Revitalizing Stressed Assets

Early recognition, and time-bound resolution or liquidation of stressed assets is critical for de-clogging bank balance sheets and for efficient reallocation of capital. The Reserve Bank and the Government of India have been working together to comprehensively address the challenge through a multi-pronged approach. Specific measures are aimed at strengthening the legal, regulatory, supervisory and institutional framework with the ultimate objective of facilitating quick resolution of stressed assets in a time bound manner.

What is NPA?

Definition: A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

Description: Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.

  • Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
  • Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
  • Loss assets: As per RBI, “Loss 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.”

How the taxpayer pays for bad loans–and other effects of NPAs:

There are two effects that the rising tide of bad loans has on the banking system:

  • First, the taxpayer ends up paying. Banks take money from depositors that they lend to borrowers. If a borrower cannot repay loans, banks make up the shortfall from their own capital and profits. If a bank has bad loans, its shareholders take the hit. India’s public-sector banks are owned by the government, and, so, these bad loans are a loss to the government and the taxpayer.
  • Second, bad loans slow economic activity. Banks lend to companies to make profits and grow their working capital. High levels of bad loans erode bank capital, reduce their ability to raise fresh capital and reduce a bank’s capacity to lend, slowing the economy.

Wilful Defaulters

According to the RBI, a wilful default is deemed to have occurred in any of the following four circumstances:

  • When there is a default in repayment obligations by the unit (company/individual) to the lender even when it has the capacity to honour the said obligations. There is deliberate intention of not repaying the loan.
  • The funds are not utilised for the specific purpose for which finance was availed but have been diverted for other purposes.
  • When the funds have been siphoned off and not been utilised for the purpose for which it was availed. Further, no assets are available which justify the usage of funds.
  • When the asset bought by the lenders’ funds have been sold off without the knowledge of the bank/lender.

Prompt Corrective Measures

Several measures have been put in place for resolution of stressed assets through optimal structuring of credit facilities, the ability to change ownership/management, and greater transparency in the sale of stressed assets. The system of Prompt Corrective Action (PCA) under which specific regulatory actions are taken by the Reserve Bank if banks breach certain trigger points was revised recently. The endeavour is to ensure timely supervisory action by following a rule-based approach. In order to ensure effective supervisory action on serious violations/breaches, a separate Enforcement Department has been established.

Concept of Bad Bank

The concept of Bad Bank is simple. The bank divides its assets into two categories. Into the bad pile go the illiquid and risky securities that are the bane of the banking system, along with other troubled assets such as nonperforming loans. For good measure, the bank can toss in non-strategic assets from businesses it wants to exit, or assets it simply no longer wants to own as it seeks to lessen risk and deleverage the balance sheet. What are left are the good assets that represent the ongoing business of the core bank.

By segregating the two, the bank keeps the bad assets from contaminating the good. So long as the two are mixed, investors and counterparties are uncertain about the bank’s financial health and performance, impairing its ability to borrow, lend, trade, and raise capital. The bad-bank concept has been used with great success in the past and has today become a valuable solution for banks seeking shelter from the financial crisis.

Asset Reconstruction Companies (ARCs)

At present, there are 24 ARCs in the country, which are regulated and supervised by the Reserve Bank under the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002). After an amendment to the SARFAESI Act 2002 carried out in August 2016 through the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016, securitisation companies and reconstruction companies will be known as ARCs.

Other Measures

In November 2016, the Reserve Bank revised its guidelines on resolution of stressed assets to further strengthen the regulatory framework for dealing with stressed assets. Some of the significant measures include harmonization of the stand-still clause applicable in the case of the Strategic Debt Restructuring (SDR) Scheme with other guidelines; a scheme for sustainable structuring of stressed assets (S4A); flexible restructuring of existing long-term project loans to infrastructure and core industries; guidelines for projects under implementation; and clarification on the deemed date of commencement of commercial operations.

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