MAHARASHTRA NATIONAL LAW UNIVERSITY MUMBAI

B.A., LL.B. (Hons.), 4th Semester

Mid Semester Assignment 1

Name: Anushka Rungta Subject: Economics IV

Enrolment No.: 2018 005 Submitted to: Prof. Rohit Jadhav

“NON- PERFORMING ASSETS”

AN ENQUIRY INTO THE DEFINITION OF NON-PERFORMING ASSETS

The Reserve Bank of India defines Non Performing Assets (hereinafter referred to as NPAs)
a credit facility in respect of which the interest and/or instalment of principal has remained
‘past due’ for a specified period of time. In simple terms, an asset is tagged as non performing
when it ceases to generate income for the lender.

EFFECTS OF NON-PERFORMING ASSETS ON A COUNTRY

• Impact of NPAs on Balance Sheet

High Non Performing Assets are the foremost problem for the banking system for any
economy, that shakes the whole banking system of the country.The confidence level of the
investor, Depositors, Stack holders also effects. This also causes the rotation of money.

Profitability due to NPA: Non Performing Assets not only reduces the profit of the Bank but
also increases the Loss. Also, banks also provide 25 % to 30% additional provision on Non -
Performing Assets which directly impact the Profitability of the Bank.

Liability Management: Due to high Non Performing Assets, Bank for forced for lower the
interest rates of the deposit and on advances likely to pay Higher interest rates on advances.
This situation is a very difficult situation and also hamper the banking business.

Share Holders confidence: Not in the Banking sector, but shareholders need their money in
safe hands, Shareholders are interested in the enhancement of investment and market
capitalization. High Non Performing Assets reduces the confidence level of the investor which
significantly impact the Share price of the Bank in this situation, banks stop payout of dividend
to the shareholders, which was not in the interest of the investor.
Public Confidence: The poor performance of the Bank due to increases in Non-Performing
Assets not only lower the sentiments of the investor but the bank also lose the faith of Public,
this directly affects the deposits into the bank. High Non Performing Assets affects the
economy as a whole.

• Effects of High NPA’s for Banks

Higher NPA impact the revenue strength of the banks and also lose the confidence level of
consumers and depositors, banks are back boon to the Financial economy of every country.
Here are some effects in details :

Changes in Interest Rates: Higher NPA reflects the reduction of interest rate on the deposit
into banks, only poor public directly impact the consequences of Higher NPA’s of the bank.

Levies of charges for every operation: Looking at the above scenario, the bank is recovering
their losses by levies charges on those operations which were free of cost like – Withdrawal
limit from ATM; withdrawal number of times; cash deposits in other branches; internet
transaction charges.

Increase in Current account deficit: NPA plays an important role in every economic
condition and also the main cause of the increase in the current account deficit. Interest rates,
Loan, Housing Loans, CRR, SLR all are directly affected by the system.The Corporates also
affect the impact of higher NPA.

Confidence in Share Holders: Higher NPA’s in banking system losing the confidence of
shareholders, and the depositors, they are switching the segments and losing the trust in the
system.

Effect on the serious borrower: Increase in NPA not only affect the public but also affecting
the serious honest borrower with good credentials and credit ranking. they have to suffer and
on the other hand, the economy is losing hope of improvement.

THE PATTERN OF NON-PERFORMING ASSETS IN INDIAN ECONOMY

• During the credit boom of the years 2004-05 to 2008-09, commercial credit (or what is
called ‘non-food credit’) doubled. It was a period in which the world economy as well
as the Indian economy were booming. 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 and they believed, as many others did, that India had
entered an era of 9% growth.
• But soon after, as the Economic Survey of 2016-17 notes, many things began to go
wrong. There were problems in acquiring land and getting environmental clearances
and several projects got stalled. Project costs soared. 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. As a result, financing costs rose as policy rates
were tightened in India in response to the crisis. Further, 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 (i.e maintain
and repay) their loans to Indian banks.

• The year 2014-15 marked a watershed because of tightening of banking norms. 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 is not as if bad
decisions had suddenly happened. It’s just that the cumulative bad decisions of the past
were now coming to be more accurately captured. 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. Capital from the government was
slow in coming and it was barely adequate to meet regulatory norms for minimum
capital. Without adequate capital, bank credit cannot grow.

• Once NPAs happen, it is important to effect to resolve them quickly. Otherwise, the
interest on dues causes NPAs to rise relentlessly.

• In an attempt to bolster the reforms around NPA, the RBI in 2019 issued fresh
guidelines, which have now replaced all the previous models, which state that defaults
are to be recognized within 30 days. If the government’s numbers are correct, bad loans
as a percent of total loans have dropped from 11.18 percent in March 2018 to 9.07
percent in March 2019 and according to a CRISIL report, could drop to around eight
percent by March 2020.
 Gross NPAs (% of Total Loans)
Series 1

16 14.7
14 12.8
11.45 11.18
12 10.4
9.06 9.23 9.07
10
7.2 7.47
8
6 4.94
3.3 3.82 4.27
3.23
4 2.51 2.25 2.28 2.39 2.25 2.75
2
0
1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019
THE GROWING CONCERNS OF NON-PERFORMING ASSETS IN INDIA

In order to have emerging and evolving economy it is extremely important that the Banking
Sector is functioning smoothly i.e. person who require money should get the money in a hassle
free manner and the Banks must get back the money lent by them to borrowers in a hassle free
manner. Banks are backbone for a sound economy of a country .For want of efficient banking
industry, businesses cannot grow, as sick banks cannot and will not provide the money requisite
for businesses’ growth.
NPA is going to affect the Indian Economy inter alia in the following manner:

• BASEL norms which have been adopted by RBI require banks to reserve more money
as against the probability of default. From this it can be easily implied that Banks
struggling with NPA would have lesser liquid money at hand as it has pursuant to
provisioning norms of RBI would have lock more money. This will upset both interest
rates i.e. interest rate at which banks lend money and the interest rate which depositors
get while depositing money in the Bank. Thus, either the depositor or borrower will
have to bear its brunt the in form of lower return as interest rate would lower(for
depositors) or higher interest rates for the borrowers but in either case bank would be
at loss. Higher interest rates would cause higher cost of capital and thus will contribute
to surge in inflation.

• Higher NPAs will deter Banks from offering the amount that the Companies require to
do business (which can be witnessed from the fact that as per an economic survey banks
are reluctant to lend loans to real estate sector due to their rising NPA. Limited capital
 of the company causes companies to have limited capital expenditure, thus, companies
cannot grow and expand; and with such limited growth, the demand for human
resources will remain challenged. And, companies in dearth of money might have to
terminate employees. Thus, it will add hugely to soaring unemployment in India.

• Higher NPA affects the liquidity position of the banks and raises cost of funds which
in turn destroys banks’ profitability and upsets the financial stability. Thus, growing
NPA shrinks the profit of the Bank and takes away the incentive to be in the banking
business. Continuing NPA has the tangible potential to cause loss to Banks. Thus, the
shareholders of the banks will lose of money as banks themselves will find it tough to
survive in the market and it would certainly dissuades the prospective investors from
investing in the economy. This will lead to a crisis situation in the market.

• The fact that NPA in worst case may even hit innocent tax payers cannot be ruled out
as Government in exigency may be forced to increase tax rate to save public banks from
getting drowned

SOME STEPS TAKEN TO TACKLE THE PROBLEM OF NON-PERFORMING ASSETS

A proposed agency was initiated by the Government to address and handle the NPA problem
in the country: The Public Sector Asset Rehabilitation Agency.
Institutional Framework to tackle NPAs:
1. SARFESI Act
2. Asset Reconstruction Companies
3. 5:25 Scheme
4. Strategic Debt Reconstructing Scheme

However, in spite of these reforms led by the RBI, there is room for further headway. One of
the primary reasons for stressed assets can be attributed to lethargic due diligence and an
ineffective sanctioning process. Past records of borrowers should be available to banks to form
an opinion and conduct financial background checks of prospective borrowers. The credit team
of banks should also undergo periodic training to update their skills and industry benchmarks
along with credit evaluation sheets, which should be upgraded regularly . Data analytics can
also be a significant tool to conduct effective periodic review and audits.