NEGATIVE IMPACT OF NPA ON INDIAN ECONOMY
By- Akanksha Shukla

>Abstract:

Any asset which stops giving returns to its investors for a specified period of time is known as Non-Performing Asset (NPA). Indian Banking industry is seriously affected by Non-Performing Assets. More than Rs. 7 lakh crore worth loans are classified as Non-Performing Loans in India. This is a huge amount. The figure roughly translates to near 10% of all loans given. This means that about 10% of loans are never paid back, resulting in substantial loss of money to the banks. When restructured and unrecognised assets are added the total stress would be 15-20% of total loans. NPA crisis in India is set to worsen. Restructuring norms are being misused. This bad performance is not a good sign and can result in crashing of banks as happened in the sub-prime crisis of 2008 in the United States of America. Also, the NPA problem in India is worst when comparing other emerging BRICS Economies. In India banking sector has played pivotal role in our nation building. After Liberalisation of the economy the banking sector has faced severer challenges, but due to its solid foundation and management it has withered all the subsequent challenges including 2008 sub-prime crisis. But the recent problem has been grave. In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that government of India gets less money as a dividend. Therefore it may impact easy deployment of money for social and infrastructure development and results in social and political cost.NPAs related cases add more pressure to already pending cases with the judiciary one. In this paper it has been discussed in details with best possible solutions.

>Introduction:

Today, the Indian banking industry is dealing with the mammoth amount of NPAs which is fifth largest in the world. As on June 30, 2018, the gross NPAs of the banking sector were 11.52% of the total assets while the net NPAs were 5.92%. As on March 31, 2018, the gross NPAs were at 11.68% and net NPAs were 6.21%. Thus there is slight improvement in NPAs this year.

Strong banking sector is one of the most significant prerequisite of strong economy because it channels the savings into the investment. A fragile banking sector will ultimately give way to the fragile economy. It is clear that infrastructure accounted for biggest chunk of NPAs. Because of massive amount of NPA in infrastructure, the banks are now reluctant to fund this sector. As the infrastructure is one of the most important sectors in economy which fuels the growth of other sectors, draining of resources to infrastructure may hamper the growth of Indian economy.
Among the other sectors, food processing also accounted for 5.3% of total NPAs. Food processing is one of the most employment intensive industries and its growth also pushes the growth of agriculture. Any loss to the food processing industry will ultimately percolate to the employment as well as agriculture sector.
Other sectors will also directly or indirectly affect the overall economic scenario due to the exposure to the bad loans. Hence, the issue of NPA must be resolved on urgent basis.

>Objective and research methodology:

The objective of this paper is to discuss why NPA is threat to the banking system in India and its possible solution. This paper is exploitative by nature and secondary sources have been used as the source of information.

>History of Indian banking System:

Although the banking system in India has around 300 years old history but the real growth happened after independence. We can also divided this into three parts. First period is just after independence, second period is after nationalization of banks and the last period is after introduction of Liberalization of the Indian economy.
Immediately after independence banking system in India was limited to only few privilege classes. Mass had to depend on land lords and village sahukars. And also to expand the industrial activities private investment was needed. But private banks were unable to provide these investment needs due to various reasons. Also high rate of interest were charged. Therefore industrial base was not developed in India due to lack of cheap capital. This had prompted the then government to nationalize all the private sector banks in 1969 and then in 1984.
Nationalizations of banks created a wave of development in our country. Government has entrusted various function to the banks for eradication of poverty, for entrepreneurship, for development of agriculture. Lead bank system and priority sector banking were some of the programs of the governments. But the real value addition of these programmes was negligible compared to the cost involved with it. A lot of public money were got wasted. It prompted the government to think after the priority of banking sectors.
The watershed period of banking sector was introduction of Liberalisation by then government. A committee was formed under former RBI Governor M. Narsimham in August 1991 to look into all aspects of the financial system of India. The report of this committee had comprehensive recommendations for financial sector reforms including the banking sector and capital markets.
The key recommendations with respect to the banking sector were as follows:
(1) Reduction in the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)
(2)Redefining the priority sector
(3) Deregulation
Many of the recommendations of the committee were acceded to by the government. The government also enacted Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993 Debt Recovery Tribunals with an appellate Tribunal at Mumbai for quicker recovery of bad debts. In 1995, Banking Ombudsman scheme was launched with an objective to provide quicker solutions to customers’ complaints.

>What is Non-Performing Assets (NPAs):

You may note that for a bank, the loans given by the bank is considered as its assets. So if the principle or the interest or both the components of a loan is not being serviced to the lender (bank), then it would be considered as a Non-Performing Asset (NPA).
Any asset which stops giving returns to its investors for a specified period of time is known as Non-Performing Asset (NPA).
Generally, that specified period of time is 90 days in most of the countries and across the various lending institutions. However, it is not a thumb rule and it may vary with the terms and conditions agreed upon by the financial institution and the borrower.

>Types of NPA’s:

Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets
1. Substandard assets: An assets which has remained NPA for a period less than or equal to 12 months.
2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
3. Loss assets: As per RBI, “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.”

>Possible reasons for NPAs:

There are many possible reasons for NPAs in the banking system in India. Important reasons among them are;
1. Diversification of funds to unrelated business/fraud.
2. Lapses due to diligence.
3. Business losses due to changes in business/regulatory environment.
4. Lack of morale, particularly after government schemes which had written off loans.
5. Global, regional or national financial crisis which results in erosion of margins and profits of companies, therefore, stressing their balance sheet which finally results into non-servicing of interest and loan payments. (For example, the 2008 global financial crisis).
The general slowdown of entire economy for example after 2011 there was a slowdown in the Indian economy which resulted in the faster growth of NPAs.
The slowdown in a specific industrial segment, therefore, companies in that area bear the heat and some may become NPAs.

The above table depict the % of Net, Gross NPA and Stress assets during the period 2013 to 2016 the % increase continuously. It forecast that in 2017 it will reach at 8.5and 9.3 and it will be critical for banking system.

>Impacts of NPA:

Unplanned expansion of corporate houses during boom period and loan taken at low rates later being serviced at high rates, therefore, resulting into NPAs. The problem of NPAs in the Indian banking system is one of the foremost and the most formidable problems that had impact the entire banking system. Higher NPA ratio trembles the confidence of investors, depositors, lenders etc. It also causes poor recycling of funds, which in turn will have deleterious effect on the deployment of credit. The non-recovery of loans effects not only further availability of credit but also financial soundness of the banks. Profitability: NPAs put detrimental impact on the profitability as banks stop to earn income on one hand and attract higher provisioning compared to standard assets on the other hand. On an average, banks are providing around 25% to 30% additional provision on incremental NPAs which has direct bearing on the profitability of the banks. Asset (Credit) contraction: The increased NPAs put pressure on recycling of funds and reduces the ability of banks for lending more and thus results in lesser interest income. It contracts the money stock which may lead to economic slowdown. Liability Management: In the light of high NPAs, Banks tend to lower the interest rates on deposits on one hand and likely to levy higher interest rates on advances to sustain NIM. This may become hurdle in smooth financial intermediation process and hampers banks business as well as economic growth. Capital Adequacy: As per Basel norms, banks are required to maintain adequate capital on risk-weighted assets on an ongoing basis. Every increase in NPA level adds to risk weighted assets which warrant the banks to shore up their capital base further. Capital has a price tag ranging from 12% to 18% since it is a scarce resource. Shareholders’ confidence: Normally, shareholders are interested to enhance value of their investments through higher dividends and market capitalization which is possible only when the bank posts significant profits through improved business. The increased NPA level is likely to have adverse impact on the bank business as well as profitability thereby the shareholders do not receive a market return on their capital and sometimes it may erode their value of investments. As per extant guidelines, banks whose Net NPA level is 5% & above are required to take prior permission from RBI to declare dividend and also stipulate cap on dividend payout. Public confidence: Credibility of banking system is also affected greatly due to higher level NPAs because it shakes the confidence of general public in the soundness of the banking system. The increased NPAs may pose liquidity issues which is likely to lead run on bank by depositors. Thus, the increased incidence of NPAs not only affects the performance of the banks but also affect the economy as a whole. In a nutshell, the high incidence of NPA has cascading impact on all important financial ratios of the banks viz., Net Interest Margin, Return on Assets, Profitability, Dividend Payout, Provision coverage ratio, Credit contraction etc., which may likely to erode the value of all stakeholders including Shareholders, Depositors, Borrowers, Employees and public at large.
Our banking system is robust and based on strong foundation. The Reserve Bank of India as a central bank of India doing great job. In 2008 sub-prime crisis when banking system in rest of the world is in danger of collapse, our domestic banking system was secured. It was due to solid foundation of our banking system. But the situation has changed a lot. As economy has slowed down due to global slowdown and structural problem, it has indirect impact on credit disbursement. When mining sector was in boom, a lot of iron industries were open up in India. So other ancillaries industries were also mushroomed as a result. Banking sector has invested a lot in these industries, but due to crash in global commodity market and subsequent slowdown in the economy has affected the credit worthiness of the bank. There are other industries like aviation sectors, infrastructure sectors , telecom sectors which has shown early promise but slowdown in the market has negative impact on these sectors as a result banks cannot recover their due and it became a NPA. Established and willful defaulters like Vijaya Mallya have created tremendous loss to the banking sector. Another reason is debt written off by successive state governments and central government on agricultural loan and industrial loans. It has very bad effect on fiscal discipline of state finance and major reason of increasing NPAs.

>Solutions:

The Reserve Bank of India has identified growing NPAs is the major problem of our economy. The then Governor of the RBI Raghuram Rajan has taken a number of steps to cleared the NPAs. The public sector banks has twin balance sheet problem. Therefore the RBI has clearly directed the banks to clear off old NPAs. It was expected that demonetization would solved the NPAs problem of banks. But the result has not been so success full. Another solution is recapitalization of banks and merger of the banks. But it requires huge capital and the government has not that fiscal ability. Merger of the banks are although passed by the cabinet, it will take sometimes to be fruitful.
Therefore from our above analysis it was proved that NPAs are detrimental to our economy. There are different solution tried by the government, but it couldn’t solve the main problem. So a strong political will the all-round effect of all these steps can solve NPAs problem.

>Government initiatives to tackle NPAs:

• The Debt Recovery Tribunals (DRTs) – To decrease the time required for settling cases. They are governed by the provisions of the Recovery of Debt Due to Banks and Financial Institutions Act, 1993. However, their number is not sufficient therefore they also suffer from time lag and cases are pending for more than 2-3 years in many areas. The original aim of the Debts Recovery Tribunal was to receive claim applications from Banks and Financial Institutions against their defaulting borrowers.
• 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 and 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 create 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.
• Credit Information Bureau – A good information system is required to prevent loan falling into bad hands and therefore prevention of NPAs. It helps banks by maintaining and sharing data of individual defaulters and willful defaulters.
• Lok Adalats – They are helpful in tackling and recovery of small loans however they are limited up to 5 lakh rupees loans only by the RBI guidelines issued in 2001. They are positive in the sense that they avoid more cases into the legal system.
• Compromise Settlement – It provides a simple mechanism for recovery of NPA for the advances below Rs. 10 Crores. It covers lawsuits with courts and DRTs (Debt Recovery Tribunals) however wilful default and fraud cases are excluded.
• SARFAESI Act – The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 – The Act permits Banks / Financial Institutions to recover their NPAs without the involvement of the Court, through acquiring and disposing of the secured assets in NPA accounts with an outstanding amount of Rs. 1 lakh and above. The banks have to first issue a notice. Then, on the borrower’s failure to repay, they can:
1. Securitization – It refers to the process of converting loans and other financial assets into marketable securities worth selling to the investors.
2. Asset Reconstruction – It refers to conversion of non-performing assets into performing assets.
3. Enforcement of Security without the intervention of the Court.

>Conclusion:

Looking at the giant size of the banking industry, there can be hardly any doubt that the menace of NPAs needs to be curbed. It poses a big threat to the macro-economic stability of the Indian economy. An analysis of the present situation brings us to the point that the problem is multi-faceted and has roots in economic slowdown; deteriorating business climate in India; shortages in the legal system; and the operational shortcoming of the banks. The recommendations given by RBI are a welcome step in this regard.

>References:

• Non-Performing Assets of Indian Banking System and its Impact on Economy Pro. D.S. Rathore, Dr. Sangeeta Malpani, Sunita Sharma,
• OSR Journal of Economics and Finance Volume 7, Issue 6 Ver. III (Nov. – Dec. 2016),
• www.iosrjournals.org
• Annual Research Journal of Symbiosis Centre for Management Studies, Pune Vol. 4, March 2016 125 Chatterjee, C. and Mukherjee, J. and Das, R., “Management of nonperforming assets – a current scenario”, International Journal of Social Science & Interdisciplinary Research, Vol.1Issue 11, 2012.