NPA Crisis

NPA Crisis

Gross NPAs of Banks to Rise

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPAs and related terms

Mains level : NPA Crisis

Gross Non-Performing Assets (NPAs) of banks are expected to rise to 8-9% this fiscal from 7.5% as on March 31, 2021 but they would still remain below the peak of 11.2% seen at the end of fiscal 2018.

What are Non-Performing Assets?

  • For a bank, the loans given by the bank is considered as its assets.
  • Any asset which stops giving returns to its investors for a specified period of time is known as Non-Performing Asset (NPA).
  • 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 NPA.

Classification of NPAs in India

  • According to the RBI, a NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
  • Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
  1. Substandard Assets: Assets which has remained NPA for a period less than or equal to 12 months.
  2. Doubtful Assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
  3. Loss Assets: As per RBI, loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.

NPAs of Agriculture Loans

In terms of Agriculture/Farm Loans, the NPA is defined as under:

  • For short duration crop such as paddy, Jowar, Bajra etc. if the loan (instalment/interest) is not paid for 2 crop seasons, it would be termed as an NPA.
  • For Long Duration Crops, the above would be 1 Crop season from the due date

Reasons for NPAs in India

Impact of NPA on Economy

  • Depositors’ loss: Depositors do not get rightful returns and many times may lose uninsured deposits.
  • High interest on lending: Banks may begin charging higher interest rates on some products to compensate NPA loan losses.
  • Trust issues: Bad loans imply redirecting of funds from good projects to bad ones. Hence, the economy suffers due to loss of good projects and failure of bad investments

Steps taken to curb NPA

(A) By the Govt

  • Mission Indradhanush:to make the working of public sector bank more transparent and professional in order to curb the menace of NPA in future.
  • Insolvency and Bankruptcy Code: To make it easier for banks to recover the loans from the debtors.
  • Stringent NPA recovery rules: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act or SARFESI Act of 2002 was amended in 2016.

(B) By RBI

RBI introduced number of measures in last few years which include:

  • Corporate Debt Restructuring (CDR) mechanism,
  • Setting up a Joint Lenders’ Forum, providing banks to disclose the real picture of bad loans, asking them to increase provisioning for stressed assets,

Other terms related to NPAs

Write-off effect

  • A loan write-off is a tool used by banks to clean up their balance-sheets.
  • If a loan turns bad on the account of the repayment defaults for at least three consecutive quarters, the exposure (loan) can be written off.
  • A loan write-off sets free the money parked by the banks for the provisioning of any loan.

Twin Balance Sheet

  • It deals with two balance sheet problems. One with Indian companies and the other with Indian Banks.
  • Debt accumulation on companies is very high and thus they are unable to pay interest payments on loans.

Four Balance Sheet Challenge

  • In his paper named ‘India’s Great Slowdown’, Arvind Subramanian (former Chief Economic Advisor) mentions the new ‘Four balance sheet challenge’.
  • It includes the original two sectors – infrastructure companies and banks, plus NBFCs and real estate companies.

 

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By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Why banks want inspection reports by RBI to be kept confidential?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : NPA Crisis

The contentious issue of whether banks should disclose inspection reports by the Reserve Bank of India (RBI) is back in the news once again after a division bench of the Supreme Court referred writ petitions filed by banks to another bench for reconsideration.

What is RBI’s inspection on banks?

  • The Banking Regulation Act, 1949 empowers the Reserve Bank of India to inspect and supervise commercial banks.
  • These powers are exercised through on-site inspection and off-site surveillance.
  • RBI carries out dedicated and integrated supervision overall of credit institutions, i.e., banks, development financial institutions, and non-banking financial companies.
  • The Board for Financial Supervision (BFS) carries out this function.
  • Banks currently disclose the list of wilful defaulters and names of defaulters against whom they have filed suits for loan recovery.

Note: CAMELS is an international rating system used by regulatory banking authorities to rate financial institutions, according to the six factors represented by its acronym. The CAMELS acronym stands for “Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity.”

Why in news now?

  • In 2015, the Supreme Court had come down on the RBI for trying to keep the inspection reports and defaulters list confidential.
  • This was aimed for the public disclosure of such reports of the RBI, much against the wishes of the banking sector.
  • The SC had said the RBI has no legal duty to maximize the benefit of any public sector or private sector bank, and thus there is no relationship of ‘trust’ between them.
  • It added that the RBI was duty-bound to uphold the public interest by revealing these details under RTI.

What is the issue?

  • The RBI was allowed to make such reports public following the Supreme Court order.
  • The SC had wanted full disclosure of the inspection report.
  • However, the court agreed that only some portions on bad loans and borrowers would be made public.
  • Banks have been refusing to disclose inspection reports and defaulters’ lists.

Issues with report publication

  • Bank defamation: As banks are involved in dealing in money, they fear any adverse remarks — especially from the regulator RBI — will affect their performance and keep customers away.
  • Trust of the account holder: Banks are driven by the “trust and faith” of their clients that should not be made public.
  • The invalidity of RTI: On the other hand, private banks insisted that the RTI Act does not apply to private banks.
  • Right to Privacy: Banks also argued that privacy is a fundamental right, and therefore should not be violated by making clients’ information public.

Why are banks against disclosing inspection reports?

  • Many feel that the RBI’s inspection reports on various banks, with details on alleged malpractices and mismanagement, can open up a can of worms.
  • As these reports have details about how the banks were manipulated by rogue borrowers and officials, banks want to keep them under wraps.
  • Obviously, banks don’t want inspection reports and defaulters’ lists to be made public as it affects their image.
  • Customers may also keep out of banks with poor track records.

Try this PYQ now:

Q.In the context of the Indian economy non-financial debt includes which of the following?

  1. Housing loans owed by households
  2. Amounts outstanding on credit cards
  3. Treasury bills

Select the correct answer using the code given below:

(a) 1 only

(b) 1 and 2 only

(c) 3 only

(d) 1, 2 and 3

 

Post your answers here (You need to sign-in for that).
1
Please leave a feedback on thisx

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

[pib] Bad Bank launched for stressed assets

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bad Banks

Mains level : Asset reconstruction

The Government has launched a Bad Bank with all the regulatory approvals in place.

What is a Bad Bank?

  • A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
  • Technically, it is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
  • Such a bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
  • The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

Global examples of Bad Bank

  • US-based BNY Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
  • However, resolution agencies or ARCs set up as banks, which originate or guarantee to lend, have ended up turning into reckless lenders in some countries.

Do we need a bad bank?

  • The idea gained currency during Rajan’s tenure as RBI Governor.
  • The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet.
  • However, the idea remained on paper amid lack of consensus on the efficacy of such an institution.
  • ARCs have not made any impact in resolving bad loans due to many procedural issues.

What is the stand of the RBI and government?

  • While the RBI did not show much enthusiasm about a bad bank all these years, there are signs that it can look at the idea now.
  • Experts, however, argue that it would be better to limit the objective of these asset management companies to the orderly resolution of stressed assets, followed by a graceful exit.

Good about the bad banks

  • The problem of NPAs continues in the banking sector, especially among the weaker banks.
  • The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
  • The presence of the government is seen as a means to speed up the clean-up process.
  • Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Bad bank

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bad bank

Mains level : Paper 3- Lessons from China as India operationalise its new bad bank

The article suggests drawing the lessons from China’s experience with the bad bank as India India gets ready to operationalise a new bad bank.

Bad bank in China and issues

  • In the aftermath of the Asian financial crisis, China set up dedicated bad banks for each of its big four state-owned commercial banks.
  • These bad banks were meant to acquire non-performing loans (NPLs) from those banks and resolve them within 10 years.
  • In 2009, their tenure was extended indefinitely.
  • Chinese banks can currently transfer NPLs only to the national or local bad banks.
  • One of China’s biggest bad banks is the China Huarong Asset Management Co. Ltd. (Huarong).
  • The Chinese government is its principal shareholder.
  • Recently this bad bank stoked financial stability concerns when it skirted a potential bond default.
  • An incentive to conceal: Recent research at the National University of Singapore and others highlights that Chinese bad banks effectively help conceal Non-Performing Loans.
  • The banks finance over 90 per cent of NPL transactions through direct loans to bad banks or indirect financing vehicles.
  • The bad banks resell over 70 per cent of the NPLs at inflated prices to third parties, who happen to be borrowers of the same banks.
  • The researchers conclude that in the presence of binding financial regulations and opaque market structures bad bank model could create incentives to hide bad loans instead of resolving them.
  • Broadening of tenure: In case of Huarong, the main source of the problem appears to be the gradual broadening of the original mandate and tenure of Chinese bad banks.

Four lessons for India

  • India is about to operationalise a new bad bank, the National Asset Reconstruction Company Ltd. (NARCL).
  • The Chinese experience holds four important lessons for India.

1) Finite tenure of bad bank

  • A centralised bad bank like NARCL should ideally have a finite tenure.
  • Such an institution is typically a swift response to an abrupt economic shock (like Covid) when orderly disposal of bad loans via securitisation or direct sales may not be possible.
  • The banks could transfer their crisis-induced NPLs to the bad bank and focus on expanding lending activity.
  • The bad bank in turn can restructure and protect asset value.
  • Over time, it could gradually dispose of the assets to private players.

2) Narrow mandate

  •  A bad bank must have a specific, narrow mandate with clearly defined goals.
  • Transferring NPLs to a bad bank is not a solution in itself.
  • There must be a clear resolution strategy.
  • Otherwise, allowing a bad bank to exist in perpetuity risks a potential mission creep, which might in the long run threaten financial stability itself.

3) Diversify the sources of funds for ARC

  • Indian banks remain exposed to these bad loans even after they are transferred to asset reconstruction companies (ARCs).
  • The RBI Bulletin (2021) notes that sources of funds of ARCs have largely been bank-centric.
  • The same banks also continue to hold close to 70 per cent of the total security receipts (SRs).
  • To address this problem, RBI has tightened bank provisioning while liberalising foreign portfolio investment norms.

4) Resolution of bad loans should be through market mechanism

  • In a steady state, the resolution of bad loans should happen through a market mechanism and not through a multitude of bad banks.
  • In India, the Narasimham Committee (1998) had envisaged a single ARC as a bad bank.
  • Yet, the SARFAESI Act, 2002 ended up creating multiple, privately owned ARCs.
  • As a result, regulations have treated ARCs like bad banks, although functionally they are closer to stressed asset funds registered as Alternative Investment Fund Category II (AIFs).
  • With the setting up of NARCL as a centralised bad bank, the regulatory arbitrage between ARCs and AIFs must end.
  • While AIFs should be allowed to purchase bad loans directly from banks and enjoy enforcement rights under the SARFAESI Act.
  • ARCs should be allowed to purchase stressed assets from mutual funds, insurance companies, bond investors and ECB lenders.
  • ARC trusts should be allowed to infuse fresh equity in distressed companies, within IBC or outside of it.
  • Lastly, the continued interest of the manager/sponsor of ARCs should be at par with AIFs, that is, at least 2.5 per cent in each scheme or Rs 5 crore, whichever is lower.

Conclusion

The Chinese experience should nudge Indian policymakers to limit the mandate and tenure of NARCL, while facilitating market-based mechanisms for bad loan resolution in a steady state.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Growth of ARCs not in line with NPA trends

Note4Students

From UPSC perspective, the following things are important :

Prelims level : ARCs

Mains level : Paper 3- RBI report on ARCs

Key takeaways from the RBI report

  • The RBI report states that notwithstanding the rise in the number of Asset Reconstruction Companys (ARCs), the growth in their assets under management (AUM) has been largely trendless except for a major spurt in FY14.
  • The growth of the ARC industry has not been consistent over time and not always been synchronous with the trends in non-performing assets (NPAs) of banks and non-banking financial companies (NBFCs).
  • During 2019-20, asset sales by banks to ARCs declined, which could probably be due to banks opting for other resolution channels such as IBC and SARFAESI.
  • The acquisition cost of ARCs as a proportion to the book value of assets declined, suggesting lower realisable value of the assets.

Overview of ARCs in India

  • The ARC industry began with the establishment of the Asset Reconstruction Company India Ltd (ARCIL) in 2003.
  • Of the total AUM, about 62 per cent and 76 per cent was held by the top-three and top-five ARCs in March 2020, respectively.
  • After remaining subdued in the initial years of their inception, a jump was seen in the number of ARCs in 2008, and then in 2016.
  • Although the number of ARCs has risen over time, their business has remained highly concentrated.

Role of the government

  • Indian ARCs have been private sector entities registered with the Reserve Bank.
  • Public sector AMCs in other countries have often enjoyed easy access to government funding or government-backed.
  • By contrast, capital constraints have often been highlighted as an area of concern for ARCs in India.

Scope for new ARC supported by the government

  • The ARC proposed in the Budget will be set up by state-owned and private sector banks, and there will be no equity contribution from the Centre.
  • The RBI report supported the government’s proposal for a new ARC, saying that “such an entity will strengthen the asset resolution mechanism further.”
  • Introduction of a new asset reconstruction company for addressing the NPAs of public sector banks may also shape the operations of the existing ARCs, it added. 
  • The ARC, which will have an Asset Management Company (AMC) to manage and sell bad assets, will look to resolve stressed assets of Rs 2-2.5 lakh crore that remain unresolved in around 70 large accounts.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Bad bank is good move

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bad bank

Mains level : Paper 3- Advantages of bad bank

The article explains the important role bad bank can play in cleaning up the balance sheets of the banks.

How India banks dealt successfully with pandemic

  • Indian banks were written off in the early days of the pandemic due to expectations of an exponential jump in non-performing assets.
  • Only after the banks consistently talked about the lower number of restructuring requests, and the higher provision coverage ratios that the markets began to get convinced.
  • What finally turned the corner were the budget announcements related to the financial sector
  • There are several reasons for this good performance by the banks.
  • First, banks in India and globally were much better capitalised prior to the pandemic.
  • Second, Indian banks had built up a sizeable buffer to provide for bad assets negating any surprise on balance sheets during and even after the pandemic.
  • Third, independent research shows that as the size of the middle class grows to about two-thirds of Asian households.
  • Banks in Asia, including in India, have begun to adjust for this steady growth in the size of pie by experimenting with new business models, rationalising costs and providing faster and superior customer digital experience, as was clear during pandemic.
  • Fourth, Indian banks and the RBI brought about financial discipline much before the pandemic.

Creation of Bad Bank

  • The budget this year has the provision for reation of a bad bank.
  • The proposed structure envisages setting up of a National Asset Reconstruction Company (NARC) to acquire stressed assets in an aggregated manner from lenders, which will be resolved by the National Asset Management Company (NAMC). 
  • A skilled and professional set-up dedicated for Stressed Asset Resolution will be ably supported by attracting institutional funding in stressed assets through strategic investors, AIFs, special situation funds, stressed asset funds, etc for participation in the resolution process.
  • The net effect of this approach would be to build an open architecture and a vibrant market for stressed assets.

How it will work

  • Banks may first transfer those assets to the proposed bad bank with a 100 per cent provision on its book and then based on the experience they will decide on transferring assets with less than 100 per cent provisioning at a later date.
  • It is also being speculated that of the total amounts recovered, a specified percentage will be in the form of security receipts.
  • These receipts will reside in the bank balance sheets, but will carry a zero-risk weight, with full government guarantees for a specified period of time.

How it will benefit the banks

  • The benefits of this process includes the recovered value, and significant lending leverage because of three factors:
  • One, capital being freed up from less than fully provisioned bad assets.
  • Two, capital freed up from security receipts because of a sovereign guarantee.
  • Three, cash receipts that come back to the banks and can be leveraged for lending, also freeing up provisions from the balance sheet.
  • There are several international success stories of a bad bank accomplishing its mission and there is no reason to believe why India cannot accomplish its objective.
  • The current Indian approach will drive consolidation of stressed assets under the AMC for better and faster decision making.
  • This will free up management bandwidth of banks enabling them to focus on credit growth, leading to an enhancement in their valuations.
  • Governance of the AMC and its independence is central to its successful functioning, there are multiple suggestions to make.
  • These include keeping majority ownership in the private sector, putting together a strong and independent board, a professional team, and linking AMC compensation to returns delivered to investors.

Consider the question “What is a bad bank? How its creation could help the banking sector?”

Conclusion

The creation of a bad bank will help the banking sector contribute more in the growth of the country

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Balance sheet of a Bad Bank

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPA, Bad Bank

Mains level : Asset reconstructions post NPA buzz

The idea of setting up a bad bank to resolve the growing problem of non-performing assets (NPAs), or loans on which borrowers have defaulted, is back on the table.

Q.What is Bad Bank? Discuss how it is different from an Asset Reconstruction Company (ARC)?

Why in news?

  • Commercial banks are set to witness a spike in NPAs, or bad loans, in the wake of the contraction in the economy as a result of the pandemic.
  • Hence the RBI recently agreed to look at the proposal for the creation of a bad bank.
  • This is in the response to a six-month moratorium it has announced to tackle the economic slowdown.

What is a Bad Bank?

  • A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
  • Technically, it is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
  • Such bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
  • The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

Global examples of Bad Bank

  • US-based BNY Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
  • However, resolution agencies or ARCs set up as banks, which originate or guarantee to lend, have ended up turning into reckless lenders in some countries.

Do we need a bad bank?

  • The idea gained currency during Rajan’s tenure as RBI Governor.
  • The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet.
  • However, the idea remained on paper amid lack of consensus on the efficacy of such an institution.
  • ARCs have not made any impact in resolving bad loans due to many procedural issues.

What is the stand of the RBI and government?

  • While the RBI did not show much enthusiasm about a bad bank all these years, there are signs that it can look at the idea now.
  • Experts, however, argue that it would be better to limit the objective of these asset management companies to the orderly resolution of stressed assets, followed by a graceful exit.

Key suggestions

Former RBI Dy. Governor Acharya suggested two models to solve the problem of stressed assets.

  1. The first is a private asset management company (PAMC), which is said to be suitable for stressed sectors where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness.
  2. The second model is the National Asset Management Company (NAMC), which would be necessary for sectors where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short to medium terms.

Good about the bad banks

  • The problem of NPAs continues in the banking sector, especially among the weaker banks.
  • The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
  • The presence of the government is seen as a means to speed up the clean-up process.
  • Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

Pandemic and the NPAs

  • Bad loans in the system are expected to balloon in the wake of contraction in the economy and the problems being faced by many sectors.
  • The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector is expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020.
  • The report warned that if the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

[pib] Partial Credit Guarantee Scheme (PCGS) 2.0

Note4Students

From UPSC perspective, the following things are important :

Prelims level : CRAR, PCGS

Mains level : Asset reconstructions post NPA buzz

As part of Aatmanirbhar Bharat Abhiyan, announced by the Government, the Partial Credit Guarantee Scheme (PCGS) 2.0   was launched to provide Portfolio Guarantee for purchase of Bonds or Commercial Papers (CPs) with a rating of AA and below issued by NBFCs/HFCs/ MFIs by Public Sector Banks (PSBs).

Try this PYQ:

When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen? (CSP 2015)

(a) India’s GDP growth rate increases drastically

(b) Foreign Institutional Investors may bring more capital into our country

(c) Scheduled Commercial Banks may cut their lending rates

(d) It may drastically reduce the liquidity to the banking system

About Partial Credit Guarantee Scheme (PCGS)

  • Under the scheme, any PSB can purchase securities (minimum rating of ‘AA’) of financially-sound non-banking finance companies.
  • The objective is to address temporary asset-liability mismatches of otherwise solvent NBFCs/Housing finance companies (HFCs) without having to resort to distress sale of their assets to meet their commitments.
  • The government will provide a one-time, six months’ partial credit guarantee to public sector banks for first loss of up to 10%.
  • Also, these NBFCs/HFCs are mandated that the CRAR (capital to risk-weighted assets ratio) shall not go below the regulatory minimum while exercising of the option to buy back the assets.

What is CRAR?

  • CRAR also known as Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital to its risk.
  • CRAR is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.
  • The Basel III norms stipulated a capital to risk-weighted assets of 8%.
  • In India, scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12% as per RBI norms.
  • It is arrived at by dividing the capital of the bank with aggregated risk-weighted assets for credit risk, market risk, and operational risk.
  • RBI tracks CRAR of a bank to ensure that the bank can absorb a reasonable amount of loss and complies with statutory Capital requirements.
  • The higher the CRAR of a bank the better capitalized it is.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Need for a Bad Bank

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bad Banks

Mains level : Asset reconstructions post NPA buzz

The idea of setting up a bad bank often comes up for debate, especially when stress in the banking sector is projected to rise in the near term.

Practice question for mains:

Q. What is a Bad Bank? Discuss how it can rescue the covid induced bad loans in India.

COVID induced NPAs

  • Several economists and agencies project a recession in the Indian economy this year, due to the adverse effects of Covid-19 on economic activity.
  • This will hit the banking and financial sector in particular, as a slump in earnings of companies and individuals could lead to a jump in NPAs, reversing the early trends.
  • Various analysts suggest that in a couple of years, the proportion of stressed assets in the banking system could jump to as high as 18 per cent from around 11 per cent at present.
  • To tackle this upcoming challenge, the banking industry has proposed the setting up of a government-backed bad bank.

What is the Bad Bank?

  • A bad bank is a bank set up to buy the bad loans and other illiquid holdings of another financial institution.
  • The entity holding significant NPAs will sell these holdings to the bad bank at market price.
  • By transferring such assets to the bad bank, the original institution may clear its balance sheet—although it will still be forced to take write-downs.
  • A bad bank structure may also assume the risky assets of a group of financial institutions, instead of a single bank.

What is the recent proposal of a bad bank?

  • The banking sector, led by the Indian Banks Association (IBA), had in May submitted a proposal for setting up a bad bank to the finance ministry and the RBI.
  • The IBA proposed for having equity contribution from the government and the banks.
  • This was based on an idea proposed by a panel on faster resolution of stressed assets in public sector banks headed by former PNB Chairman Sunil Mehta.
  • This panel had proposed an asset management company (AMC), ‘Sashakt India Asset Management’, for resolving large bad loans two years ago.
  • There were talks about creating a bad bank in 2018 too, but it never took shape.

What kind of NPA spike is expected during this outbreak?

  • The impact of Covid-19 and the associated policy response is likely to result in an additional Rs 1,67,000 crore of debt from the top 500 debt-heavy private sector borrowers turning delinquent between FY21 and FY22.
  • Given that 11.57 per cent of the outstanding debt is already stressed, the proportion of stressed debt is likely to increase to 18.21 per cent of the outstanding quantum.

What is the government’s view over Bad Banks?

  • While the finance ministry has not formally submitted its view on the proposal, senior officials have indicated that it is not keen to infuse equity capital into a bad bank.
  • The government’s view is that bad loan resolution should happen in a market-led way, as there are many asset reconstruction companies already operating in the private space.
  • The government has significantly capitalized state-owned banks in recent years and pursued consolidation in the PSU banking space.
  • In the last three financial years, the government has infused equity of Rs 2.65 lakh crore into state-owned banks.
  • These steps, along with insolvency resolution under the IBC, are seen as adequate to tackle the challenge of bad loans.

What is the RBI view?

  • The RBI has so far never come out favourably about the creation of a bad bank with other commercial banks as main promoters.
  • Former RBI Governor Raghuram Rajan had opposed the idea of setting up a bad bank with a majority stake by banks, arguing it would solve nothing.
  • Rajan argued that a government-funded bad bank would just shift loans “from one government pocket (the public sector banks) to another (the bad bank) and did not see how it would improve matters”.
  • Indeed, if the bad bank were in the public sector, the reluctance to act would merely be shifted to the bad bank.
  • Alternatively, if the bad bank were to be in the private sector, the reluctance of public sector banks to sell loans to the bad bank at a significant haircut would still prevail.

Alternatives to a bad bank

  • Many experts argue that the enactment of IBC has reduced the need for having a bad bank, as a transparent and open process is available for all lenders to attempt insolvency resolution.
  • The view is that an IBC-led resolution, or sale of bad loans to ARCs already existing, is a better approach to tackle the NPA problem rather than a government-funded bad bank.

Former RBI Deputy Governor Viral Acharya has proposed two models:

1) Private Asset Management Company

  • The first model is a Private Asset Management Company (PAMC) which would be suitable for sectors where the stress is such that assets are likely to have economic value in the short run, with moderate levels of debt forgiveness.

2) Setting up National Asset Management Company (NAMC)

  • The second model is a NAMC for sectors where the problem is not just of excess capacity, but possibly also of economically unviable assets in the short- to medium-term, such as in the power sector.
  • The NAMC would raise debt for its financing needs, keep a minority equity stake for the government, and bring in asset managers such as ARCs and private equity to manage and turn around the assets.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Why bad loans won’t start piling right away

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPA

Mains level : Paper 3- Issue of bad loans

Steps taken by the government have averted the piling up of the bad loans, though for the time being only. When the moratorium period ends, we will see the spike in the bad loans. This article explains the same.

Why bad loans are expected to increase

  •  Consumer spending has collapsed over the last few months due to the pandemic.
  • Though lately there have been some signs of revival, it will take a while before spending comes anywhere near the pre-covid level.
  • This will mean that many businesses will start running out of cash pretty soon if they have not already.
  • A company that starts running out of cash will not be in a position to repay its loans and, thus, will ultimately default.

How individuals will be affected

  • A recent estimate by rating agency Crisil suggests that about 70% of 40,000 companies have cash to cover employee costs for only two quarters.
  • This tells us that companies will fire employees, before, during, or even after defaulting on a loan.
  • If companies do not resort to employee retrenchment, they will cut salaries and many already have.
  • Past payments and future business with vendors and suppliers will be negatively impacted.
  • In this situation, the problem at the company level will impact individuals too.
  • When individuals start having a cash flow problem, it will lead to defaults on retail loans

But why we are not seeing the defaults happening already?

  • A moratorium is a deferment of repayment to provide temporary relief to borrowers. The loan ultimately needs to be repaid.
  • The Reserve Bank of India has let banks and non-banking financial companies (NBFCs) offer a moratorium on loans.
  • Hence, until the end of August, borrowers have an option to not repay the loans, without it being considered as a default.
  • Hence, any loan defaults will start only after August but they won’t be immediately categorized as a non-performing asset or a bad loan.
  • Bad loans are largely those loans that have not been repaid for 90 days or more.
  •  Hence, defaulted loans will be categorized as bad loans only post-November.
  • This will be revealed when banks publish their results for October to December 2020, in January-February 2021.

Conclusion

Even if 20% of loans that end up under a moratorium are defaulted on, the quantum of bad loans, especially those of public sector banks, will go up big time.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

What is the doctrine of Force Majeure?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Doctrine of Force Majeure

Mains level : Doctrine of Force Majeure, frustration of a contract

The recent spread of the Coronavirus has triggered a global slowdown and has rendered ongoing business operations of several organisations to almost a standstill. This has resorted them to invoking the ‘force majeure’ clause to seek some relief.

Practice question for mains:

Q) What is the doctrine of Force Majeure and Frustration of a Contract? Discuss how it can worsen the NPA crisis in India.

What is Force Majeure?

  • Force majeure is purely a contractual remedy available to an affected party under a contract and for seeking relief, the reference would be to the express terms of the contract.
  • It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.
  • While force majeure has neither been defined nor specifically dealt with, in Indian statutes, some reference can be found in Section 32 of the Indian Contract Act, 1872 (the “Contract Act”).
  • It envisages that if a contract is contingent on the happening of an event which event becomes impossible, then the contract becomes void.

Where are such clauses found?

  • Force majeure clauses can usually be found in various contracts such as power purchase agreements, supply contracts, manufacturing contracts, distribution agreements, project finance agreements, agreements between real estate developers and home buyers, etc.

Circumstances qualified for force majeure

  • A force majeure clause typically spells out specific circumstances or events, which would qualify as force majeure events, conditions which would have be fulfilled for such clause to apply.
  • As such, for a force majeure clause to become applicable the occurrence of such events should be beyond the control of the parties.
  • The parties will be required to demonstrate that they have made attempts to mitigate the impact of such force majeure event.
  • If an event or circumstance qualifies, the consequence would be that parties would be relieved from performing their respective obligations to be undertaken by them under the contract.

Why it is in news, now?

  • Due to the lockdown restrictions placed by the government, the parties’ ability to perform and fulfil their contractual obligations is affected.
  • Where the contract does not specifically cover the current situation is a matter of debate.
  • The Indian Contract Act, 1872 is more than a century old and does not have any specific provisions relating to suspension of contracts or termination of contracts in cases of a pandemic.
  • The Act clearly provides that an agreement to do an act impossible in itself is void (Section 56).
  • After a contract is made, if any act becomes impossible or unlawful by reason of some event, such a contract becomes void.

What is the difference between force majeure and frustration of a contract?

  • Under the doctrine of frustration, the impossibility of a party to perform its obligations under a contract is linked to the occurrence of an event/circumstance subsequent to the execution of a contract and which was not contemplated at the time of execution of the contract.
  • However, under in case of a force majeure, parties typically identify, prior to the execution of a contract, an exhaustive list of events, which would attract the applicability of the force majeure clause.
  • The doctrine of Frustration renders the contract void and consequently, all contractual obligations of the parties cease to exist.

What did the Supreme Court say?

  • Recently, the Supreme Court observed that the doctrine of frustration as enumerated in the Act would apply only where the parties have not specified the consequences of an event which renders the performance of the contract impossible.
  • Termination of a frustrated contract would be possible only in cases where the contract becomes impossible to perform which means the damage to the contract should be of permanent nature and not something which can be performed with the passage of time.
  • Hence a temporary inability or force majeure event would not qualify under the doctrine.

What lies ahead?

  • The force majeure clause in contracts should not be misconstrued as an event of frustration covered under the Act.
  • Force majeure is purely a contractual remedy available to an affected party under a contract and for seeking relief; the reference would be to the express terms of the contract.
  • However, a party claiming frustration of contract and seeking to escape liability or other obligation under a contract will necessarily have to approach an appropriate judicial forum.
  • It is likely that ‘force majeure’ clauses in contracts need to be more heavily negotiated to include references to epidemics or pandemics, in addition to other situations.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Co-operative banks can use SARFAESI Act to recover dues: Supreme Court

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Sarfaesi Act, 2002

Mains level : NPA issue

A five-judge Constitution Bench of the Supreme Court (SC) has ruled that all co-operative banks in the country could make use of the SARFAESI Act to make recovery against defaulting persons.

Possible mains question:

What is the SARFAESI Act, 2002? Discuss its various provisions and efficacy to curb Non-Performing Assets (NPAs)?

What is Sarfaesi Act, 2002?

  • Sarfaesi is an acronym for Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest.
  • It allows banks and other financial institution to auction residential or commercial properties (of Defaulter) to recover loans.
  • The first asset reconstruction company (ARC) of India, ARCIL, was set up under this act.
  • Under this act secured creditors (banks or financial institutions) have rights for enforcement of security interest under section 13 of SARFAESI Act, 2002.

Provisions of the Act

  • If the borrower of financial assistance makes any default in repayment of a loan or any instalment and his account is classified as NPA by secured creditor, then secured creditor may require before the expiry of a period of limitation by written notice.
  • The act does not apply to unsecured loans, loans below ₹100,000 or where remaining debt is below 20% of the original principal.
  • This law allowed the creation of asset reconstruction companies (ARC) and allowed banks to sell their non-performing assets to ARC’s (which are regulated by the RBI).
  • Banks are allowed to take possession of the collateral property and sell it without the permission of a court.

To summarize, the SARFAESI Act empowers financial institutions to ‘seize and desist’. They should give a notice to the defaulting borrower asking to repay the amount within 60 days.

If the debtor doesn’t comply, the bank can resort to one of the three following measures:

1) Take possession of loan security

2) Sell or lease or assign the right over the security

3) Manage the asset or appoint someone to manage the same

Ambit of the Act

  • The recent judgment said that the SARFAESI Act qualifies the test of legislative competence, as well as the definition, cannot be said to be beyond the competence of the Parliament.
  • In 2013, the Gujarat High Court had, while hearing a challenge to the amendment of Banking Regulation Act of 1949, to include cooperative societies as financial institutions, ruled it null and void.
  • The high court had then agreed with the submissions of the petitioners who had argued that Sarfaesi would not be applicable to cooperative banks formed under the state law.
  • The Delhi High Court had, on the other hand, ruled that the cooperative banks and societies were for all purposes banks and financial institutions and thus were allowed to use Sarfaesi to make recoveries against defaulters.
  • In its judgment, the apex court held that all such cooperative banks involved in the activities related to banking are covered within the meaning of ‘banking company’.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

What is ‘Yes Bank Crisis’?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Role of RBI coping bank failures

Mains level : Read the attached story

On the advice of the Reserve Bank of India (RBI), the government imposed a moratorium on Yes Bank with effect from 6 p.m. on March 5 up to April 3. This has created a furore among the account holders of the bank.

What restrictions did RBI put?

  • The RBI superseded the private sector lender’s board and appointed as an administrator.
  • Under the moratorium, deposit withdrawals have been capped at ₹50,000.
  • Within 24 hours, the RBI proposed a reconstruction scheme under which SBI could take a maximum 49% stake in the restructured capital of the bank.

Why was it imposed?

  • The RBI cited a steady decline in Yes Bank’s financial position mainly due to the lender’s inability to raise adequate capital to make provisions for potential non-performing assets.
  • This failing resulted in downgrades by credit rating agencies, which in turn made capital raising even more difficult — a vicious cycle that further worsened its financials.
  • This apart there were serious lapses in corporate governance.
  • The bank has also experienced serious governance issues and practices in the recent years which have led to steady decline of the bank.

When did it all start?

  • As on March 31, 2014, the bank’s loan book was ₹55,633 crore and deposits were ₹74,192 crore.
  • Since then the loan book expanded fourfold to ₹2,24,505 crore while deposit growth failed to keep pace and increased less than three times to ₹2,09,497 crore.
  • Asset quality also worsened during the period with gross non-performing assets sharply rising from 0.31% as on March 31, 2014, to 7.39% at the end of September 2019.
  • The exponential growth at Yes Bank during that period also came under the regulator’s scanner.
  • The lender has substantial exposure to several troubled borrowers including the IL&FS.

What will be the likely impact on depositors?

  • While deposit withdrawals have been capped at ₹50,000, there are exceptions under which a higher amount can be withdrawn, with the permission of the RBI.
  • The RBI can allow a customer to withdraw more than ₹50,000 under the following conditions:
  1. in connection with the medical treatment of the depositor or any person actually dependent on the depositor;
  2. towards the cost of higher education of the depositor or any person actually dependent on him for education in India or outside India;
  3. to pay obligatory expenses in connection with marriage or other ceremonies of the depositor or his/her children or of any other person actually dependent upon depositor;
  4. or any other unavoidable emergency.
  • The total withdrawal should, however, not exceed ₹5 lakh or the actual balance in the account, whichever is lower.

What about deposit insurance?

  • In case Yes Bank goes belly up for any reason, depositors will not lose all their money since deposits up to ₹5 lakh are covered under deposit insurance.
  • While the deposit insurance cover was ₹1 lakh till recently, this was increased to ₹5 lakh in the aftermath of the crisis at the Punjab and Maharashtra Cooperative (PMC) Bank Limited.
  • Finance Minister has announced the increase in deposit insurance in this year’s Budget.

What do such bank failures imply?

  • While the government and the regulator have asserted that the problem is solely related to this particular bank, the latest developments spotlight the governance risks in India’s banking sector.
  • There is a risk that the already poor operating environment for the banking sector could suffer further impairment if the government’s efforts to tackle problems in the bank fail to provide reassurance to depositors and investors.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

[pib] Partial Credit Guarantee Scheme

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Partial Credit Guarantee Scheme

Mains level : NPA issue


The Union Cabinet has approved a partial credit guarantee scheme for public sector banks (PSBs) to purchase high-rated pooled assets from financially sound NBFCs and housing finance companies.

What is the decision about?

  • PSBs can purchase high-rated pooled assets from financially sound NBFCs/Housing Finance Companies (HFCs), with the amount of overall guarantee provided by government till the first loss of up to 10 per cent of fair value of assets being purchased by banks or Rs 10,000 crore, whichever is lower.
  • The scheme would cover NBFCs / HFCs that may have slipped into SMA-0 category during the one year period prior to 1.8.2018, and asset pools rated “BBB+” or higher.

Partial Credit Guarantee Scheme

  • The Union Government had issued the PCG Scheme in the Union Budget this year to provide a one-time partial credit guarantee to PSBs for purchase of pooled assets of financially sound NBFCs.
  • It aims to address temporary asset liability mismatches of otherwise solvent NBFCs/HFCs without having to resort to distress sale of their assets for meeting their commitments.
  • It allows PSBs to purchase pooled assets enabled by Government guarantee support under the Scheme to addressing temporary liquidity / cash flow mismatch issues of otherwise solvent NBFCs / HFCs.
  • This pooling would allow NBFCs without them having to resort to distress sale of their assets for meeting their commitments.
  • This will provide liquidity to the NBFC / HFC concerned for financing the credit demand of the economy, and also protect the financial system of the country from any adverse contagion effect that may arise due to the failure of such NBFCs / HFCs.

Validity of the scheme

  • The window for one-time partial credit guarantee offered by GoI will open from the date of issuance of the Scheme by the Government for a period of six months, or till such date by which Rupees One lakh crore assets get purchased by banks, whichever is earlier.

Major Impact

  • The proposed Guarantee support and resultant pool buyouts will help address NBFCs/HFCs resolve their temporary liquidity or cash flow mismatch issues.
  • It will enable them to continue contributing to credit creation and providing last mile lending to borrowers, thereby spurring economic growth.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Advisory Board for Banking Frauds (ABBF)

Note4Students

From UPSC perspective, the following things are important :

Prelims level : ABBF

Mains level : Terms of reference for ABBF

Advisory Board for Banking Frauds (ABBF)

  • The Central Vigilance Commission (CVC) has constituted an Advisory Board for Banking Frauds (ABBF).
  • It will be headed by former Vigilance Commissioner T.M. Bhasin to examine bank fraud of over ₹50 crore and recommend action.
  • The panel in its previous avatar was called the Advisory Board on Bank, Commercial and Financial Frauds.

Terms of reference

  • The ABBF, formed in consultation with the RBI, would function as the first level of examination of all large fraud cases before recommendations or references are made to the investigative agencies by the respective public sector banks (PSBs)..
  • The four-member board’s jurisdiction would be confined to those cases involving the level of officers of General Manager and above in the PSB in respect of an allegation of a fraud in a borrowal account.
  • Lenders would refer all large fraud cases above ₹50 crore to the board and on receipt of its recommendation or advice, the bank concerned would take further action in such matter.
  • The CBI may also refer any case or matter to the board where it has any issue or difficulty or in technical matters with the PSB concerned.
  • The board would also periodically carry out frauds analysis in the financial system and give inputs for policy formulation related to the fraud to the RBI.
  • Headquartered in Delhi, the Reserve Bank of India will provide required secretarial services, logistic and analytical support along with the necessary funding to the board.

Membership of the panel

  • The tenure of the Chairman and members would be for a period of two years from August 21, 2019, .

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

Project Sashakt

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Project Sashakt

Mains level : Curbing NPAs

  • RBI made it mandatory for lenders to enter into an Inter-Creditor Agreement (ICA) during the review of the borrower account within 30 days from date of first default to any lender.
  • ICA allows banks to decide resolution strategy outside the IBC and it will help lenders to accelerate process to resolve stressed assets.

New Framework under Sashakt

  • The Sashakt ICA can be modified to incorporate the requirements of New Framework and serve as the Master Inter-Creditor Agreement for resolution of all stressed asset.
  • Under the new framework, it is a mandatory requirement for lenders to enter into an Inter-Creditor Agreement (ICA) during the review of the borrower account within 30 days from date of first default to any lender.
  • The New Framework further lays down some parameters to be included in the ICA including decision-making by lenders holding 75% (by value of total outstanding facilities) and 60% by number and protection of dissenting lenders.
  • The ICA is required to be executed by all lenders covered under the New Framework and asset reconstruction companies.

What is Project Sashakt?

  • Project Sashakt was proposed by a panel led by PNB chairman Sunil Mehta to help consolidate stressed assets.
  • Bad loans of up to ₹ 50 crore will be managed at the bank level, with a deadline of 90 days.
  • For bad loans of ₹ 50-500 crore, banks will enter an inter-creditor agreement, authorizing the lead bank to implement a resolution plan in 180 days, or refer the asset to NCLT.
  • For loans above ₹ 500 crore, the panel recom­mended an independent AMC, supported by institutional funding through the AIF.

Working

  • According to the committee, banks will have to set up an AMC under which there will be multiple sector-specific AIFs.
  • These funds will invest in the stressed assets bought by existing (Asset Reconstruction Companies) ARCs, such as ARCIL.
  • The ARCs will use the Alternative Investment Funds (AIFs) to redeem security receipts issued to banks against the bad loans.
  • Other AMC-AIFs and ARCs will be allowed to bid for these assets, and match the pricing offered by ARCIL or the national AMC.
  • The AMC will be responsible for the operational turnaround of the asset.

Who will own the stressed asset?

  • The ARC after buying the asset from lenders will transfer ownership to the AIF.
  • The new owner, the AMC-AIF, will hold a stake of at least 76%.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

RBI revises stressed asset resolution norms

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not Much

Mains level : Steps for stressed asset resolution


  • The RBI has released revised set of norms on stressed asset resolution which are substantially less stringent from the previous one.

Inter-Creditor Agreement (ICA)

  • The inter-creditor agreement is aimed at the resolution of loan accounts with a size of ₹50 crore and above that are under the control of a group of lenders.
  • It is part of the Sashakt plan approved by the government to address the problem of resolving bad loans.
  • The lenders may also choose to initiate legal proceedings for insolvency or recovery as per the news circular.
  • If the RP is to be implemented, lenders have been asked to enter into an inter-creditor agreement (ICA), within the review period, to provide for ground rules for finalization and implementation of the RP.
  • The ICA shall provide that any decision agreed by lenders representing 75% by value of total outstanding credit facilities (fund-based as well as non-fund based) and 60% of lenders by number shall be binding upon all the lenders.
  • The RP will have to implement within 180 days from the end of review period.

Review Period

  • The new circular asked lenders to undertake a prima facie review of the borrower account within 30 days from a default, which is termed as review period.
  • During this review period, lenders may decide on the resolution strategy, including the nature of the resolution plan (RP), the approach for implementation of the RP etc.
  • The review period shall commence not later than the date of the this circular for loans above Rs. 2000 crore; January 1 ,2020 for loans above Rs. 1,500 crore to Rs. 2,000 crore.

What if Resolution Plan delayed?

  • There is a disincentive for banks if they delay implementing a viable resolution plan.
  • In case the plan is not implemented within 180 days from the end of review period, banks have to make additional provision of 20% and another 15% if the plan is not implemented within 365 days from the start of the review period.
  • The additional provisions would be reversed if resolution is pursued under Insolvency and Bankruptcy Code (IBC).

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

RBI uses divergence to compel banks to improve their loan-loss ratios

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPA Divergence

Mains level : NPA Crisis

  • Few public sector banks that have reported earnings for the January-March quarter have mentioned ‘divergence’ in bad loan recognition and have made provisions for such loans.

What is NPA Divergence?

  • Divergence is the difference between central bank and RBI’s assessment and that reported by the lender.
  • Divergence takes place when the RBI finds that a lender has under-reported (or not reported at all) bad loans in a particular year and hence asks the lender to make disclosures if under-reporting is more than 10% of bad loans or the provisioning.
  • Higher provisioning for divergence was one of the reasons for them to report losses for the quarter.
  • Interestingly, divergence was identified not because these banks hadn’t classified the loan as non-performing assets (NPA) but because they were late in classifying them.

Classifying NPA’s

  • Since the date of classification as NPA had been pushed back, the banks had to make higher provisioning due to the ageing factor.
  • In the first stage of NPA, which is the ‘sub-standard’ category, 15-20% provision is required and for next category, which is ‘doubtful’, a 40% provision is required.
  • RBI has now made it mandatory that when one bank declares an account as NPAs, all other banks need to classify it as an NPA, so the sources of funds are blocked to the errant borrowers.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

RBI asks NBFCs to appoint Chief Risk Officer

Note4Students

From UPSC perspective, the following things are important :

Prelims level : CRO and its terms of reference

Mains level : Curbing NPAs


  • The RBI has asked the non-banking financial companies (NBFCs) with assets of more than ₹5,000 crore to appoint a chief risk officer (CRO).

Why such move?

  • With the increasing role of NBFCs in direct credit intermediation, there is a need for NBFCs to augment risk management practices.
  • RBI’s move comes in the wake of ongoing rating downgrades of non-banks which has raised fears of another liquidity crisis.
  • Following a series of defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) last year, mutual funds with exposure to debt papers of the company had to write off a chunk of their holdings.
  • This, and the ensuing defaults by some non-banking financial companies (NBFCs), had led to the liquidity crisis.

Terms of Reference for Chief Risk Officer (CRO)

  • The primary role of the risk officer will be identification, measurement and mitigation of risks.
  • All credit products (retail or wholesale) shall be vetted by the CRO from the angle of inherent and control risks.
  • The CRO’s role in deciding credit proposals shall be limited to being an adviser.

Reporting by CRO

  • RBI has mandated that the CRO shall report directly to the MD and CEO or the risk management committee (RMC) of the board.
  • Moreover, in case the CRO reports to the MD and CEO, the risk management committee or the board shall meet the CRO in the absence of the MD and CEO, at least on a quarterly basis.
  • The CRO shall not have any reporting relationship with the business verticals of the NBFC and shall not be given any business targets.

Appointment and Transfer

  • The CRO shall be a senior official in the hierarchy of an NBFC and shall possess adequate professional qualification or experience in the area of risk management.
  • The CRO shall be appointed for a fixed tenure with the approval of the board.
  • There shall not be any ‘dual hatting’ i.e. the CRO shall not be given any other responsibility.
  • The CRO can be transferred or removed from his post before completion of the tenure only with the approval of the board.
  • And such premature transfer or removal shall be reported to the department of non-banking supervision of the regional office of RBI under whose jurisdiction the NBFC is registered.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

NPA Crisis

[op-ed snap] Resolving India’s banking crisis

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPA

Mains level : Resolving NPA crisis

CONTEXT

The government that assumes office after the general election will have to crack a serious and unresolved problem: India’s banking sector.

Background

  • Non-performing assets (NPAs) at commercial banks amounted to ₹10.3 trillion, or 11.2% of advances, in March 2018. Public sector banks (PSBs) accounted for ₹8.9 trillion, or 86%, of the total NPAs.
  • The ratio of gross NPA to advances in PSBs was 14.6%.
  • These are levels typically associated with a banking crisis.

Origin of the crisis

1. Credit Boom –

  • The answer lies partly in the credit boom of the years 2004-05 to 2008-09. In that period, commercial credit (or what is called ‘non-food credit’) doubled. I
  • Indian firms borrowed furiously in order to avail of the growth opportunities they saw coming.
  • Most of the investment went into infrastructure and related areas — telecom, power, roads, aviation, steel. Businessmen were overcome with exuberance, partly rational and partly irrational.

2.Problems with projects

  • Thereafter, as the Economic Survey of 2016-17 notes, many things began to go wrong.
  • Thanks to problems in acquiring land and getting environmental clearances, several projects got stalled.
  • At the same time, with the onset of the global financial crisis in 2007-08 and the slowdown in growth after 2011-12, revenues fell well short of forecasts. Financing costs rose as policy rates were tightened in India in response to the crisis.
  • The depreciation of the rupee meant higher outflows for companies that had borrowed in foreign currency.
  • This combination of adverse factors made it difficult for companies to service their loans to Indian banks.
  • The year 2014-15 marked a watershed.
  • The Reserve Bank of India (RBI), acting in the belief that NPAs were being under-stated, introduced tougher norms for NPA recognition under an Asset Quality Review.
  • NPAs in 2015-16 almost doubled over the previous year as a result.  It’s just that the cumulative bad decisions of the past were now coming to be more accurately captured.

Impact of higher NPAs

  • Higher NPAs mean higher provisions on the part of banks.
  • Provisions rose to a level where banks, especially PSBs, started making losses. Their capital got eroded as a result. Without adequate capital, bank credit cannot grow.
  • Even as the numerator in the ratio of gross NPAs/advances rose sharply, growth in the denominator fell.

Reason for high NPAs in Public Sector Banks

  • PSBs had a higher exposure to the five most affected sectors — mining, iron and steel, textiles, infrastructure and aviation.
  • These sectors accounted for 29% of advances and 53% of stressed advances at PSBs in December 2014.
  • For private sector banks, the comparable figures were 13.9% and 34.1%. Our rough calculations show that PSBs accounted for 86% of advances in these five sectors.

Plans to prevent such crises

1. Resolve NPAs –

  • One immediate action that is required is resolving the NPAs.
  • Banks have to accept losses on loans (or ‘haircuts’).
  • They should be able to do so without any fear of harassment by the investigative agencies.

2. Loan Resolution Authority – An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament.

3. Recapitalising Banks – Second, the government must infuse at one go whatever additional capital is needed to recapitalise banks — providing such capital in multiple instalments is not helpful.

4. Monitoring macro-prudential indicators –Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators.

5.Governance strengthening at PSBs – Actions needs to be taken to strengthen the functioning of banks in general and, more particularly, PSBs. Governance at PSBs, meaning the functioning of PSB boards, can certainly improve.

6.Risk management

  • Other aspects of concentration risk remain to be addressed. We need to induct more high-quality professionals on PSB boards and compensate them better.
  • Succession planning at PSBs also needs to improve.

Conclusion

The task of accelerating economic growth is urgent. This is not possible without finding a solution to the problems that confront the banking system. There is ample scope for improving performance within the framework of public ownership. It can be done. What is needed is a steely focus on the part of the government.

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

  • What is NPA?
  • Impact of NPA on economy
  • Reasons for the rise in NPA in recent years
  • Why most NPA in Public sector?
  • Steps taken by RBI and Government in last few years to curb NPA
  • How to curb the menace of NPA

source

According to RBI’s recent data, the gross non-performing assets (NPAs) of public sector banks are just under Rs 4 lakh crore, and they collectively account for 90 percent of such rotten apples in the country’s banking portfolio.

In terms of net NPAs, their share is even higher – at 92 percent of the total bad loans reported so far in the banking system. The total NPAs of Indian banks, as a percentage of the total loans, has grown from 2.11 per cent(2008) to 5.08 percent(2016).

In this article we will explain what is NPA, The reason why NPA increased in India and steps taken by Government in recent years to curb the menace of NPA and what else needs to be done.

What is NPA?

  • The assets of the banks which don’t perform (that is – don’t bring any return) are called Non Performing Assets (NPA) or bad loans. Bank’s assets are the loans and advances given to customers. If customers don’t pay either interest or part of principal or both, the loan turns into bad loan.
  • According to RBI, terms loans on which interest or instalment of principal remain overdue for a period of more than 90 days from the end of a particular quarter is called a Non-performing Asset.
  • However, in terms of Agriculture / Farm Loans; the NPA is defined as under: For short duration crop agriculture loans such as paddy, Jowar, Bajra etc. if the loan (installment / interest) is not paid for 2 crop seasons, it would be termed as a NPA. For Long Duration Crops, the above would be 1 Crop season from the due date.
source

Impact of NPA on Economy

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 leads to following adverse impact on Economy:

  1. Depositors do not get rightful returns and many times may lose uninsured deposits. Banks may begin charging higher interest rates on some products to compensate Non-performing loan losses
  2. Bank shareholders are adversely affected
  3. Bad loans imply redirecting of funds from good projects to bad ones. Hence, the economy suffers due to loss of good projects and failure of bad investments
  4. When bank do not get loan repayment or interest payments, liquidity problems may ensue.

Reasons for the rise in NPA in recent years

  • GDP slowdown: Between early 2000’s and 2008 Indian economy were in the boom phase. During this period Banks especially Public sector banks lent extensively to corporates. However, the profits of most of the corporate dwindled due to slowdown in the global and domestic economy, bans in mining projects, delays in environmental related permits ,Land acquisition hurdles and volatility in prices of raw material. This has adversely affected their ability to pay back loans and is the most important reason behind increase in NPA of public sector banks.
  • Relaxed lending Norms: One of the main reasons of rising NPA was the relaxed lending norms especially for corporate honchos when their financial status and credit rating was not analyzed properly. Also, to face competition banks were hugely selling unsecured loans .
  • Priority Sector Lending: There is a myth that main reason for rise in NPA in Public sector banks was Priority sector lending as according to the findings of Standing Committee on Finance , NPAs in the corporate sector are far higher than those in the priority or agriculture sector. However, even if PSL is not the main cause but it is still a cause for rising NPA which can be seen from the fact that As per the latest estimates by the SBI, education loans constitute 20% of its NPAs.
  • The Lack of Bankruptcy code in India and sluggish legal system makes it difficult for banks to recover these loans from both corporate and noncorporate.

Other factors

  • Banks did not conducted adequate contingency planning, especially for mitigating project risk. They did not factor eventualities like failure of gas projects to ensure supply of gas or failure of land acquisition process for highways.
  • Restructuring of loan facility was extended to companies that were facing larger problems of over-leverage & inadequate profitability. This problem was more in the Public sector banks.
  • Companies with dwindling debt repayment capacity were raising more & more debt from the system.

Why most NPA in Public sector?

  • Five sectors Textile, aviation, mining, Infrastructure contributes to most of the NPA, since most of the loan given in these sector are by PSB, they account for most of the NPA.
  • Public Sector banks provide around 80% of the credit to industries and it is this part of the credit distribution that forms a great chunk of NPA. Last year, when kingfisher was marred in financial crisis, SBI provided it huge amount of loan which it is not able to recover from it.
  • Less Professional management
  • Political Pressure and interference forces PSB to lend to not so commercially sounds project.

Steps taken by RBI and Government in last few years to curb NPA

  • Government has launched Mission Indradhanush to make the working of public sector bank more transparent and professional in order to curb the menace of NPA in future.
  • Government has also proposed to introduce Bankruptcy code which will make it easier for banks to Recover the loans from the debtors.
  • RBI introduced number of measures in last few years which include:
    • Tightening the Corporate Debt Restructuring (CDR) mechanism,
    • Setting up a Joint Lenders’ Forum, prodding banks to disclose the real picture of bad loans, asking them to increase provisioning for stressed assets,
    • Introducing a 5:25 scheme where loans are to be amortized over 25 years with refinancing option after every five years, and
    • Empowering them to take majority control in defaulting companies under the Strategic Debt Restructuring (SDR) scheme.

How to curb the menace of NPA?

#1. Short Term measures

  • Review of NPA’S/Restructured advances- We need to assess the viability case by case. Viable accounts need to be given more finance for turnaround and unviable accounts should either be given to Asset Reconstruction Company or Management/ownership restructuring or permitting banks to take over the units.
  • Bankruptcy code should be passed as soon as possible. Bankruptcy code will make it easier for banks to recover loans from unviable enterprises.
  • Government should establish ARC with equity contribution from the government and the Reserve Bank of India (RBI). The established ARC should take the tumor (of non-performing assets or NPAs) out” of the banking system. An ARC acquires bad loans from banks and financial institutions, usually at a discount, and works to recover them through a variety of measures, including sale of assets or a turnaround steered by professional management. Relieved of their NPA burden, the banks can focus on their core activity of lending.

#2. Long term Measures

  • Improving credit risk management– This includes credit appraisal, credit monitoring, and efficient system of fixing accountability and analyzing trends in group leverage to which the borrowing firm belongs to
  • Sources/structure of equity capital– Banks need to see that promoter’s contribution is funded through equity and not debt.
  • Banks should conduct necessary sensitivity analysis and contingency planning while appraising the projects and it should built adequate safeguards against such external factors.
  • Strengthen credit monitoring– Develop an early warning mechanism and comprehensive MIS(Management information system) can play an important role in it.MIS must enable timely detection of problem accounts, flag early signs of delinquencies and facilitate timely information to management on these aspects.
  • Enforce accountability- Till now lower ring officials considered accountable even though loaning decisions are taken at higher level. Thus sanction official should also share the burden of responsibility.
  • Restructured accounts should treated as non performing and technical write offs where Banks remove NPA’S from their balance sheets Permanently should be dispensed with.
  • Address corporate governance issues in PSB- This includes explicit fit and proper criteria for appointment of top executives and instituting system of an open market wide search for Chairman.

References:

By Dr V

Doctor by Training | AIIMSONIAN | Factually correct, Politically not so much | Opinionated? Yes!

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Nimisha Goswami
Nimisha Goswami
1 year ago

Very helpfull