BANKING LAW PROJECT

NON PERFORMING ASSETS:

REGULATION AND ROLE OF THE
RBI

SUBMITTED BY,
GOURI MEEMPAT
ROLL NO: 1279
SEMESTER VIII-B
 INTRODUCTION

The efficient flow and allocation of financial resources from the surplus units to the deficient
unit accelerates the economic development of a country. The financial intermediation is
imperative for the transfer of funds for development activities. A healthy financial sector is a
matter of policy concern in all countries (especially developing countries) where the failure of
financial intermediation can critically distort the development process. It is in this context that
the NPAs (Non-Performing Assets) gain importance as commercial banks are major constituents
in the financial service sector and NPAs poses a serious threat to the efficiency of the banking
sector in allocating funds for development purposes. Rapid increase in NPA during the last two
decades resulted in the collapse of many banking institutions across the world.

Optimization of asset performances is the most important part of overall asset management. If
the assets are not managed in an appropriate manner, they turn to a non-performing state. Such
assets are generally termed as “Non-Performing Assets”. In the field of bank, non-performing
assets include non-performing cash and bank balances, non-performing loans and advances,
interest on which is not realizable. 1

1
Bhagavat, T.K.K. (1990), paper titled “Management of Non-Performing Assets in Banks”, p. 351
 EMERGENCE OF NON- PERFORMING ASSETS

Non-performing assets were in existence from the olden times. Only, it was without a proper
coinage of the term. A nonperforming asset in the banking sector was termed as an asset not
contributing to the income of the bank. In other words it is a “zero-yielding asset”. The zero-
yielding assets include surplus cash and banker’s balance held over the norms, amount lying in
suspense account, investments in shares or debentures of companies not yielding any dividend or
interest, advances where interest is not realized and even the principal amount is difficult to
recover.2

In Indian banking sector also the concept of NPA is not new. In olden days the assets were
classified into eight categories as follows:

a) Satisfactory

b) Irregular

c) Sick-viable under nursing

d) Sick-non-viable/sticky

e) Advances recalled

f) Suit filed accounts

g) Decreed debts

h) Debts classified by the banks as bad/doubtful

Even though out of the above eight, four were deemed as nonperforming assets; the discretion to
classify were left to each bank and there was no objective attempt to segregate bad-loans from
good loans.

The transition from pre-liberalization period to post-liberalization period is characterized with a

deviation from regulated to deregulated banking, not only in India but as well in various other
transition economies including Turkey , Malaysia etc. To mitigate the challenges of new world

2
Ibid, p. 413
order and to improve the banking sector, many reformative measures have been introduced in
Indian banking sector since 1991.

In the year 1991, The Narasimham Committee on Financial Sector Reforms (CFSR) and in the
year 1998, The Narasimham Committee on Banking Sector Reforms (CBSR) focused on this
zero- yielding assets. The committee created various norms for the zero yielding assets and the
new term “Non-Performing Assets” was coined by the committee. The term non-performing
assets can now be defined both in the wider and the narrow sense. While in the narrower sense, it
includes only non-earning credit portfolio, in the wider sense it may include also the volume of
unutilized cash balances and unutilized or underutilized physical assets like building and
premises. In the wider sense it may also include non-performing human resources-a large volume
of work force not effectively utilized. However, The Narasimham Committee, 1991 made it
mandatory on the part of the banks to publish annually the magnitude of NPAs and according to
them, NPAs are those categories of assets (advances, bills discounted, overdraft, cash credits
etc…….) for which any amount remains due for a period of 180 days.

DEFINING NON-PERFORMING ASSETS

The term “Non-Performing Assets” has been defined in the SARFAESI Act, 2002 and RBI
Guidelines.

1. SARFAESI Act, 2002 section 2(o) defines NPA as “an asset or account of a borrower,
which has been classified by a bank or financial institution as sub-standard, doubtful or
loss asset”
2. In RBI Circular dated August 30, 2001 on Prudential Norms on Income recognition
section 2.1 says that “An asset, including a leased asset, becomes non-performing when it
ceases to generate income for the bank.”

An NPA is a loan or an advance where:

 Interest and/or installment of principal remains overdue for a period of more than
90 days in respect of a term loan.
  The account remains "out-of-order'' in respect of an Overdraft or Cash Credit
(OD/CC). The bill remains overdue for a period of more than 90 days in case of
bills purchased and discounted.
 A loan granted for short duration crops will be treated as an NPA if the
installments of principal or interest thereon remain overdue for two crop seasons.
 A loan granted for long duration crops will be treated as an NPA if the
installments of principal or interest thereon remain overdue for one crop season.

The Bank classifies an account as an NPA only if the interest imposed during any quarter is not
fully repaid within 90 days from the end of the relevant quarter.

In fact, recovery management is also linked to the banks‟ interest margins. The cost and
recovery management supported by enabling legal framework hold the key to future health and
competitiveness of the banks. No doubt, improving recovery- management in India is an area
requiring expeditious and effective actions in legal, institutional and judicial processes.

CLASSIFICATION OF NPAs

For the evaluation of bank performance, it is important to identify the quality of assets of the
bank. In the light of Narasimham Committee recommendations, the Reserve Bank of India has
redefined the non-performing assets and advised all commercial banks in public sector, old and
new private sector banks, development banks and the co- operative banks, to classify their
advances into four broad categories i.e. Standard, Sub- standard, Doubtful and Loss assets. The
standard assets are treated as performing assets and the remaining three categories are treated as
non-performing assets.

With reference to master circular No. DBOD. No. BP. BC. 17/21.04.048/2009-10 dated July 1,
2009 banks are required to classify nonperforming assets further into the following three
categories based on the period for which the asset has remained nonperforming and the
realizability of the dues:
1. Substandard Assets: With effect from 31 March 2005, a substandard asset would be one,
which has remained NPA for a period less than or equal to 12 months. In such cases, the current
net worth of the borrower/ guarantor or the current market value of the security charged is not
enough to ensure recovery of the dues to the banks in full. In other words, such an asset will have
well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized
by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

2. Doubtful Assets: With effect from March 31, 2005, an asset would be classified as doubtful if
it has remained in the substandard category for a period of 12 months. A loan classified as
doubtful has all the weaknesses inherent in assets that were classified as sub standard, with the
added characteristic that the weaknesses make collection or liquidation in full, – on the basis of
currently known facts, conditions and values – 12 highly questionable and improbable.

3. Loss Assets: A loss asset is one where loss has been identified by the bank or internal or
external auditors or the RBI inspection but the amount has not been written off wholly. In other
words, such an 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.

The alarming situation of non-performing assets is an issue of concern not only to the bank
management but also to the authorities regulating the working of the banks and to the policy
makers at the national level.3 Realities cannot be escaped. it is necessary to face them. In the
context of NPA’s, the situation is no different.4 It has been observed that the nonperforming
assets in public sector banks are higher than that of private sector banks and foreign banks
working in India.

RULES AND REGULATIONS ON NPA

The government has by various measures tried to curb the rising NPAs over time. The RBI has
also introduced various norms and regulations via circulars. The RBI has under Banking

3
Ibid, p. 351
4
Godse, V.T. (1990), paper titled “Management of Non-Performing Assets”, p. 373
Regulation Act, 19495 and the Reserve Bank of India Act, 1934 powers to make directions and
regulations from time to time on NPAs. According to the new rule, under the 'Prudential
framework for resolution of stressed assets; released by the RBI on June 7, 2019 lenders will
have complete discretion to design, implement resolution plan.

* Banks may start resolution, IBC process within 30 days of default.

* Once a borrower is reported to be in default by any lenders, they may review of the borrower
account within 30 days from the day of default.

* Lenders should follow a board-approved policy for resolution of bad loans.

* Mandatory to sign inter-creditor agreement (ICA) by all lenders, which will provide for a
majority decision making criteria.

* RBI changed its earlier norm of 100 percent approval from creditors. ICA shall now provide
any decision agreed by lenders representing 75 percent by value of total outstanding credit
facilities and 60 percent of lenders by number shall be binding upon all the lenders.

*Lenders must resolve over Rs 2000 crore NPA account within 180 days.

* Higher provisioning for delay in resolution. Lenders will have to make 35 percent provisions

first 20 percent for 180 days and then an additional 15 percent if no resolution is found within
365 days.

* The joint lenders' forum (JLF) as mandatory institutional mechanism for resolution also stands
discontinued.

5
Section 35AA, Banking Regulation Act, 1949
* The accounts would be classified according to this time table:

Basis for classification –

Principal or interest
SMA Sub-categories payment or any other
amount wholly or partly
overdue between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

In the case of revolving credit facilities like cash credit, the SMA sub-categories will be as
follows:

Basis for classification –

Outstanding balance
remains continuously in
SMA Sub-categories excess of the sanctioned
limit or drawing power,
whichever is lower, for a
period of:

   

SMA-1 31-60 days

SMA-2 61-90 days

* In addition, the lenders shall submit a weekly report of instances of default by all borrowers
(with aggregate exposure of Rs 50 million and above) by close of business on every Friday, or
the preceding working day if Friday happens to be a holiday," RBI said in its circular.
* For borrowers with exposure between Rs 1,500 crore and Rs 2,000 crore, the new norms will
be applicable from January 1, 2020, while for loans up to Rs 1,500 crore will be announced in
due course.

* RBI also warned that any action by lenders to conceal the actual status of accounts or ever
greening the stressed accounts, will be subjected to stringent supervisory/enforcement actions.

REASONS FOR GROWING NPAS

The banking sector all over the world is facing the problem of mounting NPAs. The rate of
growth of NPAs is such a high that it has become the matter of concern for the bankers. The
bankers are investigating the reasons for such high growth rate of NPAs. Following are some of
the reasons for the high growth rate of NPAs.

(a) Inability and unwillingness of the borrower to pay: Sometimes the borrower takes the loan
from the bank in a large amount but they are unable to repay the same or sometimes they are
unwilling to repay the amount. Such amount is not realized back by the bank and as a result the
NPA is created. Sometimes willful defaults, frauds and misappropriations of accounts by the
borrowers also results in NPA.

(b) Mismanagement and diversion of funds: Because of the mismanagement of the fund or
because of diversion of the investment, the fund is invested in low interest securities or the
securities that dont pay any interest. Such kind of investment creates the NPA.

(c) Failure of the activity: When the borrower has taken the loan for any specific business
activity and that very activity fails, the borrower is unable to repay the loan. This creates NPA in
the bank.

(d) Recessionary market trend: Because of the effect of economic cycles, the profits of the
firm decreases. In the situation of recession, the firm is not able to generate enough revenue and
it is unable to repay the borrowed fund. When the recession becomes very stiff, it results into the
bankruptcy of the firms, which results into NPAs for the banks. Recently such situation was
faced in America when the Lehman Bros. filed the bankruptcy; it created NPA in several banks
over there from which the Lehman Bros. had taken the loan.

(e) Improper selection of borrowers/activities: Sometimes the banker makes the mistake in the
selection of borrower or the business activity. When the less creditworthy borrower is selected
by the bank, the amount given as a loan does not realize back and the NPA results.

(f) Selection of borrower under influence: For the banks RBI has issued guidelines for
sanctioning the loans. Banks have to compulsorily follow these guidelines but sometimes the
banks have to act under the political pressure and relativism. The banks sanction the loans to
such less creditworthy borrowers. The amounts of such loans are not recovered and consequently
the NPA is created. Generally such cases happen more in co- operative banks.

(g) Lack of proper pre-appraisal and follow-up: According to RBI guidelines, the banks must
appraise the project report before sanctioning the loan to any borrower. But sometimes the banks
do not perform proper appraisal of the project reports. Without such pre-appraisal, the loan is
sanctioned. In addition to it, proper follow-up is also not taken by the bank. In such situation the
bank does not get the installments regularly and sometimes such loan is converted into NPA.

(h) Non-compliance of sanction terms and conditions: The banks must follow the terms and
conditions provided by the RBI for sanctioning the loan. In some cases, the banks do not comply
with this terms and conditions and they sanction the loan. In such cases, there are chances of
NPAs.

(i) Inadequate/excess sanction of the loan: While sanctioning the loan, the bank must consider
the economic size of the unit to which the loan is to be sanctioned. In some cases, bank does not
consider the economic size of the unit and sanction the loan. If the amount sanctioned is
inadequate for the business, the business will face the financial crunch and it will not survive for
longer. It will result into NPAs for the bank. On the other hand if the excessive amount is
sanctioned as a loan to the smaller unit, it will not be able to utilize the fund effectively. It will
not be able to generate enough cash flow to repay the amount of loan and ultimately it will result
into NPAs.

CONCLUSION
The Non-Performing Assets have always created a big problem for the banks in India. It is just
not only problem for the banks but for the economy too. The money locked up in NPAs has a
direct impact on profitability of the bank as Indian banks are highly dependent on income from
interest on funds lent. Although various steps have been taken by government to reduce the
NPAs but still a lot needs to be done to curb this problem. The NPAs level of our banks is still
high as compared to the foreign banks. It is not at all possible to have zero NPAs. The bank
management should speed up the recovery process. The government should also make more
provisions for faster settlement of pending cases and also it should reduce the mandatory lending
to priority sector as this is the major problem creating area.