% while that
decreased to 15.1% in FY2013 and to 7.1% in 2019 with the decline of GDP. A lack of
budgeted capital for public sector banks for FY21 will limit credit growth for lenders to
around 6%.
Why assets become NPA?

As it is clear from the above figure that India has one of the highest percentages of NPAs
compared to other emerging economies. Few prominent reasons for increasing NPAs are as:

1. Lack of proper monitoring and follow-up measures due to economic and political
pressure
2. Lack of sincere corporate culture. Inadequate legal provisions on foreclosure and
bankruptcy.
3. Change in economic policies/environment like the loans and advances provided after
global crisis during upturn
4. Non transparent accounting policy and poor auditing practices.
5. Lack of coordination between banks/FIs.
6. Directed landing to certain sectors like priority sector lending and loans to Micro,
Small and Medium Enterprises.
7. Failure on part of the promoters to bring in their portion of equity from their own
sources or public issue due to market turning unfavourable.
8. Reckless lending-Advancing loans without considering repayment capacity and
without taking any security

Further, NPAs is one of the indicators to assess the soundness of banking sector. They
adversely impact the banks by reducing their profits in the form of interests and provisions,
reducing their lending capacity and making them more risk averse, which in turn impacts the
economy.

 The banks inability to recover and realize such assets result in write offs which leads
to a decrease in their net profits.
  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.

 It results in the lowering of the deposit interest rates by the banks to recover the bank
loss from the depositors. On the contrary, the lending rates are increased by the banks
that discourage the genuine borrowers from seeking loans and thereby affecting the
economic productivity. Even more, the domestic businesses cannot survive in an
environment where they pay higher interest for their borrowings while their global
competitors are furnishing the loans at low rates. This results in negative balance of
trade and large unemployment and social unrest.

 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.

 Shareholders’ confidence: 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.

 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 depositors. Thus, the increased incidence of NPAs not only
affects the performance of the banks but also affect the economy as a whole.

Twin Balance Sheet (TBS) Problem: TBS problem refers to the stress on the balance sheets
of banks due to non-performing assets (NPAs) or bad loans on the one hand, and heavily
indebted corporates on the other. Thus, TBS is two-fold problem for Indian economy which
deals with:

Overleveraged companies – Debt accumulation on companies is very high and thus they are
unable to pay interest payments on loans. About 40% of corporate debt is owed by companies
who are not earning enough to pay back their interest payments.
Bad-loan-encumbered-banks – Gross NPA ratio of banks declines to 9.1% in FY19: RBI
annual report. Early recognition and resolution of stressed assets have helped banks contain
their gross non- performing loans ratio at 9.1 percent in FY19 down from 11.2 percent a year
before, says the monetary authority. The gross non-performing assets (NPAs) of public sector
banks (PSBs) have declined by Rs 89,189 crore from a peak of more than Rs 8.95 lakh crore
in March 2018 to Rs. 7.27 lakh crore as on September 30, 2019.

Steps taken to tackle NPAs

The Debt Recovery Tribunals (DRTs) – 1993

SARFAESI Act – 2002

The Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest (SARFAESI) Act, 2002 – The Act permits Banks / Financial Institutions to recover
their NPAs without the involvement of the Court, through acquiring and disposing of the
secured assets in NPA accounts with an outstanding amount of Rs. 1 lakh and above. The
banks have to first issue a notice. Then, on the borrower’s failure to repay, they can:

1. Take ownership of security and/or

2. Control over the management of the borrowing concern.
3. Appoint a person to manage the concern.

Features of the amendment to the SARFAESI Act in 2016

Government has amended the SARFAESI Act in August 2016 to empower the ARCs (Asset
Reconstruction Companies), to rejuvenate Debt Recovery Tribunals (DRTs) and to enhance
the effectiveness of asset reconstruction under the new bankruptcy law. The amendment has
given more regulatory powers to the RBI on the working of ARCs. It was also aimed to
empower asset reconstruction and the functioning of DRTs in the context of the newly
enacted bankruptcy law. As per the amendment, the scope of the registry that contains the
central database of all loans against properties given by all lenders has been widened. RBI
will get more powers to audit and inspect ARCs and will get the freedom to remove the
chairman or any director. It can also appoint central bank officials into the boards of ARCs.
RBI will get the power to impose penalties on ARCs when the latter doesn’t follow the
central bank’s directives. Similarly, it can regulate the fees charged by ARCs from banks
while dealing with NPAs. The penalty amount has been increased from Rs 5 lakh to Rs 1
crore.

5/25 rule – 2014 (Refinancing of Infrastructure Scheme)

This scheme offered a larger window for the revival of stressed assets in the infrastructure
sector and eight core industry sectors. Under this scheme, lenders were allowed to extend
amortisation periods to 25 years with interest rates adjusted every 5 years, so as to match the
funding period with the long gestation and productive life of these projects. The scheme thus
aimed to improve the credit profile and liquidity position of borrowers, while allowing banks
to treat these loans as standard in their balance sheets, reducing provisioning costs.

Some Steps taken in last four years

Mission Indradhanush – 2015

The Indradhanush framework for transforming the PSBs represents the most comprehensive
reform effort undertaken since banking nationalization in the year 1970 to revamp the Public
Sector Banks (PSBs) and improve their overall performance by ABCDEFG.
 A-Appointments: Based upon global best practices and as per the guidelines in the
companies act, separate post of Chairman and Managing Director and the CEO will get the
designation of MD & CEO and there would be another person who would be appointed as
non-Executive Chairman of PSBs.
B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials,
which will replace the Appointments Board for the appointment of Whole-time Directors as
well as non-Executive Chairman of PSBs
C-Capitalization: As per finance ministry, the capital requirement of extra capital for the
next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000
crores will be provided by the GOI and the rest PSBs will have to raise from the market.
D-DEstressing: PSBs and strengthening risk control measures and NPAs disclosure.
E-Employment: GOI has said there will be no interference from Government and Banks are
encouraged to take independent decisions keeping in mind the commercial the organizational
interests.
F-Framework of Accountability: New KPI(key performance indicators) which would be
linked with performance and also the consideration of ESOPs for top management PSBs.
G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial
institutions. Bank board Bureau for transparent and meritorious appointments in PSBs.

Strategic debt restructuring (SDR) – 2015

Under this scheme banks who have given loans to a corporate borrower gets the right to
convert the complete or part of their loans into equity shares in the loan taken company. Its
basic purpose is to ensure that more stake of promoters in reviving stressed accounts and
providing banks with enhanced capabilities for initiating a change of ownership in
appropriate cases.

Asset Quality Review – 2015

Classify stressed assets and provisioning for them so as the secure the future of the banks and
further early identification of the assets and prevent them from becoming stressed by
appropriate action.

Sustainable structuring of stressed assets (S4A) – 2016

It has been formulated as an optional framework for the resolution of largely stressed
accounts. It involves the determination of sustainable debt level for a stressed borrower and
bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments
which are expected to provide upside to the lenders when the borrower turns around.

Insolvency and Bankruptcy code Act-2016

It has been formulated to tackle the Chakravyuaha Challenge (Economic Survey) of the
exit problem in India. The aim of this law is to promote entrepreneurship, availability of
credit, and balance the interests of all stakeholders by consolidating and amending the laws
relating to reorganization and insolvency resolution of corporate persons, partnership firms
and individuals in a time-bound manner and for maximization of value of assets of such
persons and matters connected therewith or incidental thereto.
Recently the government has implemented a comprehensive 4R’s strategy, consisting of
recognition of NPAs transparently, resolution and recovery of value from stressed accounts,
recapitalising of PSBs, and reforms in PSBs and the wider financial ecosystem for a
responsible and clean system. Comprehensive steps have been taken under the 4R’s strategy
to reduce NPAs of PSBs.

Why did the above measures fail to solve the TBS problem?

 Loss recognition: Banks do not recognise stressed assets and continue giving loans.
They are reluctant to conduct the asset quality review for their assets.
 Coordination problems: Difficulty in deciding compensation by different banks on
Joint Lenders Forums which has not achieved much success.
 Court cases: Public Sector Banks are reluctant to write down loans as bank managers
are afraid of accusation of favouritism.
 Lack of Capital: Indradhanush Scheme promised to infuse Rs 70,000 crore into
Public Sector Banks by 2018-19. But this amount is not enough and banks need
atleastRs 1.8 lakh crore more.

To solve the TBS Problem India needs a Public Sector Asset Rehabilitation Agency
(PARA)

 PARA would purchase loans from banks and then work them by different ways like
converting debt to equity and selling the stakes in the auction.
 After taking off the loans from Public Sector Banks, the government would
recapitalize them. Similarly, once the financial viability of the over-indebted
enterprises is restored, they will be able to focus on their operations, rather than their
finances and will be able to consider new investments.

Sources:
https://www.business-standard.com/article/finance/rbi-allows-banks-30-day-window-after-
default-to-draw-resolution-plan-119060701489_1.html

https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?Id=449&Mode=0
https://www.thehindu.com/business/Economy/resolution-of-twin-balance-sheet-problem-to-
take-upto-nine-months/article23546804.ece

https://www.clearias.com/non-performing-assets-npa/