SUBJECT: BANKING law

Project topic: NON PERFORMING ASSETS

MANAGEMENT

Submitted By
ABHIJYOT SAHAY
Roll no. 1103
4 Year , 8 Semester, B.A.LL.B(Hons.)
th

Submitted to
DR. AJAY KUMAR
Faculty of BANKING Law

Chanakya national Law University, Patna

APRIL, 2018
 CERTIFICATE

THIS IS TO CERTIFY THAT ABHIJYOT SAHAY, ROLL NO.1103, 4th

YEAR, SESSION 2014-2019 WAS DEPUTED TO MAKE THIS PROJECT
ON POWERSOF NCLT. HE HAS DONE THIS WORK UNDER MY
SUPERVISION AND GUIDANCE. HIS WORK IS GOOD AS HE
WORKED WITH FULL DEVOTION.

SO, I HEREBY RECOMMENED THIS PROJECT TO BE ACCCEPTED

AND EVALUATED.

DATE:

Teacher’s name

DR. AJAY KUMAR

FACULTY OF

BANKING LAW

C.N.L.U
 ACKNOWLEDGEMENT

Writing a project is one of the most significant academic challenges i have

ever faced. Though this project has been presented by us but there are many
people who remained in veil, who gave their all support and helped us to
complete this project.
First of all we are very grateful to our subject teacher
Dr. AJAY KUMAR without the kind support of whom and help the
completion of the project was a herculean task for us. He donated her
valuable time from her busy schedule to help me to complete this project and
suggested us from where and how to collect data.
We are very thankful to the librarian who provided us several books on this
topic which proved beneficial in completing this project.
We acknowledge our friends who gave their valuable and meticulous advice
which was very useful and could not be ignored in writing the project.

ABHIJYOT SAHAY

3|Page
 TABLE OF CONTENT

• AIMS AND OBJECTIVES

• HYPOTHESIS
• RESEARCH METHODOLOGY

CHAPTERISATION
PAGE

1) INTRODUCTION: MEANING OF NPA 06- 10

2) TYPES OF NPA 11- 14

3) TOOLS FOR RECOVERING NPAs 15-20

4) NEW LEGISLATIONS TO CONTROL NPAs 20- 27

5) FINDINGS & RECOMMENDATION CAUSES OF

NPA’S IN BANKS 28- 32

6) CONCLUSION AND SUGGESTIONS 33- 35

-BIBLIOGRAPHY 36

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Aims and Objectives

The objectives behind this project are:

 To understand the meaning & nature of NPAs.

 To analyze the NPA and its relation with operating profit of the bank.

 To study the general reasons for assets become NPAs.

 To study the recent development’s to prevent NPAs.

Hypothesis
The Researcher hypothesis are:
 The researcher hypothesized that the NPA has its direct impact on Bank profitability.
 The Central govt. have taken many steps like passing of Insolvency and bankruptcy code
to manage NPAs.

Research Methodology
The researcher aims to research with ‘Doctrinal Method’ by referring to books, journals, articles,
Bare acts, documentary, cases prevalent and the online sources as Research Paper.

5|Page
 CHAPTER- I
INTRODUCTION: MEANING OF NPA

A strong banking sector is important for flourishing economy. One of the most important and
major roles played by banking sector is that of lending business. It is generally encouraged because
it has the effect of funds being transferred from the system to productive purposes, which also
results into economic growth. As there are pros and cons of everything, the same is with lending
business that carries credit risk, which arises from the failure of borrower to fulfill its contractual
obligations either during the course of transaction or on a future obligation. The failure of the
banking sector may have an adverse impact on other sectors1.

The banking industry has undergone a sea change after the first phase of economic liberalization
in 1991 and hence credit management. While the primary function of banks is to lend funds as
loans to various sectors such as agriculture, industry, personal loans, housing loans etc., in recent
times the banks have become very cautious in extending loans. The reason being mounting non-
performing assets (NPAs). An NPA is defined as a loan asset, which has ceased to generatemany
income for a bank whether in the form of interest or principal repayment. As per the prudential
norms suggested by the Reserve Bank of India (RBI), a bank cannot book interest on an NPA on
accrual basis. In other words, such interests can be booked only when it has been actually received.
Therefore, this has become what is called as a ‘critical performance area’ of the banking sector as
the level of NPAs affects the profitability of a bank2.
1. A NPA is a loan or an advance where;
2. Interest and/ or installment of principal remain overdue for a period of more than 90 days in
respect of a term loan,
3. The account remains “out of order” in respect of an overdraft/ cash credit
4. The bill remains overdue for a period of more than 90 days in the case of bills purchased and
discounted.
5. The installment or interest remains overdue for two crop seasons in case of short duration crops
and for one crop season in case of long duration crops.

1
www.ibmrdjournal.com/index.php/ibmrd/article/
2
ibid

6|Page
IMPACT OF NPAS IN BANKS PROFITABILITY
An NPA account not only reduces profitability of banks by provisioning in the profit and loss
account, but their carrying cost is also increased which results in excess & avoidable management
attention. Apart from this, a high level of NPA also puts strain on a bank’s net worth because banks
are under pressure to maintain a desired level of Capital Adequacy and in the absence of
comfortable profit level, banks eventually look towards their internal financial strength to fulfill
the norms thereby slowly eroding the net worth.
Today the Net NPAs of Indian PSBs (which account for around three-fourths of the total assets of
Indian banking industry) are as low as 0.72 percent and gross NPAs are at 2.5 percent.
However, once there is a slowdown in private expenditure and corporate earnings growth,
companies on these banks’ books will not be in a position to service their debts on time and there
is a strong likelihood of generation of new NPAs3.
Moreover, he also suggests that with rising interest rates in the government bond market, the
banks’ treasury incomes have declined considerably. So banks will not have enough profits to
make provisions for NPAs4.

Non- performing assets are one of the major concerns for banks in India. NPAs reflect the
performance of banks. A high level of NPAs suggests high probability of a large number of credit
defaults that affect the profitability and net-worth of banks and also erodes the value of the asset.
The NPA growth involves the necessity of provisions, which reduces the overall profits and
shareholders value. The issue of Non-Performing Assets has been discussed at length for financial
system all over the world. The problem of NPAs is not only affecting the banks but also the whole
economy. In fact high level of NPAs in Indian banks is nothing but a reflection of the state of
health of the industry and trade. This project deals with understanding the concept of NPAs, its
magnitude and major causes for an account becoming non-performing, projection of NPAs over
next years in banks and concluding remarks.5

The magnitude of NPAs have a direct impact on Banks profitability legally they are not allowed
to book income on such accounts and at the same time banks are forced to make provisions on

3
https://www.sesameindia.com/npa-management-solutions
4
ibid
5
http://www.mospi.gov.in/109-balance-payments

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such assets as per RBI guidelines The RBI has advised all State Co-operative Banks as well as the
Central Co-operative Banks in the country to adopt prudential norms from the year ending 31-03-
1997. These have been amended a number of times since 19976. As per their guidelines the
meaning of NPAs, the norms regarding assets classification and provisioning Its now very known
that the banks and financial institutions in India face the problem of amplification of non-
performing assets (NPAs) and the issue is becoming more and more unmanageable. In order to
bring the situation under control, various steps have been taken. Among all other steps most
important one was the introduction of Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 by Parliament, which was an important step towards
elimination or reduction of NPAs7.

An asset is classified as non-performing asset (NPAs) if dues in the form of principal and interest
are not paid by the borrower for a period of 180 days, However with effect from March 2004,
default status would be given to a borrower if dues are not paid for 90 days. If any advance or
credit facility granted by bank to a borrower becomes non-performing, then the bank will have to
treat all the advances/credit facilities granted to that borrower as non-performing without having
any regard to the fact that there may still exist certain advances / credit facilities having performing
status.

The NPA level of our banks is way high than international standards. One cannot ignore the
fact that a part of the reduction in NPA’s is due to the writing off bad loans by banks. Indian banks
should take care to ensure that they give loans to credit worthy customers. In this context the
dictum “prevention is always better than cure” acts as the golden rule to reduce NPA’s.

Non Performing assets (NPA) - Concept

Non Performing Asset means an asset or account of borrower, which has been classified by a bank
or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or
guidelines relating to asset classification issued by The Reserve Bank of India. An asset, including
a leased asset, becomes nonperforming when it ceases to generate income for the bank. A NPA is
a loan or an advance where Interest and/ or installment of principal remain overdue for a period of

6
https://rbidocs.rbi.org.in/rdocs/publicationreport/pdfs/77577.pdf
7
https://rbidocs.rbi.org.in/rdocs/publicationreport/pdfs/77577.pdf

8|Page
more than 90 days in respect of a term loan. Earlier assets were declared as NPA after completion
of the period for the payment of total amount of loan and 30 days grace. In present scenario assets
are declared as NPA if none of the installment is paid till 180 days i.e six months in respect of term
loan. With effect from march, 30, 2004, a non performing asset (NPA) shall be a loan or an advance
where: Interest and/or installments of principal remain overdue for a period of more than 90 days
in respect of a term loan, The account remains ‘out of order’ for a period of more than 90 days, in
respect of an overdraft/cash credit(od/cd). The bill remains overdue for a period of more than 90
days in the case of bills purchased and discounted, interest and or installments of principal remains
overdue for two harvest seasons but for a period not exceeding two half years in the case of advance
granted for agricultural purpose, and any amount to be received remains overdue for a period of
more than 90 days in respect of other accounts8.

RBI introduced, in 1992, the prudential norms for income recognition, asset classi-
fication & provisioning – IRAC norms in short – in respect of the loan portfolio of the Co opera-
tive Banks. The objective was to bring out the true picture of a bank’s loan portfolio. The fallout
of this momentous regulatory measure for the management of the CBs was to divert its focus to
profitability, which till then used to be a low priority area for it. Asset quality assumed greater
importance for the CBs when Maintenance of high quality credit portfolio continues to be a ma-
jor challenge for the CBs, especially with RBI gradually moving towards convergence with more
stringent global norms for impaired assets.The quality of a bank’s loan portfolio can impact

its profitability, capital and liquidity. Asset quality problems are at the root of other financial
problems for banks, leading to reduced net interest income and higher provisioning costs. If loan
losses exceed the Bad and Doubtful Debt Reserve, capital strength is reduced. Reduced income
means less cash, which can potentially strain liquidity. Market knowledge that the bank is having
asset quality problems and associated financial conditions may cause outflow of deposits. Thus,
the performance of a bank is inextricably linked with its asset quality . Managing the loan portfo-
lio to minimise bad loans is, therefore, fundamentally important for a financial institution in to-
day’s extremely competitive and market driven business environment. This is all the more im-

8
http://rbi.org.in/scripts/PublicationReportDetails.aspx?ID=377

9|Page
portant for the CBs, which are at a disadvantage of the commercial banks in terms of profession-
alised management, skill levels, technology adoption and effective risk management systems and
procedures. Management of NPAs begins with the consciousness of a good portfolio, which war-
rants a better understanding of risks in lending. The Board has to decide a strategy keeping in view
the regulatory norms, the business environment, its market share, the risk profile, the availa-ble
resources etc. The strategy should be reflected in Board approved policies and procedures to
monitor implementation. The essential components of sound NPA management are

i) quick identification of NPAs,

ii) their containment at a minimum level,

iii) ensuring minimum impact of NPAs on the financials.

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 CHAPTER II

TYPES OF NPA

The RBI has issued the guidelines to banks for classification of assets in to following categories.

1. Standard assets:- Standard Asset is one which does not disclose any problems and which does
not carry more than normal risk attached to the business/banks. These are loans which do not have
any problem are less risk. Such an asset is not a non-performing asset. In other words, it carries
not more than normal risk attached to the business.

2. Sub Standard Assets:-

(i) It is classified as non-performing for a period not exceeding 12 months. The account holder
comes in this category when they don’t pay three installment continuously after 90 days
and upto 1 year. For this category bank has made 10% provision of funds from their profit to
meet the losses generated from NPA. With effect from March 31, 2005 an asset would be
classified as sub-standard if it remained NPA for a period less than or equal to 12 months. In such
cases, the current net worth of the borrowers/ guarantors 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
assets will have well defined credit weaknesses that jeopardies the liquidation of the debt and are
characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are
not corrected9.

(ii) An asset where the terms of the loan agreement regarding interest and principal have been re-
negotiated or rescheduled after commencement of production, should be classified as sub-standard
and should remain in such category for at least 12 months of satisfactory performance under the
re-negotiated or rescheduled terms. In other words, the classification of an asset should not be
upgraded merely as a result of rescheduling, unless there is satisfactory compliance of this
condition.

9
iibf.org.in/documents/caiib_gbm_moda_partII.ppt

11 | P a g e
3. Doubtful NPA: An asset that has remained an NPA for a period exceeding 12 months is a
doubtful asset. These are NPA exceeding 12 months.
Under doubtful NPA there are three sub categories:

With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has remained
NPA for more than 12 months. The 12-month period of classification of a substandard asset in
doubtful category is effective from April 1, 2009. A loan classified as doubtful has all the
weaknesses inherent as that 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, highly questionable and improbable.

4. Loss Assets:- A loss asset is one where loss has been identified by the bank or internal or
external auditors or by the Co-operation Department or by the Reserve Bank of India inspection
but the amount has not been written off, wholly or partly. In other words, such an asset is
considered un-collectible and of such little value that its continuance as a bankable asset is not
warranted although there may be some salvage or recovery value. Here loss is identified by the
banks concerned, by internal auditors, by external auditors, or by the Reserve Bank India upon
inspection. These NPA which are identified unreliable by internal inspector of bank or auditors or
by RBI. Under this 100% provision is made10.

Effects of NPA on Bank:

1. Restriction on flow of cash done by bank due to the provisions of fund made against
NPA.

2. Drain of profit.

3. Bad effect on Goodwill.

4. Bad effect on equity value.

10
www.tradingeconomics.com/india/gdp-per-capita-ppp
12 | P a g e
Difficulties with the non-performing assets:

1. Owners do not receive a market return on their capital. In the worst case, if the bank fails, owners
lose their assets. In modern times, this may affect a broad pool of shareholders.

2. Depositors do not receive a market return on savings. In the worst case if the bank fails,
depositors lose their assets or uninsured balance. Banks also redistribute losses to other borrowers
by charging higher interest rates. Lower deposit rates and higher lending rates repress savings and
financial markets, which hampers economic growth11.

3. Non- performing loans epitomize bad investment. They misallocate credit from good projects,
which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital
and, by extension, labour and natural resources. The economy performs below its production
potential.

4. Non- performing loans may spill over the banking system and contract the money stock, which
may lead to economic contraction. This spillover effect can channelize through illiquidity or bank
insolvency;

(a) When many borrowers fail to pay interest, banks may experience liquidity shortages. These
shortages can jam payments across the country,

(b) Illiquidity constraints bank in paying depositors e.g. cashing their paychecks. Banking
panic follows. A run on banks by depositors as part of the national money stock become
inoperative. The money stock contracts and economic contraction follows undercapitalized
banks exceeds the bank’s capital base.

Lending by banks has been highly politicized. It is common

knowledge that loans are given to various industrial houses not on commercial
considerations and viability of project but on political considerations; some politician
would ask the bank to extend the loan to a particular corporate and the bank would oblige.
In normal circumstances banks, before extending any loan, would make a thorough study
of the actual need of the party concerned, the prospects of the business in which it is

11
www.bis.org/review/r061221d.pdf

13 | P a g e
 engaged, its track record, the quality of management and so on. Since this is not looked
into, many of the loans become NPAs. The loans for the weaker sections of the society and
the waiving of the loans to farmers are another dimension of the politicization of bank
lending12.

Parameters which were selected for “Reasons of NPAs” are as follows:

• Market Failure

• Willful Defaults

• Poor follow-up and Supervision

• Non-cooperation from Banks

• Poor Legal framework

• Lack of Entrepreneurial Skills

• Diversion of funds

12
"ECB limit raised for infrastructure NBFCs". The Hindu

14 | P a g e
 CHAPTER III
TOOLS FOR RECOVERING NPAs

1. Lok Adalats

Lok Adalats is a mechanism to settle matters relating to recovery of dues, out of court. These are
convened by Debt Recovery Tribunals / Debt Recovery Appellate Tribunals. Lok Adalats have no
judicial powers. It is a mutual forum for the bank and the borrower to meet and arrive at a mutual
settlement. Once the settlement is signed by both the parties, the same is placed before the court.
The court would then pass a suitable decrees / orders as per the terms of settlement. Such decrees
cannot be challenged in the next higher courts. At present, accounts in category with outstanding
above Rs. 5.00 lacs can be referred to this forum. Lok Adalats Proved to be quite effective for
speedy justice and recovery of small loans13.

• To settle disputes involving account in “doubtful” and “loss” category.

• Outstanding balance of Rs. 5 lacs for compromise settlement.

• Proved to be quite effective for speedy justice and recovery of small loans.

2. Debt Recovery Tribunals (DRT)

Keeping in line with the international trends on helping financial institutions recover their bad
debts quickly and efficiently, the Government of India has constituted thirty three Debts Recovery
Tribunals and five Debts Recovery Appellate Tribunals across the country.

The Debts Recovery Tribunal (DRT) enforces provisions of the Recovery of Debts Due to Banks
and Financial Institutions (RDDBFI) Act, 1993 and also Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002.

Under the Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993 banks
approach the Debts Recovery Tribunal (DRT) whereas, under Securitization and Reconstruction
of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 borrowers,

13
https://www.livemint.com › Industry › Financial Services

15 | P a g e
guarantors, and other any other person aggrieved by any action of the bank can approach the Debts
Recovery Tribunal (DRT)14.

Debts Recovery Tribunal are located across the country. Some cities have more than one Debts
Recovery Tribunals. New Delhi, Chennai, Kolkata and Mumbai have three Debts Recovery
Tribunals. Ahmedabad and Chandigarh have two Debts Recovery Tribunal (DRT) each. One
Debts Recovery Tribunal has been constituted at Allahabad, Aurangabad, Bangalore, Coimbatore,
Cuttack, Earnakulam, Guwahati, Hyderabad, Jabalpur, Jaipur, Lucknow, Madurai,Nagpur, Patna,
Pune, Vishakapatnam and Ranchi.

• To recover bad debt quickly and efficiently.

• DRT has powers to grant injunctions against the disposal, transfer or creation of third party
interest by debtors in the properties charged to creditor and to pass attachment orders in respect of
charged properties

• In case of non-realization of the decreed amount by way of sale of the charged properties, the
personal properties if the guarantors can also be attached and sold.

• It is the special court established by Central Government for the purpose of bank or any financial
institutions recovery.

• The judges of the court are the retired judges of high court15.

3. SARFAESI act, 2002

The full form of SARFAESI Act as we know is Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002. Banks utilize this act as an effective tool
for bad loans (NPA) recovery. It is possible where non-performing assets are backed by securities
charged to the Bank by way of hypothecation or mortgage or assignment16.

SARFAESI is effective only for secured loans where bank can enforce the underlying security eg
hypothecation, pledge and mortgages. In such cases, court intervention is not necessary, unless the

14
ibid
15
ibid
16
https://www.researchgate.net/

16 | P a g e
security is invalid or fraudulent. However, if the asset in question is an unsecured asset, the bank
would have to move the court to file civil case against the defaulters17.

• The Act provides three alternative methods for recovery of non-performing assets, namely

Securitization

o Asset reconstruction

o Enforcement of security without the intervention of the court.

• NPA loans with outstanding above Rs. 1. Lac.

• NPA loan accounts where the amount is less than 20% of the principal and the interest are not
eligible to be dealt with this act.

This act empowers the bank:

• To issue demand notice to the defaulting borrower and guarantor, calling upon them to discharge
their dues in full within 60 days from the day of the notice.

• To give notice to any person who has acquired any of the secured assets from the borrower to
surrender the same to the bank.

• To ask the debtor of the borrower to pay any sum due or becoming due the borrower.

• Any security interest created over agricultural land cannot be proceeded with18.

4. ASSET RECOVERY CONSTRUCTION INDUSTRY LIMITED(ARCIL)

The word asset reconstruction company is a typical used in India. Globally the equivalent phrase
used is " asset management companies". The word "asset reconstruction" in India were used in
Narsimham I report where it was envisaged for the setting up of a central Asset Reconstruction
Fund with money contributed by the Central Government, which was to be used by banks to shore
up their balance sheets to clean up their non-performing loans19.

17
ibid
18
ibid
19
bankingscenario.in/reduction-technique-of-npas-management/

17 | P a g e
ARCIL

A company which is set up with the objective of taking over distressed assets (NPA) from banks
or financial institutions and to reconstruct or re- pack these assets to make those assets saleable.

To buy out troubled loans from banks and make special efforts at recovering value from the assets,
if necessary by special legislation, with special powers for recovery.

Restructuring of weak banks to divest the bad loan portfolio20.

India’s first ARC with an initial equity of Rs.10 crore with State Bank of India, IDBI and SBI to
pick up 24.5% stake each(and remaining to be acquired by HDFC and UTI Bank).

Incorporated as a public limited company

Unlocking capital for the banking system and the economy

Creating a vibrant market for distressed debt assets /securities in India offering a trading platform
for Lenders.

To evolve and create significant capacity in the system for quicker resolution of NPAs by
deploying the assets optimally

However, this never saw the light of the day and later on Narsimham II floated the idea asset
reconstruction companies..

Why ARC21 :

In last 15 years or so the number of economies around the world have witnessed the problem of
non-performing assets. A high level of NPAs in the banking system can severely affect the
economy in many ways. The high level of NPAs leads to diversion of banking resources towards
resolution of this problems. This causes an opportunity loss for more productive use of resources.
The banks tend to become risk averse in making new loans, particularly to small and medium sized
companies. Thus, large scale NPAs when left unattended, cause continued economic and financial
degradation of the country. The realization of these problems has led to greater attention to resolve
the NPAs. ARCs have been used world-wide, particularly in Asia, to resolve bad-loan problems.

20
ibid
21
www.arcil.co.in/

18 | P a g e
However, these had a varying degree of success in different countries. ARCs focus on NPAs and
allows the banking system to act as "clean bank". A company which is set up with the objective of
taking over distressed assets from banks or financial institutions and to reconstruct or re-pack these
assets to make those assets saleable.

• To buy out troubled loan from banks and make special efforts at recovering value from the assets,
if necessary by special legislation, with special powers for recovery.

• Restructuring of weak banks to divest the bad loan portfolio22.

ARC in India :

In India the problem of recovery from NPAs was recognized in 1997 by Government of India.
The Narasimhan Committee Report mentioned that an important aspect of the continuing reform
process was to reduce the high level of NPAs as a means of banking sector reform. It was expected
that with a combination of policy and institutional development, new NPAs in future could be
lower. However, the huge backlog of existing NPAs continued to hound the banking sector. It
impinged severely on banks performance and their profitability. The Report envisaged creation of
an "Asset Recovery Fund" to take the NPAs off the lender's books at a discount23.

Accordingly, Asset Reconstruction Company (Securitization Company / Reconstruction

Company) is a company registered under Section 3 of the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest (SRFAESI) Act, 2002. It is regulated by
Reserve Bank of India as an Non-Banking Financial Company ( u/s 45I ( f ) (iii) of RBI Act, 1934).

RBI has exempted ARCs from the compliances under section 45-IA, 45-IB and 45-IC of the
Reserve Bank Act, 1934. ARC functions like an AMC within the guidelines issued by RBI.

ARC has been set up to provide a focused approach to Non-Performing Loans resolution issue by:-

(a) Isolating Non Performing Loans (NPLs) from the Financial System (FS),

(b) Freeing the financial system to focus on their core activities and

22
www.arcil.co.in/
23
Banks can sell secured assets of defaulters: SC". The Economic Times. 8 April 2004.

19 | P a g e
(c) Facilitating development of market for distressed assets24.

5. CORPORATE DEBT RESTRUCTURING (CDR)

Corporate debt restructuring is the reorganization of a company's outstanding obligations, often

achieved by reducing the burden of the debts on the company by decreasing the rates paid and inc
Objective was to ensure timely and transparent mechanism for restructuring of the corporate debts

- CDR mechanism will be a voluntary system based on debtor creditor agreement and inter-creditor
agreement.

- CDR mechanism will cover only multiple banking accounts /syndication / consortium accounts.

- An outstanding exposure of Rs.20 crore and above by banks and institutions. Easing the time the
company has to pay the obligation back.

6. ASSET MANAGEMENT COMPANY(AMC)

An asset management company (AMC) is a company that invests its clients' pooled funds into
securities that match declared financial objectives. Asset management companies provide
investors with more diversification and investing options than they would have by themselves25.

24
Banks can sell secured assets of defaulters: SC". The Economic Times. 8 April 2004.
25
ibid

20 | P a g e
 CHAPTER IV
NEW LEGISLATIONS TO CONTROL NPAs
Insolvency and Bankruptcy Code, 2016

A lot of hope is pinned on the Insolvency and Bankruptcy Code (IBC) to provide the much-needed
cure to all the ills in the banking system.

Year 2017 was eventful when it came to taking the initial steps in loan recovery. The Reserve
Bank of India’s first list of 12 large defaulters — who in aggregate owed ₹2.6 lakh crore to the
banking system — has been able to draw the attention of buyers, including global investment
funds. These 12 accounts constituted 25 per cent of the gross non-performing assets (NPAs) in the
banking system.

The reason for excitement among buyers for the assets referred to the National Company Law
Tribunal (NCLT) is not far to see. They hope to bag great bargains, as India goes about setting its
stressed assets house in order. The idea is to get hold of good assets at a fraction of the costs of
building new ones. Aiding the buyers in this quest has been a controversial government decision
to keep out existing promoters from bidding for the stressed assets. The silver lining is that the
existing promoters could bid if they repay the dues to the banking system, which is a tough ask.

According to a recent Motilal Oswal Securities report, tightening the eligibility norms in bidding
for stressed assets might lead to higher haircuts for banks in the short run. However, in the long
run, it would prevent the re-entry of wilful defaulters in the system and promote transparency, it
added26.

Interested buyers

From London-based Arcelor Mittal, Korea’s POSCO, Blackstone, TPG Capital to domestic
biggies like the Tata Group, Mumbai-based Shapoorji Pallonji Group, Ajay Piramal-controlled
Piramal Enterprises and Sajjan Jindal’s JSW Steel, there is now a good line-up of interested buyers
for the stressed assets/companies referred to the NCLT under the insolvency process27.

26
https://www.livemint.com › Industry › Financial Services
27
ibid

21 | P a g e
In India, the total outstanding amount for top 50 stressed borrowers, funded by scheduled
commercial banks, stood at ₹3,72,379 crore as on September 30, 2017, according to the RBI28.

Banks’ haircuts

The main issue is how are banks going to play the insolvency game. Rather than holding on to
stressed assets in their balance sheets, will they be ready to take big haircuts? The grapevine in the
market is that many prospective buyers are looking for an average 50 per cent haircut in large
cases. All eyes are on banks to see if they would take the plunge and accept the haircuts29.

Of course, the buyers’ response has been good only for large corporates. There are few takers for
small and medium companies.

Going by the recent case of resolution at Murli Industries, banks had to settle for as high as 75 per
cent haircut, which is not a happy situation for the lenders.

However, Pawan Agrawal, Chief Analytical Officer, Crisil, felt that the quantum of haircuts were
more a function of specific cases. High haircuts may be reflective of lower economic value and
viability of the businesses being referred, rather than it being a reflection of the IBC process,
Agrawal said. “In future, once the resolution process is initiated early, the haircuts are expected to
be lower,” he said. Tarun Bhatia, Managing Director, Kroll, a global risk consulting firm, said that
ultimately recovery for the banks will be market determined and “we anticipate meaningful write-
offs”30.

He said these are early days for the IBC and one needs to see how many accounts achieve
meaningful resolution or successful liquidation.

Meanwhile the Motilal report highlights that haircut at 70 per cent of net stressed loans can impact
net worth of lenders by 37-100 per cent. Private banks are better placed than PSU banks in terms
of capital availability to absorb such potential losses. However, the government’s recapitalisation
plan will enable the PSU banks to make necessary provisions towards such assets, according to
the report31.

28
ibid
29
www.mca.gov.in/MinistryV2/insolvency+and+bankruptcy+code.html
30
ibid
31
ibid

22 | P a g e
Some visibility

By April 2018, there should be some visibility on how the entire IBC process is moving, said an
economy watcher. Metal (mainly steel) and power assets form bulk of the cases referred to the
NCLT (45 per cent in the RBI’s two lists taken together). Healthy recovery in these sectors are
critical to assess the success of the NCLT route32.

One of the many challenges faced in resolution of accounts under IBC is the RBI’s norm of
classifying interim debt as standard, which will encourage bankers to go for interim lending in
case of operating companies witnessing cash crunch, and thus, help them make a turnaround.
Crisil’s Agrawal said that 2018 will be a critical year where one would get to know the
effectiveness of the IBC, especially about the key expectation of a time-bound resolution. In
particular, progress in resolution of large NPAs referred by banks can materially change the asset
quality picture of banking system, according to Agrawal.

“2017 can be considered as an initial phase of implementation of an effective IBC in India. Even
as the rules, infrastructure, and skills of Insolvency Resolution Professionals are falling in place,
the number of cases initiated under the code have gathered pace. Even in this initial phase, the IBC
has restored the much-needed balance between lenders and borrowers,” Agrawal added33.

Litmus tests

According to Kroll’s Bhatia, 2018 will be a critical year as IBC will be tested for:

i) Can promoters really be kept out despite the recent ordinance disallowing them from
participating?
ii) Will IBC be as relevant for mid and small accounts?

iii) Who will be held accountable for the write-offs. Will the borrower/defaulter be tried for fraud?

“With promoters being kept out, as of now we see only the top 25-50 accounts having meaningful
outside interest,” Bhatia said. Pankaj Dutt, Managing Partner, Alexander Hughes, a global
executive search firm, said the Indian banking system could have avoided the current NPA mess

32
https://www.moneycontrol.com › NEWS › BUSINESS › COMPANIES
33
ibid

23 | P a g e
had public sector banks given enough attention to the ‘risk management’ function and focused on
having a chief risk officer at a level next to the board34.

The scourge of “Bad Loans” have been occupying a fair amount of space in not only the news
headlines but in most financial discussions. As that was not really enough, the recent arrest of a
“Start-up” entrepreneur for failing to pay his debts to the vendor accentuated the discussions a lot
ore. The objective of this article is not to analyse the reasons for any but to examine the way
forward given the fact that bad loans are integral part of business as much as failure or problems
part of the entrepreneurial journey as some business plans are bound to go wrong. Neither, within
acceptable limits, are a stigma and warrants a rational approach to find a long term sustainable
solution.

It is against this backdrop that the Insolvency and Bankruptcy Code 2016 that has become law,
partially, in December 2016 needs to welcomed, or if one is permitted to say so, with an open mind
to ensure that every effort made that it succeeds. It may not be out of place for one to immediately
draw comparisons or evaluate the efficacy of this new law against the ones like “Recovery of Debts
and Bankruptcy Act, 1993 (more known for the Debt Recovery Tribunals) ; Securitization &
Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002 (SARFAESI!) or
Sick Industrial Companies (Special Provisions) Act 1985 (remember BIFR) not to speak of the
archaic & vintage laws like the Presidency Towns Insolvency Act 1909 and Provincial Towns
Insolvency Act 1920! There are more, in terms of circulars issued by RBI, for those who want to
question this one, Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR) and
Scheme for Sustainable Structuring of Stressed Assets (S4A)35.

Concept of Golden Hour

Problems in business are akin, sometimes, to grave health issues or an accident where the “Golden
Hour” assumes immense significance. A time that could determine if the patient survives.
Business is no different too. We need to give that chance to survive. Not all businesses turn

34
www.thehindu.com › Business › Economy
35
ibid

24 | P a g e
irretrievably bad in a short time. Even the worst cases can become sustainable if pivoted at the
right time36.

The Insolvency and Bankruptcy Code 2016 (IBC) has rightly placed the emphasis on the revival
of the enterprise by bringing in a structure that facilitates it. A company that has defaulted can be
referred to the Adjudicating Authority for evolving a Resolution Plan. The application can be
preferred by either Creditor, Financial or Operational or the

Company/members/directors/partner/proprietor immediately on a default.

Time Bound Process

One of the most positive aspects of the Code is the fact that it is time bound. A resolution plan for
the turnaround has to be finalised and approved with 180 days, with a provision for a one time
extension of 90 days. If the various parties are unable to find a sustainable resolution, the
defaulting enterprise is sent for automatic liquidation/bankruptcy. The time bound process should
definitely not only reduce the agony of all but also ensure better realisations on the assets which
are currently a pathetic twenties in terms of percentage of recoveries. This does not take into
consideration the good money being spent in perpetual hope of a turnaround.

Shift of Power

Another major change from erstwhile practice on dealing with debts in default is shift of power
from the debtor to the creditor. Law has finally recognised that the promoters control on the
enterprise is not a divine power. When the application for resolution is accepted by the
adjudicating authority a Resolution Professional, interim for the first 30 days37, is appointed who
essentially takes over the entire management of the enterprise. This includes assets and business
where the powers of the directors/partners/proprietors stands suspended and is exercised by the
Resolution Professional. The powers, and therefore accountability, of the Resolution Professional
are quite comprehensive and also facilitates symmetry of information between enterprise & its
creditors. This is quite relevant in the context of determining the state of affairs of the enterprise.
The powers of the Resolution Professional is not absolute as those powers are exercised based on
the decision of the Committee of Creditors (CoC) comprising primarily of the Financial Creditors,

36
ibid
37
www.nishithdesai.com/.../ibc-amendment-act-parliament-confirms-bidding-restrictions

25 | P a g e
only in the absence of whom the Operational Creditors, representatives of the workman and
employees. All decisions, including the Resolution Plan, have to be approved by 75%, in value
terms, of the CoC. The Resolution Professional is vested with the responsibility of executing the
decision of the CoC38.

One question that is bound to inevitably crop up is about the Resolution Professional. The whole
resolution process comes under the aegis of the Insolvency and Bankruptcy Board of India a
statutory body that has been created under the Act that has been empowered to ensure proper
conduct of the resolution process. Another issue relates to the ability of the Resolution
Professional to manage the affairs of the enterprise whilst under resolution process. The challenge
here is on the understanding. The Resolution Professional is expected to engage with other
professionals, including domain experts, in the management of affairs of the enterprise during the
period.

Moving Forward

Going forward the IBC is going to be the single point resolution process for financial defaults.
The authority for adjudication being vested with the National Company Law Tribunal (NCLT) for
Companies & Limited Liability Partnerships and Debt Recovery Tribunal for Partnerships Firms
and Individuals. In the case of individuals who have offered personal guarantees in respect of
corporate/LLP loans, the jurisdiction will lie with the NCLT.

One of other key aspects that warrants closer review from the banks is that the IBC should not be
viewed from a limited perspective of another law to deal with the NPAs. IBC may not be able to
achieve what the others have not except that the liquidation/bankruptcy proceedings will be
initiated at the expiry of the resolution period! IBC should be used as an opportunity to deal with
enterprises that are showing early stress. Dealing with them at that stage would give greater elbow
to all the stakeholders rather than allow the ship to run aground when the only option would be to
send it to the ship breaking yard.

38
www.nishithdesai.com/.../ibc-amendment-act-parliament-confirms-bidding-restrictions

26 | P a g e
A collateral to the comprehensive and time based resolution mechanism would also bring a greater
buoyancy to the corporate debt market that would help not only corporates to raise monies would
give investors an investible opportunity.

In the final analysis, it quite possible that we may still be confronted with a couple of sticky issues
but those should not be allowed to stand in way of ensuring the success of the Code. Structured,
well calibrated system for exits are integral part of the entrepreneurial ecosystem and this could
well be one of key cogs in the wheel39.

39
ibid

27 | P a g e
 CHAPTER V
FINDINGS & RECOMMENDATION CAUSES OF NPA’S IN
BANKS
Non-performing Assets (NPAs) are the smoking gun threatening the very stability of Indian banks.
NPAs wreck a bank's profitability both through a loss of interest income and write-off of the
principal loan amount itself. In a bid to stem the lurking rot, RBI issued in 1993 guidelines based
on recommendations of the Narasimham Committee that mandated identification and reduction of
NPAs40. Their implementation immediately pushed many banks into the red. So serious is the
problem that an RBI report suggested that reducing NPAs be treated as a 'national priority'

Dealing with NPAs involves two sets of policies

1. Relating to existing NPAs

2. To reduce fresh NPA generation.

As far as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMCs to
clean up its balance sheet. For preventing fresh NPAs, the bank itself should adopt proper
policies41.
A strong banking sector is important for a flourishing economy. The failure of the banking sector
may have an adverse impact on other sectors. The Indian banking system, which was operating in
a closed economy, now faces the challenges of an open economy. On one hand a protected
environment ensured that banks never needed to develop sophisticated treasury operations and
Asset Liability Management skills. On the other hand a combination of directed lending and social
banking relegated profitability and competitiveness to the background. The net result was
unsustainable NPAs and consequently a higher effective cost of banking services. One of the main
causes of NPAs into banking sector is the directed loans system under which central cooperative

40
Ibid
41
https://www.ft.com/content/7110a75e-c85c-11de-a69e-00144feabdc0#axzz3ZyPObhBe
28 | P a g e
banks are required a prescribed percentage of their credit (40%) to priority sectors. As of today
nearly 7 percent of Gross NPAs are locked up in 'hard-core' doubtful and loss assets, accumulated
over the years.
The problem India Faces is not lack of strict prudential norms but

i. The legal impediments and time consuming nature of asset disposal proposal.
ii. Postponement of problem in order to show higher earnings.
iii. Manipulation of debtors using political influence.

Causes for an Account becoming NPA

There are several reasons for an account becoming NPA42.

* Internal factors

* External factors

Internal factors:

1. Funds borrowed for a particular purpose but not use for the said purpose.
2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
5. In-ability of the corporate to raise capital through the issue of equity or other
debt instrument from capital markets.

6. Business failures.

42
http://www.scribd.com/doc/17156683/NPA-Management-project-in-state-bank-of-mysore
29 | P a g e
7. Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting
sister concerns.
8. Willful defaults, siphoning of funds, fraud, disputes, management disputes,
mis-appropriation etc.
9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delay
in settlement of payments\ subsidiaries by government bodies etc
External factors43:

1. Sluggish legal system –

 Long legal tangles
 Changes that had taken place in labour laws
 Lack of sincere effort.

2. Scarcity of raw material, power and other resources.

3. Industrial recession.
4. Shortage of raw material, raw material\input price escalation, power shortage, industrial
recession, excess capacity, natural hazards like floods, accidents.
5. Failures, non payment\ over dues in other countries, recession in other countries, externalization
problems, adverse exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.
Some Other Reasons:
 Failure to bring in Required capital

 Too ambitious project

 Mis management

30 | P a g e
  Unwanted Expenses

 Over trading

 Imbalances of inventories

 Lack of proper planning

 Dependence on single customers

 Lack of expertise

 Improper working Capital Mgmt.

Treatment of Accounts as NPA’s

Record of Recovery

The treatment of an asset as NPA should be based on the record of recovery. Banks should not
treat an advance as NPA merely due to existence of some deficiencies which are of temporary in
nature such as non-availability of adequate drawing power, balances outstanding exceeding the
limit. A credit facility should be treated as NPA.

Treatment of NPAs – Borrower-wise and not Facility-wise

I. In respect of a borrower having more than one facility with a bank, all the facilities granted
by the bank will have to be treated as NPA and not the particular facility or part thereof
which has become irregular.

II. However, in respect of consortium advances or financing under multiple banking

arrangements, each bank may classify the borrowal accounts according to its own record
of recovery and other aspects having a bearing on the recoverability of the advances.

Recognition of Income on Investment Treated as NPAs

The investments are also subject to the prudential norms on income recognition. Banks should not
book income on accrual basis in respect of any security irrespective of the category in which it
is included, where the interest/principal is in arrears for more than 90 days .

31 | P a g e
NPA Reporting to Reserve Bank

Banks should report the figures of NPAs to the Regional Office of the Reserve Bank at the end of
each year within two months from the close of the year.

32 | P a g e
 CHAPTER VI

CONCLUSION AND SUGGESTIONS

At the pre-disbursement stage, appraisal techniques of bank need to be sharpened. All
technical, economic, commercial, organizational and financial aspects of the project need to be
assessed realistically. Bankers should satisfy themselves that the project is technically feasible
with reference to technical knowhow, scale of production etc. The project should be commercially
feasible in that all background linkages by way of availability of raw materials at competitive rates
and that all forward linkages by way of assured market are available44. It should be ensured
assumptions on which the project report is based are realistic. Some projects are born sick because
of unrealistic planning, inadequate appraisal and faulty implementation. As the initiative to
sanction or reject the project proposal lies with the banker, he can exercise his judgment
judiciously. The banker should at the pre-sanction stage not only appraise the project but also the
promoter – his character and his capacity. It is said that it is more prudent to sanction a 'B' class
project with an 'A' class entrepreneur than vice-versa. He has to ensure that the borrower complies
with all the terms of sanction before disbursement.
A major cause for NPA is fixation of unrealistic repayment schedule. Repayment schedule may
be fixed taking into account gestation or moratorium period, harvesting season, income generation,
surplus available etc. If the repayment schedule is defective both with reference to quantum of
instalment and period of recovery, assets have a tendency to become NPA. At the post-
disbursement stage, bankers should ensure that the advance does not become and NPA by proper
follow-up and supervision to ensure both assets creation and asset utilisation. Bankers can do either
off-site surveillance or on site inspection to detect whether the unit / project is likely to become
NPA. Instead of waiting for the mandatory period before classifying an asset as NPA, the banker
should look for early warning signals of NPA45.
The following are the sources from which the banker can detect signals, which need quick remedial
action:

44
http://www.taxmann.net/FEMAOnlineweb/FEMA_Online/FemaRBImasterCircular.aspx?pId=
80502
45
Ibid

33 | P a g e
  Scrutiny of accounts and ledger cards – During a scrutiny of these, banker can be on
alert if there is persistent regularity in the account, or if there is any default in payment of
interest and instalment or when there is a downward trend in credit summations and
frequent return of cheques or bills,
 Scrutiny of statements – If the scrutiny of the statements submitted by the borrower reveal
a sharp decline in production and sales, rising level of inventories, diversion of funds, the
banker should realise that all is not well with the unit.
 External sources – The banker may know the state of the unit through external sources.
Recession in the industry, unsatisfactory market reports, unfavourable changes in
government policy and complaints from suppliers of raw material, may indicate that the
unit is not working as per schedule.
 Computerisation of loan monitoring – In computerised branches, it is possible to
computerise the loan monitoring system so that accounts, which show signs of sickness or
weakness can be monitored more closely than other accounts.Personal visit and face-to-
face discussion – By inspecting the unit the banker is able to see for himself where the
problem lies - either production bottlenecks or income leakage or whether it is a case of
willful default. During discussion with the borrower, the banker may come to know details
relating to breakdown in plant and machinery, labour strike, change in management, death
of a key person, reconstitution of the firm, dispute among the partners etc. All these factors
have a bearing on the functioning of the unit and on its financial status.

‘Strategy for reducing provision – The extent of provision for doubtful asset is with reference to
secured and unsecured portion. Cent percent provision needs to be made for the unsecured portion.
If banks can ensure that the loan outstanding is fully secured by realisable security, the quantum
of provision to be made would be less. It takes one year for a sub standard asset to slip into doubtful
category. Therefore, as soon as an account is classified as substandard, the banker must keep strict
vigil over the security during the next one year because in the event of the account being classified
as doubtful, the lack of security would be too costly for the bank46.

46
http://www.rbi.org.in/scripts/bs_viewmastercirculars.aspx
34 | P a g e
Cash recovery – Banks, instead of organising a recovery drive based on overdues, must short list
those accounts, the recovery of which would provide impetus to the system in reducing the
pressure on profitability by reduced provisioning burden47. Vigorous efforts need to be made for
recovery of critical amount (overdue interest and instalment) that can save an account from NPA
classification:

a) In case of a term loan, the banker gets 90 days after the date of default to take appropriate
action and to persuade the borrower to pay interest or instalment whichever is due.
b) In case of a cash credit account, the banker gets 90 days for ensuring that the irregularity
in the account is rectified.
c) In case of direct agricultural loans, the account is classified NPA only after two crop
seasons (from sowing to harvesting) from the due date in case of short duration loans and
one crop season from the due date in case of long duration loans48.

Up gradation of assets – Once accounts become NPA, then bankers should take steps to upgrade
them by recovering the entire overdues. Close follow-up will generally ensure success.

Compromise settlements – Wherever feasible, in case of chronic NPAs, banks can consider
entering into compromise settlements with the borrowers.

Reasons Behind NPA:-

1. Lack of proper pre –enquiry by the bank for sanctioning a loan to a customer.

2. Non- performance of the business or the purpose for which the customer has taken the loan.

3. Willful defaulter.

4. Loans sanctioned for the agriculture purposes.

5. Change in govt. policies leads to NPAs.

47
ibid
48
Supra 14

35 | P a g e
 BIBLIOGRAPHY
BOOKS
·1. Tannan’s Banker’s Manual- A Commentary on Banking Laws and Allied Acts
2. ·Avtar Singh, Banking and Negotiable Instruments, Eastern Book Company, 16th edition
·3. Tannan, Banking Law, Lexis Nexus, 14th Edition, 2016

WEBSITES
1. www.thehindubusinessline.com
2. www.mca.gov.in
3. www.business-standard.com
4. www.nclt.gov.in
5. www.manupatra.com
6. www.legalserviceindia.com

STATUTES
1. Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002
2. The Recovery of Debts Due to Banks and Financial Institutions Act, 1993
3. Insolvency and Bankruptcy Code, 2016

ARTICLES

1. Bakshi, Avijit, ‘NPA Management in Banks’ research paper, Asia- Pacific Institute of
Management, New Delhi.
2. Bhatia, U. (1988), “Predicting Corporate Sickness in India”, Studies in Banking &
Finance, 7, 57–71.
3. Bidani, S.N. (2002) “Managing Non-Performing Assets in Banks”, Vision Books
Publication.
4. Das, A., and S. Ghosh (2003), “Determinants ofCredit Risk”, paper presented at the
Conference on Money, Risk and Investment held at Nottingham Trent University,
November 2003.
5. Mor, Nachiket and Bhavna Sharma (2002). “Rooting Out Non-Performing Assets”, ICICI
Research Paper, September 2002.
6. Reddy, P. K. (2002), “A Comparative Study of Non-Performance Assets in India’
research paper in Oct, IIMAhmedabad.

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