Non-Performing Assets & Twin Balance Sheet Problem (TBS)

Non-Performing Assets

- Loan repayment or interest not made more than 90 days for company & Crop year (Short & Long Duration) for Agriculture Loan.

- If its genuine reason, Bank Restructure the loan duration or Decrease interest rate, etc…

- Insolvency – state of being unable to pay the debts (Salary, interest, Raw Material), by a person or company (debtor), at maturity.

- Bankruptcy – Legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. bankruptcy is imposed by a court order, often initiated by the debtor

- Enforcement of Security Interest - legal claim or lien on collateral that has been pledged, usually to obtain a loan. If loan became NPA, sell collateral to get loan amount.

- Creditor start managing company to get profit, if it fails move to Liquidation.

- Liquidation - Selling the collateral, but bank not get the total loan amount goes to liquidation. It is process of bringing a business to an end and distributing its assets to claimants to get loan amount. (Also Merger & Acquisition is done).

- Loan Waive-off - where the loan-taker is released from the burden of paying back the loan amount. (Ex: Education loan, Agriculture loan are discount by Government)

- Loan Write-off the financial institute still hopes to recover the loan amount from the person who not repaid it back. (bank taken out the loan of company assert making to loss making in their bank balance sheet)

• Non-performing assets, also called non-performing loans, are loans, made by a bank or finance company, on which repayments or interest payments are not being made on time (More than 90 days).
• NPA is any asset of a bank which is not producing any income.
• Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.
• But in terms of Agriculture / Farm Loans; the NPA is defined as under:
• Short duration crop loan: Loan is termed as NPA in this scenario if the loan either in terms of installment or interest is not paid for 2 crop seasons, it would be termed as NPA.
• Example: Agri loans such as paddy, jowar, Bajra etc.
• For Long Duration Crops, the above would be 1 Crop season from the due date.
1. Sub-standard: When the NPAs have aged <= 12 months.
2. Doubtful: When the NPAs have aged > 12 months.
3. Loss assets: When the bank or its auditors have identified the loss, but it has not been written off.
• After a certain amount of time, a bank will try to recoup its money by foreclosing on the property that secures the loan.

Reasons for NPAs

Borrower’s side

• Domestic economy slowdown - Lack of demand for their products as foreseen by the industrialists.
• Wilfull default - Diversion of funds by borrowers for purposes other than mentioned in loan documents. (They have money but not pay loan)
• Global economy slowdown.
• volatility in prices of raw material and the shortage in availability of power etc. impacts the performance of the corporate sector.
• The Lack of Bankruptcy code in India and sluggish legal system make it difficult for banks to recover these loans from both corporate and non-corporate.

Bank’s side

• Bad lending practices.
• Speculation is one of the major reason behind the default.
• Sometimes banks provide loans to borrowers with bad credit history.
• There is high probability of default in these cases.
• Inadequate Capacity to evaluate projects – poor credit appraisal system
• Absence of regular industrial visits.

Other external factors:

• Economic condition of a region effected by natural calamities.
• Ineffective recovery tribunals.
• Change in government policies – For example – any government scheme diverting manpower of PSBs for its implementation affecting the regular activities of banks.
• Administrative hurdles – delay in getting permits and other clearances affects the cost of project.

How it began?

• The answer lies partly in the credit boom of the years 2004-05 to 2008-09.
• In that period, commercial 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.
• 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.

Twin Balance Sheet Problem (TBS)

(Both bank & Company balance Sheet is in Loss)

Ex: Bank give loan to company, Company make profit and repay the loan. Bank get profit by loan repayment.

If Company is loss, bank not able to pay interest became NPA, so bank does not able to get profit. Both bank & Company balance sheet is loss).

• The problem of bad loans is compounded by another problem of overleveraged corporate; and these two combine to create India’s twin balance sheet problem.
• On the one hand, the public sector banks are burdened with the high non-performing assets (NPAs) while on other hand, some of the corporate houses are also under stress due to sluggish global demand and overleveraged borrowings. This has been called the “TBS problem” or “Twin Balance Sheet Syndrome”.

Impacts of rising NPAs

On banks

• It affects the profitability & liquidity of the banks as annual return on assets comes down and also the amount given as loan also gets blocked which could have been used for some return earning asset otherwise Extra time and effort to handle and manage NPAs with added cost
• Credit loss - Bank is facing problem of NPA then it adversely affects the value of bank in terms of market credit.
• It will lose its goodwill and brand image and credit which have negative impact to the people who are putting their money in the banks.
• The assets and liability mismatch will widen.
• Bank shareholders are adversely affected.
• stocks of state-owned banks will fall further and their ability to raise equity will slide.

On borrowers

• The cost of capital will go up.
• Banks tend to restrict credit to small and medium enterprises (SMEs) that are India's potential for prosperity of an entrepreneurial middle class.
• Banks may begin charging higher interest rates on some products to compensate Non-performing loan losses

On asset declared as NPA

• Poses threat on quality of asset
• 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.

On overall economy

• It leads to a situation of low off take of funds from the security market due to increase in cose of capital. This will hurt the overall demand in the Indian economy.
• And, finally it will lead to lower growth rates and of course higher inflation because of the higher cost of capital.
• It becomes a vicious cycle.

Earlier Initiatives to Tackle NPA

• SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002)– Asset Reconstruction Companies.

The NPA are given to ARC. Ex: Bank has 100 Cr NPA in a company. Given to ARC for 80 Cr, ARC give 20% (16 Cr) as cash & 80% (64 Cr) as security. After recovering loan from the company, ARC give balance 80%, until ARC give interest to bank for the 80%(64 Cr).

• ARC recover the loan give balance 80% (64 Cr) to bank. If ARC not able to recover full loan, give some percentage to bank on Recovery amount from Company.
• Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) - Debt Recovery Tribunal (For Individual).
• Strategic Debt Restructuring - Provide lenders 51% equity control in a company that fails to repay even after its debts are rejigged to give the management a second chance.
• It will come into force if the corporate debt restructuring (CDR) mechanism fails.
• 5/25 norms - Permitted banks to structure loans for 25 years while giving them the flexibility to revise rates or sell the asset to another bank every five years in infrastructure.
• (Increase the repayment period up to 25 years & Review every 5 years).

Public Sector Asset Reconstruction Company (PARA)

• The Public Sector Asset Rehabilitation Agency (PARA) colloquially called “Bad Bank” is a proposed agency to assume the Non-Performing Assets (NPA) of public sector banks in India and to deal with the recovery of the bad loans.
• This agency has been proposed in Economic Survey 2016-17.
• The main function of PARA would be to take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt.
• The funding of this body would come either by selling the bonds or by inviting private companies to buy its equities.
• The survey also suggests that instead of investing funds and recapitalize the banks year after year, it would be better for the government to focus on recovery.
• Bad bank has been experimented in several countries especially after the financial crisis of 2008-09.
• It has witnessed some success in Malaysia, Sweden, Spain and few other countries.
• Once stressed assets are sold to Bad bank, the RBI can lean harder on banks to pass on its rate cuts.
• A single government entity will be more competent to take decisions rather than individual PSBs.
• This helps banks or FIs clear-off their balance sheets by transferring the bad loans and focus on its core business lending activities.