Non-Performing Assets (NPA) in Indian Banks
According to the Reserve Bank of India (RBI), the gross non-performing assets in Indian banks, specifically in public sector banks, are valued at around Rs 400,000 crore (~US$61.5 billion), which represents 90% of the total NPA in India, with private sector banks accounting for the remainder.
What are Non-Performing Assets (NPA)?
- Money or assets provided by banks to companies as loans sometimes remain unpaid by borrowers. This late or non-payment of loans is defined as Non-Performing Assets (NPA). They are also termed as bad assets.
- In India, the RBI monitors the entire banking system and, as defined by the country’s central bank, if for a period of more than 90 days, the interest or installment amount is overdue then that loan account can be termed a Non-Performing Asset.
The increase in non-performing assets in Indian banks follows the recognition standards being pursued by the banks after the RBI highlighted it in the Asset Quality Review (AQR). Of course, the main reason is inadequate progress in the financial health of the companies.
Reasons for the Rise in NPA levels
- From 2000-2008, the Indian economy was in a boom phase and banks, especially public sector banks, started lending extensively to companies.
- However, with the financial crisis in 2008-09, corporate profits decreased and the Government banned mining projects. The situation became serious with the substantial delay in environmental permits, affecting the infrastructure sector – power, iron, and steel – resulting in volatility in prices of raw materials and a shortage of supply.
- Another reason is the relaxed lending norms adopted by banks, especially to the big corporate houses, foregoing analysis of their financials and credit ratings.
Recent Developments and Ways to Tackle NPA
- Insolvency and Bankruptcy Code (IBC) – With the RBI’s push for the IBC, the resolution process is expected to quicken while continuing to exercise control over the quality of the assets. There will be changes in the provision requirement, with the requirement for the higher proportion of provisions going to make the books better.
- Credit Risk Management – This involves credit appraisal and monitoring accountability and credit by performing various analyses on profit and loss accounts. While conducting these analyses, banks should also do a sensitivity analysis and should build safeguards against external factors.
- Tightening Credit Monitoring – A proper and effective Management Information System (MIS) needs to be implemented to monitor warnings. The MIS should ideally detect issues and set off timely alerts to management so that necessary actions can be taken.
- Amendments to Banking Law to give RBI more power – The present scenario allows the RBI just to conduct an inspection of a lender but doesn’t give them the power to set up an oversight committee. With the amendment to the law, the RBI will be able to monitor large accounts and create oversight committees.
- More “Haircuts” for Banks – For quite some time, PSU lenders have started putting aside a large portion of their profits for provisions and losses because of NPA. The situation is so serious that the RBI may ask them to create a bigger reserve and thus, report lower profits.
- Stricter NPA recovery – It is also discussed that the Government needs to amend the laws and give more power to banks to recover NPA rather than play the game of “wait-and-watch.”
- Corporate Governance Issues – Banks, especially the public sector ones, need to come up with proper guidance and framework for appointments to senior-level positions.
- Accountability – Lower-level executives are often made accountable today; however, major decisions are made by senior-level executives. Hence, it becomes very important to make senior executives accountable if Indian banks are to tackle the problem of NPAs.
The banks should also consider “raising capital” to address the problem of NPA.
- Using unclaimed deposits – Similar to provisions for unclaimed dividends, the government may also create a provision and transfer unclaimed deposits to its account. These funds, in return, can be transferred to banks as capital.
- Monetization of assets held by Banks – In this case, banks with retail franchisees should create value by auctioning a bank assurance association rather than running it themselves as an insurance company. The current set-up blocks capital inflows and doesn’t generate much wealth for the owners.
- Make Cash Reserve Ratio (CRR) attractive – At present, the RBI asks Indian banks to maintain a certain limit on CRR on which the RBI doesn’t pay interest. Hence, banks lose out a lot on interest earnings. If the CRR is made more financially rewarding for banks, it can reduce capital requirements.
- Refinancing from the Central Bank – The US Federal Reserve spent $700 billion to purchase stressed assets in 2008-09 under the “Troubled Asset Relief Program.” Indian banks can adopt a similar arrangement by involving the RBI directly or through the creation of a Special Purpose Vehicle (SPV).
- Structural change to involve private capital – The compensation structure and accountability of banks creates a problem for the market. Banks should be governed by a board while aiming to reduce the government’s stake and making the financial institutions attractive to private investors.
With the potential solutions above, the problem of NPAs in Indian banks can be effectively monitored and controlled, thus enabling the banks to achieve a clean balance sheet.
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