An Introduction to Non-Performing Assets

This article was written by Bhavana Chandak, a student of Rajiv Gandhi National University of Law.

In the 21^st century there are magnitude of businesses and large scale organisations in operation. Every organisation has items which can be categorised as assets or liabilities. The term asset is defined as the entire property of a person, association, corporation, or estate applicable or subject to the payment of debts^[1] and liability on the other hand means any pecuniary obligation; it is the total opposite of an asset. The total of assets and liabilities form the components of a business in entirety.

The big corporation houses do not have the full capacity to fund the capital of the project being undertaken hence they seek financial assistance from the financial institutions like banks. It is a must that for positive results the assets have to be managed efficiently. In case where there is a lack in management of assets then it can be terms as Non-Performing Asset (NPA).

Just like illness and death is an inevitable part of the human life, bankruptcy and liquidation are a part of the business life of a legal entity.[2] The quantity of NPAs is on the rise in the current markets. But contrary to popular belief it is not a new concept it is just a new word coined for the old concept of ‘zero-yielding asset’. There were two committees who are credited for coining the term and the conditions when an asset can be declared as an NPA, i.e. The Narasimham Committee on Financial Sector Reforms in 1991 and in 1998, The Narasimham Committee on Banking Sector Reforms.

1. What Is A Non-Performing Asset?

An asset, including a leased asset, becomes non­-performing when it ceases to generate income for the bank.[3]A NPA is termed as a loan or an advance where-

1. There is interest or instalment or both overdue for more than 90 days in respect of a term loan,
2. The account remains ‘out of order’ with respect to an Overdraft or Cash Credit,

• A bill overdue for more than 90 days wherein the bill is purchased and discounted,

1. The instalment on principal or interest keeps overdue for crop season/s,

Further the banks, can categorise an account as NPA if the interest due and charged is not paid for within 90 days.

NPAs are classified into 3 types by the Reserve Bank of India on the basis of the time period for which the asset has turned a NPA as follows-

1. Sub­standard Assets- an asset which has remained as NPA for less than 12 months is termed as a Sub­standard Assets.
2. Doubtful Assets- any asset which remained in the first category i.e. as a substandard asset for time duration of 12 months is a Doubtful Asset.

• Loss Assets- When a loss has been recognised by the external auditor or internal auditor or the banks or on inspection by the RBI but the same has not been written off in totality then it is called a Loss Asset.[4]

2. Types of Non-Performing Asset

Gross NPA as the literal meaning suggests is the total of the loan assets that comes in the category of NPA as per the RBI on the date of making the Balance Sheet. It shows the real quantity and quality of the loans given. The ratio for calculating the same is- Gross NPAs Ratio = Gross NPAs /Gross Advances.

Net NPA on the other hand is the actual current burden which is being imposed on the banks. The general custom in India which prevails today is that the Balance Sheets have a heavy sum of NPA the recovery of which is time consuming. And the Central Bank has very strict guidelines about the same which have to be followed. The ratio to calculate the same is as follows- Net NPAs = Gross NPAs – Provisions on Gross Advances.

3. What Is The Need To Study NPA?

A NPA is nothing but a bad loan. The higher the amount of such bad loans the weaker will be the banking sector. In the short run the makes may be able to bear the losses by setting it off with the capital reserves or other assets but in the long run banks will not be able to sustain such huge amounts of losses.

If a NPA is generated in the market then it is no less than the vicious circle of poverty in real life. As quantity of NPA rises it will lead to the decrease in availability of funds leading to a low lending capacity. The shareholders will lose money invested in such institutions and backing out. Since there will be scarcity of funds i.e supply will decrease but on the other hand the demand will increase so to meet up with the increased demands there will be  arise in the interest rates of loans. The effect of such events will lead to a very slow growth rate in the economy. Ex- RBI Chairman Raghuram Rajan said a deep surgery is needed to clean up the existing mess. While the profitability of some banks may be impaired in the short-run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way, Rajan added.[5]

4. Solution

The Government had come up with two legislations to deal with the problem of bad loans. There legislations are in force with the guidelines issued by the Central Bank.

1. The Recovery of Debts Due to Banks and Financial Institutions Act, 1993
2. The Securitization Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002– The Act empowers Banks to recover their non-performing assets without any form of Court intervention under Section 34 of the said Act, through acquiring and disposing of the assets by means of sale, lease or any other technique. But this can only be done is an account has an outstanding um of Rs. 1 lakh or more. The banks have to first issue a notice under Section 13 of the Act, which the account holder needs to reply to. The bank may at its discretion even reject the reply given by the account holder.  The aim of this act was to give banks and financial institutions discretionary power to recover the bad loans without any procedural or governmental delays in paperwork and filing.

Recovery of Debts Due to Banks and Financial Institutions (DRT) Act– The DRT sets up two forums that is the Debt Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT) for speedy and prompt disposal of the case filed by either Banks / Financial Institutions for recovering their amount payable in the form NPA accounts with an outstanding amount of Rs. 10 lakh or more. Till date the government has managed to so far, establish 33 DRTs and 5 DRATs in the country.

The Supreme Court in a landmark judgement on Non Performing Asset outlining the scope and power of the banks ruled that, liquidity of finances and flow of money is essential for any healthy and growth oriented economy. But certainly, what must be kept in mind is that the law should not be in derogation of the rights which are guaranteed to the people under the Constitution. The procedure should also be fair, reasonable and valid, though it may vary looking to the different situations needed to be tackled and object sought to be achieved.[6]

[1] https://www.merriam-webster.com/dictionary/asset

[2] Godse, V.T. (1990), paper titled “Management of Non-Performing Assets”, p. 373

[3] https://rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=7357#21

[4] https://rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=7357

[5]http://www.firstpost.com/business/cure-for-bank-npa-problem-raghuram-rajan-prescribes-deep-surgery-2622826.html

[6] Mardia Chemicals Ltd. Etc. Etc vs U.O.I. & Ors.