In February 2016, when the banks started reporting financial results for their December quarter, the Indian Financial Markets were rocked- Thanks to the dismal operating earnings of the banks which was on account of the soaring high value of Non-Performing Assets(NPAs).
Even though in the present scenario, the situation has reformed slightly, the 2019 Economic Survey of India declaring that the Gross Non Performing Asset (GNPA) ratio of Public Sector Banks (PSB’s) decreased from 11.5% to 10.1% between March 2018 and December 2018, it is still essential to understand and evaluate that how NPAs cropped up, how they have impacted the Indian Banking System and what steps have been taken by the government to fight this burgeoning issue.
What are the Non-Performing Assets?
Commercial Banks are a backbone for any economy. Their primary role is to make loans and advances, which stimulates investments into the economy, thereby leading to growth and development. When a bank makes loans and advances, it categorizes their performance as Standardised Asset (where principal and loan repayments are made timely) & Non-Performing Assets.
Non- Performing Assets are those loans and advances where the borrower has stopped making Principal and Interest Payments for over 90 days.
As per the Reserve Bank of India (RBI), the primary reasons behind such exorbitant high NPAs are aggressive lending by banks, willful defaults, corruption in some cases, etc.
Why are Non-Performing Assets an issue?
Rising NPAs take a toll on banks' profitability since a bank has to make excessive provisions for bad loans. The banks set aside enormous funds for anticipated losses (Prudence concept of Accounting), which ultimately decreases the profitability as measured by the Return on Assets (ROA) ratio.
For instance, the Gross Non-Performing Assets of banks as a percentage of total loans have increased from 2.3% of total loans in 2008 to 9.3% in 2017(Figure 1). This shows that even though the assets have grown, they haven't increased the banks' profitability (Figure 2) lowering their ability to extend credit.
The drop in profitability leads to low deposit rates. As a result, depositors start withdrawing their parked funds from banks, which further hampers the lending capacity of the bank. The banks thus get trapped into this vicious cycle, which ultimately puts up a big question mark on a bank's image and credibility.
When did it all begin?
The history of Non-Performing Assets can be traced the back to mid-2000s when the economy was booming, and outlook towards businesses was very positive. During this phase, the banks started lending to large corporations based on their recent performance. As a result, corporations started becoming more leveraged, meaning that they had a substantially high Debt-Equity ratio (More Debt, less reliance on Equity).
However, after the Global Financial Crisis of the year 2008, such corporations found it difficult to pay back their loans, creating a ruckus in Balance Sheets of both sides- Banks and the Corporations likewise. This is popularly referred to as the Twin Balance Sheet Crisis i.e., a situation when both the banks and the corporations are in financial distress.
What has been done to resolve the issue?
The government, in order to combat all the menace, has come up with the 4Rs strategy of Recognition, Resolution, Recapitalisation, and Reform.
The Insolvency and Bankruptcy Code(IBC), 2016 is a significant step initiated to curb this problem.
The IBC,2016 has been enacted to provide a time-bound 180-day recovery process for insolvent accounts. As of March 2019, the corporate insolvency resolution process has successfully resolved 94 cases, resulting in settlement of claims worth Rs 1,73,359 crore.
The government has even opted for the recapitalization of state-run banks- the government has already infused 2.1 trillion rupees in them since September 2017. According to the rating agency - ICRA Ltd, banks will further require ₨35000-45000 crore to support credit growth of 12-13%.
Even though this step is going to pressurize the fiscal deficit numbers, regardless it is expected to boost credit growth in the economy.
At present, NPA’s are proving to be a major factor was crashing down of some major financial banks. Yes Bank and DHFL (Dewan Housing Finance Corporation Ltd.) have been two recent preys of NPA’s.
Read how NPA’s got down the share prices of DHFL,