Drastic Failure of RBI’s Attempt to Recover the Non-Performing Assets, Will the RBI Standardize the Recovery of NPAS

Posted On - 21 May, 2019 • By - Latha Shanmugam

The banking system in India
comprises commercial and cooperative banks, of which the former accounts for
more than 90 per cent of banking system’s assets. Besides a few foreign and
Indian private banks, the commercial banks comprise nationalized banks
(majority equity holding is with the Government), the State Bank of India (SBI)
(majority equity holding being with the Reserve Bank of India) and the associate
banks of SBI (majority holding being with State Bank of India). These banks,
along with regional rural banks, constitute the public sector banking system in
India   The banking industry has
undergone a sea change after the first phase of economic liberalization in 1991
and hence credit management. Asset quality was not prime concern in Indian
banking sector till 1991, but was mainly focused on performance objectives such
as opening wide networks/branches, development of rural areas, priority sector
lending, higher employment generation, etc. While the primary function of banks
is to lend funds as loans to various sectors such as agriculture, industry,
personal loans, housing loans etc., but in recent times the banks have become
very cautious in extending loans. The reason being mounting nonperforming
assets (NPAs) and nowadays these are one of the major concerns for banks in

Despite constituting special
Tribunals like Debt Recovery Tribunals under RDDBI Act, 1993, the Banks could
not recover its dues to the extent expected. This led to further reforms in the
process and curtailing the delay in adjudication. In furtherance of financial
reforms and extending the object of RDDBI Act, 1993, the Government has enacted
“The Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002”. The SARFAESI Act, 2002 is to curtail the delay in
the process of adjudication between the Banks and its borrowers. Following an
asset quality review conducted by the RBI in 2015, Listed Indian banks saw bad
loans jump to over Rs 8.4 lakh crore as of September 2017.

To cope up with the
situation on February 12, 2018 Reserve Bank of India issued circular1
on non-performing assets which stressed upon Implementation
of Resolution Plan, As soon as there is a
default in the borrower entity’s account with any lender where all
lenders − singly or jointly − shall initiate steps to cure the default. But the
apex court turned the clock backwards and struck down a Reserve Bank of India
(RBI) circular2 that gave defaulting companies 180 days to agree on
a resolution plan with lenders or be taken to bankruptcy court to recover debt
of Rs 2,000 crore and above. The Circular3 was thus challenged by
corporate debtors across various sectors on the grounds that they were being
pushed into the IBC process because of the time bomb set out in the Circular.
The Supreme Court tagged all matters on this subject in Dharani Sugar and
Chemicals Limited vs Union of India & Ors, struck down the Circular4
as being ultra vires to Section 35AA of the Banking Regulation Act, 1949, which
empowers RBI to issue directions to banks to initiate IBC proceedings in
specific matters basis authorisation from the Central government. However, the
two conditions: (i) Central government authorisation; and (ii) the circular
being in relation to a specific default, were not adhered to by RBI with
relation to the Circular5.


What is NPA?

NPA (non-performing assets)
is related to banking and finance term. When bank or finance company is unable
to recover its lent money from borrower in 90 days than that amount which have
not been recovered will be treated as NPA. It represents bad loans, the
borrowers of which failed to satisfy their repayment obligations.

 With effect from March 31, 2004, a
non-performing asset (NPA) shall be a loan or an advance where;

  • Interest and/ or instalment 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/CC),
  • The bill remains overdue for a period of more
    than 90 days in the case of bills purchased and discounted,
  • Interest and/or instalment of principal
    remains overdue for two harvest seasons but for a period not exceeding two half
    years in the case of an advance granted for agricultural purposes, and w.e.f
    30.09.2004 following further amendments were issued by the Apex Bank,
  • A loan granted for short duration crops will
    be treated as NPA if the instalment of principal or interest thereon remains
    overdue for two crop seasons.
  • A loan granted for long duration crops will
    be treated as NPA if the instalment of principal or interest thereon remains
    overdue for one crop season.
  • Any amount to be received remains overdue for
    a period of more than 90 days in respect of other accounts.

any advance or credit facilities granted by banks to a borrower become
nonperforming, 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. 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

Committee that mandated identification and reduction of NPAs to be treated as a
national priority because NPA direct toward credit risk that bank faces and its
efficiency in allocating resources. Profitability and earnings of banks are
affected due to NPA numbers.  If we
glance on the numbers of non-performing assets we may come to know that As of
June 2016, the total amount of Gross Non-Performing Assets (NPAs) for public
and private sector banks is around Rs. 6 lakh crore.

Types of NPA

NPA may be classified into

a. Gross NPA :- Gross
NPA is advance which is considered irrecoverable, for which bank has made
provisions, and which is still held in banks’ books of account. 

b. Net NPA :- Net NPA
is obtained by deducting items like interest due but not recovered, part
payment received and kept in suspense account from Gross NPA.

Asset classification categories of NPAS

1. Standard assets :- Standard
assets are the ones in which the bank is receiving interest as well as the
principal amount of the loan regularly from the customer. Here it is also very
important that in this case the arrears of interest and the principal amount of
loan do not exceed 90 days at the end of financial year.  If asset fails to be in category of standard
asset that is amount due more than 90 days then it is NPA and NPAs are further
need to classify in sub categories.  
Banks are required to classify non-performing assets further into the
following three categories based on the period for which the asset has remained
non-performing and the reliability of the dues: 

2. Sub-standard 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 month. 

3. Doubtful assets :- A loan
classified as doubtful if it remained in the substandard category for 12

 4. Loss assets :- A loss asset is one which
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. Also, these assets would have been identified as „loss assets‟ by the bank or internal or
external auditors or the RBI inspection but the amount would not have been
written-off wholly.

Provisioning norms for NPAS

After a proper
classification of loan assets the banks are required to make sufficient
provision against each of the NPA account for possible loan losses as per
prudential norms. The minimum amount of provision required to be made against a
loan asset is different for different types of assets. The details of the
provisioning requirements as per the RBI guidelines are furnished below:

In terms of RBI circular No
RBI/2004/254/DBOD No. BP.BC.NO 97/21.04.141/2003-04 dated 17.06.2004, the
Reserve Bank of India has decided that w.e.f March31, 2005, a general provision
of 10 percent on total outstanding should be made without making any allowance
for ECGC guarantee cover and securities available.

NPAs under Substandard
Assets category, The ‘unsecured exposures’ which are identified as
‘substandard’ would attract additional provision of 10 percent, i.e a total of
20 percent on the outstanding balance. The provisioning requirement for
unsecured doubtful assets is 100 percent. NPAs under Doubtful category.

In terms of RBI Circular No.
2004/261/DBOD BP.BC.99/21.04.048/2003-2004 dated 21.06.2004, Reserve Bank
decided to introduce graded higher provisioning according to the age of NPAs in
doubtful category for more than three years, with effect from March 31, 2005.

Consequently the increase in
provisioning requirement on the secured portion would be applied in a phase manner
over a three year period in respect of the existing stock of NPAs as classified
as ‘doubtful for more three years as on March 31, 2004 as per clarification
given hereunder: In respect of all advance classified as doubtful for more than
three years on or after 1 April, 2004 the provisioning requirement would be 100

Factors for rise in NPAs

The banking sector has been
facing the serious problems of the rising NPAs. But the problem of NPAs is more
in public sector banks when compared to private sector banks and foreign banks.
The NPAs are growing due to external as well as internal factors.

External factors

a. Ineffective recovery –
The Govt. has set up numbers of recovery tribunals, which works for recovery of
loans and advances. Due to their negligence and ineffectiveness in their work
the bank suffers the consequence of non-recover, thereby reducing their
profitability and liquidity.

b. Wilful defaults – There
are borrowers who are able to pay back loans but are intentionally withdrawing
it. These groups of people should be identified and proper measures should be
taken in order to get back the money extended to them as advances and loans.

c. Natural calamities – This
is the major factor, which is creating alarming rise in NPAs of the PSBs. Every
now and then India is hit by major natural calamities thus making the borrowers
unable to pay back there loans. Thus the bank has to make large amount of
provisions in order to compensate those loans, hence end up the fiscal with a
reduced profit.

d. Industrial sickness –
Improper project handling, ineffective management, lack of adequate resources,
lack of advance technology, day to day changing govt. Policies give birth to
industrial sickness. Hence the banks that finance those industries ultimately
end up with a low recovery of their loans reducing their profit and liquidity.

e. Lack of demand –
Entrepreneurs in India could not foresee their product demand and starts
production which ultimately piles up their product thus making them unable to
pay back the money they borrow to operate these activities. The banks recover
the amount by selling of their assets, which covers a minimum label. Thus the
banks record the non-recovered part as NPAs and has to make provision for it.

f. Change on govt. Policies
– With every new govt. banking sector gets new policies for its operation. Thus
it has to cope with the changing principles and policies for the regulation of
the rising of NPAs.

g. Directed loans system –
Under this commercial banks are required to supply 40% percentage of their
credit to priority sectors. Most significant sources of NPAs are directed loans
supplied to the ―micro sector are problematic of recoveries especially when
some of its units become sick or weak.

 Internal factors

a. Defective lending process
– There are three cardinal principles of bank lending that have been followed
by the commercial banks since long. i. Principle of safety ii. Principle of
liquidity iii. Principle of profitability.

b. Inappropriate technology
– Due to inappropriate technology and management information system, market
driven decisions on real time basis can’t be taken. Proper MIS and financial
accounting system is not implemented in the banks, which leads to poor credit
collection, thus NPAs. All the branches of the bank should be computerized.

c. Improper spot analysis –
The improper strength, weakness, opportunity and threat analysis is another
reason for rise in NPAs. While providing unsecured advances the banks depend
more on the honesty, integrity, and financial soundness and credit worthiness
of the borrower.

d. Poor credit appraisal
system – Poor credit appraisal is another factor for the rise in NPAs. Due to
poor credit appraisal the bank give advances to those who are not able to repay
it back. They should use good credit appraisal to decrease the NPAs.

e. Managerial deficiencies
-The banker should always select the borrower very carefully and should take
tangible assets as security to safe guard its interests. When accepting
securities banks should consider the: 1. Marketability 2. Acceptability 3.
Safety 4. Transferability

The banker should follow the
principle of diversification of risk based on the famous maxim do not keep all
the eggs in one basket, it means that the banker should not grant advances to a
few big farms only or to concentrate them in few industries or in a few cities.
If a new big customer meets misfortune or certain traders or industries
affected adversely, the overall position of the bank will not be affected.

f. Absence of regular
industrial visit – The irregularities in spot visit also increases the NPAs.
Absence of regularly visit of bank officials to the customer point decreases
the collection of interest and principals on the loan. The NPAs due to wilful
defaulters can be collected by regular visits.

g. Faulty credit management
– like defective credit in recovery mechanism, lack of professionalism in the
work force.

Impact of NPA

NPA impact the performance
and profitability of banks. The most notable impact of NPA is change in
banker’s sentiments which may hinder credit expansion to productive purpose.
Banks may incline towards more riskfree investments to avoid and reduce
riskiness, which is not conducive for the growth of economy. If the level of
NPAs is not controlled timely they will:

  • Reduce the earning capacity of assets and
    badly affect the ROI.
  • The cost of capital will go up.
  • The assets and liability mismatch will widen.
  • Higher provisioning requirement on mounting
    NPAs adversely affect capital adequacy ratio and banks profitability.
  • The economic value additions (EVA) by banks
    gets upset because EVA is equal to the net operating profit minus cost of    capital.
  • NPAs causes to decrease the value of share
    sometimes even below their book value in the capital market.
  • NPAs affect the risk facing ability of banks.


Having pushed lenders into
resolving nearly 40 of the largest bad loan accounts via the Insolvency and
Bankruptcy Code (IBC), the Reserve Bank of India (RBI) has now revised its
stressed asset framework to ensure speedy resolution of bad loans in the
future. An overarching theme of the new framework is a reliance on the IBC to
resolve stressed assets, while doing away with a number of interim schemes
introduced before India adopted a bankruptcy code. “In view of the enactment of
the Insolvency and Bankruptcy Code, 2016 (IBC), it has been decided to
substitute the existing guidelines with a harmonised and simplified generic
framework for resolution of stressed assets,”

features of the new framework include doing away with schemes like Strategic
Debt Restructuring (SDR), the Scheme for Sustainable Structuring of Stressed
Assets (S4A), and the Corporate Debt Restructuring (CDR) scheme, among others.
To replace these schemes, the RBI has put in place a strict timeline over which
a resolution plan must be implemented, failing which stressed accounts must be
referred to the IBC. Listed Indian banks saw bad loans jump to over
Rs 8.4 lakh crore as of September 2017, following an asset quality review
conducted by the RBI in 2015. The revised rules come at a time when Indian
banks are close to completing the process of bad loan recognition but
resolution is in early stages.

The RBI framework adds that
a resolution plan must be initiated as soon as there is a default. The
resolution plan may involve:

  • Regularisation of the account by payment of
    all overdues by the borrower entity
  • Sale of the exposures to other entities /
  • Change in ownership
  • Restructuring

The framework reiterates
that restructuring could involve modification to the terms and conditions of
advances, including an alteration in the repayment period, the rate of interest
and the installments payable.

An account that has been
restructured shall immediately be downgraded to being a non-performing asset.
Non-performing assets, which have been restructured, will continue to be
classified as they were before the restructuring. Provisions attached to these
accounts would to be as per existing rules under the IRAC (Income Recognition
and Asset Classification) norms. Accounts can be upgraded only when all the
outstanding loans and facilities of the account demonstrate satisfactory
performance. For accounts with an exposure of more than Rs 100 crore, the
borrower will also need to be rated ‘investment grade’ before the account is
upgraded to standard status.


By striking down the
Circular, the Supreme Court has removed the mandatory requirement of banks/financial
institutions to commence IBC proceedings at the end of 180 days from default if
no resolution qua a corporate debtor is found. However, banks/financial
institutions at their discretion can invoke IBC proceedings against any
corporate debtor, with it being a statutory right.

The IBBI has, in its
website, published an analysis of the SC ruling on the fate of this circular in
Dharani Sugars and Chemicals Ltd vs Union of India and others. The analysis
shows that the apex court has upheld the Banking Regulation (Amendment) Act
2017, introducing sections 35AA and Sections 35AB as being constitutional
(constitutionally valid). While Section 35AA conferred the discretionary power
on the RBI to instruct banks to commence insolvency proceedings against a defaulter,
Section 35AB permits the RBI to frame policies for stressed asset resolution.

In my opinion, the apex
court ruling is likely to provide flexibility for pre-insolvency
restructurings. The banks and promoters of defaulting companies may welcome the
flexibility to enter into consensual restructuring schemes and the availability
of a lengthier window can also help achieve complex restructuring transactions
in more realistic timetables (without the pressure of time periods set out in
the circular). However, it remains to be seen if the exemptions which were
applicable to such restructuring schemes from applicability of SEBI regulations
regarding change of control situations would continue to apply to contractual
restructurings without the circular being in force. This can continue to incentivise
pre-bankruptcy restructurings, however with lesser compulsion / time

Although the SC may have struck down the RBI’s February 12 circular6 on stressed assets, but the apex court has not curtailed the rights of banks to initiate insolvency proceedings on their own. This is a statutory right available to them under the Insolvency and Bankruptcy Code (IBC) and the Governor’s statement on framework for the resolution of the stressed assets shows that the RBI stands committed to maintain and enhance the momentum of resolution of stressed assets and adherence to credit discipline.7

Contributed By – Latha Shanmugam
Designation – Associate


1.         February 12, 2018 Reserve Bank of India

5.         Dharani Sugar and Chemicals Limited vs Union of India & Ors

7.          https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=3659

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