Management Of NPA In India

Charchil Paghadar & Riya Shah

IIM Rohtak

What are NPAs?

Banks and financial institutions lend loans to individuals and firms, which are recorded in the assetside of the bank's balance sheet. If the interest or principal is not paid on the due date, it is considered installment overdue. A loan or advance for which the principal or interest payment remains overdue for more than 90 days is classified as NPA, or Non-Performing Asset.

History of NPAs

The origin of the Non-Performing Assets can be traced back to the mid-2000s, when the new millennial brought development, growth,and theboom in the economy. Corporations were grantedloans and the leverage ratio grew, leading to the reduction of their repayment capacity. This led tothe India's Twin Balance Sheet problem, where both the lender and the borrower were under financial stress.

Trends in India

The Gross NPAs of all banks for the 2020–21 fiscal year are estimated to be around Rs. 8.41 lakh crores. There has been a downward trend since the peak in 2017–18 when they rose to 10.37 lakh crores, with actual recoveries at Rs. 1.59 lakh crores in 2020–21. Despite a downward trend in loanrecovery, there has been a decreasein gross non-performingassets(NPAs).Thiscouldbecausedbythebankwrite-offs,whichtotaledaboutRs.2.2lakhcrores for the five-year period from 2016–17 to 2020–21, making up a large component of NPAs.

A significant portion of the overall Gross NPAs are attributable to public sector banks. Around 72% of the total NPAs in 2020–21 will come from public sector banks, with the remainder comingfrom private sector banks, foreign banks, and small financial institutions.

Comparison with othercountries

The Gross NPAs have hit a 6-year low of 5.9% as of March 2022. India also has one of the highestNPAs among countries with economies of a similar size, excluding Russia. Even China, Malaysia,and Indonesia, which are other South Asian economies, have a much lower NPA ratio as compared to India.

Reasons for NPA’s

• Economic/industrial slowdown

• Inaccurate Credit Evaluation and Lack of Diligence by Banks

• Natural calamities

• Changes in government regulations and policies

• Frauds and borrowers' moral degradation

• Inefficient management and political pressure

How to avoid NPAs

NPAs can be reduced through continuous monitoring of accounts and adapting sanctions. Qualitative appraisal of financial statements and accounts, understanding unhealthy developments in the working of the company and examining the viability of the project should be taken care of by deploying more efficient resources and technology. Banks must take haircuts and be recapitalized, and the Bankruptcy Code (IBC) has provided relief to lenders by giving priority to secured creditors.

Twin Balance Sheet Problem

The twin balance sheet problem is a situation where both the banking sector and the corporate sector of an economy have high levels of debt and non-performing assets (NPAs). This can lead to avicious cycle where the high levels of NPAs in thebanking sector weaken the banks' balance sheets,leading to a lack of credit availability for the corporate sector. The two balance sheets refer to the overleveraged infrastructure companies and a large

Preventive Measures

Governments and central banks around the world implemented a variety of measures to address the twin balance sheet problem, including bailouts for troubled banks, monetary easing, and fiscal stimulus. Monetary easing, which involves lowering interest rates andincreasingthesupplyof money,wasusedtostimulateeconomicactivity by making it cheaperfor businesses and householdsto borrow money and invest.

Fiscal stimulus, such as increasing government spending and/or cutting taxes, can help to stimulateeconomic activity by boosting consumer and business confidence and increasing demand for goodsand services. These measures helped to stabilize global economy and prevent full-blown depression, but the recovery from the Financial Crisis was slow and uneven, leading to slow growthand a lack of recovery for many people.

The twin balance sheet problem is a situation where both the banking and corporate sectors have high levels of debt and NPAs, leading to a vicious cycle of economic downturn. In India, most of these NPAs were present in Public Sector Banks, which hindered their ability to give out loans. During the Financial Crisis, measures were implemented to address the problem, but they were not successful in stabilizing the global economy.

Four-BalanceSheetproblem

The Four-Balance sheet problem is a recent phenomenon observed in India by Arvind Subramanian,a famous economist. It adds two sectors: Real Estate and NBFCs (Non-Banking Financial Companies)to the existing two sectors, Commercial banks and Infrastructure companies. This has caused a slowdown in consumer goods production and a decrease in non-oil tax exports and imports and government tax revenue. The proposed reasons for this are the stagnation of the growth rate of wages and inflation.

Apart from this, there was also a decline seen in private investment by companies due tofear ofundertaking risky projects and investments.

Hence, how did this Four-Balance sheet challenge come about?

The Four Balance Sheet problem is caused by the Twin Balance Sheet problem and the Global Financial Crisis, which caused a slowing down of investment and exports. This was caused by the collapse of the ILFS, which had around Rs. 90,000 crores worth of debtors. This lending was channeled toward real estate, and the repayment of these loans was dependent on the real estate inventories being sold off. After the crisis, the economy seemed to be getting back due to a large fiscal stimulus and the NBFC Credit boom.

To summarize, these were the core reasons which led to the Four Balance Sheets: Slowing down ofconsumption, credit crunch by banks, and eventually even NBFCs, slowing down of growth rate of wages, piling real estate inventory, and lower private investment.

IS-LM and Four Balance Sheet Problem

The main effect the high number of NPAs in a country has on the LM curve is that as the consumption is slow in the economy, the transitionary demand of money (k) is low. Due to these reasons, the LM curve is relatively flat as the slope (k/h) is a small number.

The economy is in a liquidity trap, where slow consumption rates affect companies and individuals,leading to more people to save and transact less. This leads to high interest rates in the economy, as banks are unwilling tolend and companies are over-leveraged and need short term loans to fulfilltheir interest payments.

Monetary policy

The monetary policy is ineffective in a liquidity trap, as the economy operates on a flat part of themoney demand curve. To reduce interest rates, the RBI aims to use the Interest Rate monetary transmission channel, but this channel is broken as banks do not pass this benefit to the public due to the fear of more NPAs. Even if the RBI reduces the CRR, it will still not make a difference due to the high number of NPAs.

Fiscal Policy

India's fiscal deficit was already 9% of the GDP in 2018-19, making it difficult to engage in more fiscal spending. However, encouraging and stimulating consumer spending is the only way to increase profits and increase factor income, which will help reduce NPAs.