Non-Performing Assets (NPAs): Classification, Special Mention Account, Measures

Introduction 

A Non Performing Assets (NPAs) is a loan or advance for which the principal or interest payment remained overdue for 90 days. Non Performing Assets (NPAs) are a significant concern for banks and financial institutions as they can impact profitability, liquidity, and overall financial stability. Managing and reducing Non Performing Assets (NPAs) is crucial for maintaining the health of the banking sector and fostering sustainable economic growth.

Classification of Non Performing Assets (NPAs)

• Banks are required to classify Non Performing Assets (NPAs) further into Substandard, Doubtful and Loss assets.
• Substandard Assets: Assets that have remained NPA for a period less than or equal to 12 months.
• Doubtful Assets: An asset would be classified as doubtful if it has remained in the substandard category for 12 months.
• Loss Assets: A 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.(As per RBI)

Special Mention Account

• SMA are those accounts that show symptoms of bad asset quality once the account is overdue or before its being identified as NPA. 
• Three Types of SMA: The Special Mention Accounts are usually categorized in terms of duration as follows:
• SMA & NPA Categorization

Twin Balance Sheet Problem

• The balance sheets of both public sector banks (PSBs) and some corporate houses private entities are in bad condition i.e. overleveraged and distressed private companies and the rising Non Performing Assets (NPAs) in Public Sector Bank balance sheets.

Measures for NPA resolution

• 3R Framework for Revitalizing Stressed Assets
  • Rectification: Conducting Asset Quality Review (AQR)
  • Restructuring: Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets (S4A), Joint Lenders Forum.
  • Recovery: SARFAESI Act, 2002 and Insolvency and Bankruptcy Code, 2016

• Sustainable Structuring of Stressed Assets (S4A) 
  • It is an optional framework for the resolution of largely stressed accounts and a tool for financial restructuring.
  • Bank hires an independent agency to evaluate how much of the stressed asset is sustainable and how much is unsustainable – it will convert the unsustainable debt into equity – no change of ownership of the company, unlike in strategic debt restructuring – helps in financial restructuring.

• Bad Banks

• • Objective: A bad bank is a set up to buy the bad loans and other illiquid holdings of another financial institution and do the loan restructuring and absorb losses.
  • Economic Survey 2016 – 17 suggested Public Sector Asset Rehabilitation Agency (PARA) to resolve the twin problems of ‘balance sheet syndrome’ (of the banks as well as the corporate sector).
  • PARA is a proposed Bad Bank that will buy bad loans from public sector banks.

• Prompt Corrective Action (PCA): 
  • The framework considers banks as risky if they fall below certain norms on three parameters i.e. Capital ratios, Asset quality and Profitability. 
  • Certain restrictions such as halting branch expansion and stopping dividend payment, restrictions in branch expansion, higher provisions etc are put in place.

• Asset Reconstruction Companies (ARC): Narasimham Committee (1998) recommended setting up an ARC. 
  • It is a specialized financial institution that buys the Non Performing Assets (NPAs) or bad assets from banks and financial institutions so that the latter can clean up their balance sheets.

• SARFAESI Act, 2002 : It provides the legal basis for the setting up ARCs in India to tackle wilful defaulters. 
  • Under this, a lender can take possession of the property or mortgaged assets after giving the borrower a 60 – day notice.
  • It is not applicable to unsecured creditors. 
  • Not applicable on Farm Loans.

• Debt Recovery Tribunal (DRT): Lenders can recover their dues by approaching a DRT and get a recovery certificate. 
  • It allows lenders to take possession of properties of borrowers anywhere in the country and sell them to recover dues.
  • Appeals against orders passed by DRTs lie before Debts Recovery Appellate Tribunal (DRAT).
  • It can go beyond the Civil procedure Code.
• e-Bkray Portal: It was launched to enable online auction by banks of attached assets transparently and cleanly for the improved realization of value.
• Capital Adequacy Ratio

• • CAR/Capital to Risk-Weighted Assets Ratio (CRAR) is the ratio of a bank’s capital to its risk. 
  • The higher the CRAR of a bank the better capitalized it is.

National Financial Reporting Authority

• • Independent regulator to oversee the auditing profession and accounting standards in India under Companies Act 2013; 
  • Came into existence in October 2018.
  • Composition: A chairperson who will be appointed by the Central Government and a maximum of 15 members.

• Powers

• • Can probe listed companies and those unlisted public companies having paid-up capital of no less than Rs 500 crore or annual turnover of no less than Rs 1,000 crore.
  • Can investigate professional misconduct committed by members of the Institute of Chartered Accountants of India (ICAI) for prescribed classes of body corporate or persons.

Insolvency and Bankruptcy Code

• For reorganization and insolvency resolution of corporate persons, partnership firms and individuals.
• Minimum default of Rs 1 crore is needed to trigger IBC. 
• Time Bound Process: 180 days, some cases 270 days maximum. 
• No Deadlock: If resolution is not done, assets are to be sold to pay debtors. 
• It is not applicable for Willful Defaulters.
• IBC proposes a new institutional setup comprising the following four critical pillars: 
  • The National Company Law Tribunal (NCLT) as the adjudicating authority.
  • Insolvency professionals (IPs) to manage the insolvency and bankruptcy cases.
  • Information utilities (IUs) to reduce information asymmetries.
  • Insolvency and Bankruptcy Board of India (IBBI), a regulator

Conclusion

• Non-Performing Assets (NPAs) pose significant challenges to the banking sector, impacting profitability and financial stability. 
• Managing Non Performing Assets (NPAs) effectively is essential for banks to mitigate risks, maintain liquidity, and sustain long-term growth. 
• Implementing robust risk management practices, proactive measures for loan recovery, and regulatory interventions are key strategies for addressing Non Performing Assets (NPAs) and safeguarding the health of the banking system.