Approach:

Introduction: Define NPA and briefly mention the factors that led to the rise of the NPA crisis in India.

Body: Mention the steps taken by the Government of India to address the NPA crisis and also mention the reasons for the persistence of the NPA crisis.

Conclusion:  Suggest a way forward.

Answer:

A NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

The Indian economy witnessed a rise in NPA due to various factors like the global financial crisis of 2008 which severely impacted the repayment capability of corporations, the practice of ‘evergreening’ of loans by banks and instances of high-profile fraudsters not being penalised e.g. fraud by Nirav Modi and DHFL fraud etc.

Steps Taken by the Government of India -

Government has implemented a comprehensive 4R’s strategy for a responsible and clean system as elaborated below:

1. Recognition of NPAs -
   • Asset Quality Review (AQR): In 2015, the Reserve Bank of India (RBI) conducted a thorough assessment of banks' balance sheets to identify and recognize stressed assets. This exercise helped in recognizing and disclosing the true extent of NPAs in the banking system.
   • Credit Information Bureau: The Credit Information Bureau (India) Ltd. (CIBIL) was incorporated in 2000 to prevent NPAs by sharing information on wilful defaulters.
2. Resolution and recovery of value from stressed accounts -
   • Insolvency and Bankruptcy Code (IBC): It fundamentally changes the creditor-borrower relationship, taking away control of the defaulting company from promoters/owners and debarring wilful defaulters from the resolution process and debarring them from raising funds from the market.
   • ARC (Asset Reconstruction Companies): Created to recover value from stressed loans bypassing courts which was a time-consuming process.
   • SARFAESI Act - The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act empowers banks to auction assets or properties that were submitted as collateral while sanctioning loans.
3. Recapitalisation of PSBs: Over the last four financial years, PSBs have been recapitalised to the extent of Rs. 3.12 lakh crore, with an infusion of Rs. 2.46 lakh crore by the Government and mobilisation of over Rs. 0.66 lakh crore by PSBs themselves enabling PSBs to pursue timely resolution of NPAs.
4. Reforms in PSBs and the wider financial ecosystem:
   • Board-approved Loan Policies of PSBs now mandate tying up necessary clearances/approvals and linkages before disbursement, scrutiny of group balance-sheet and ring-fencing of cash flows, and non-fund and tail risk appraisal in project financing.
   • Use of third-party data sources for comprehensive due diligence across data sources has been instituted, thus mitigating risk on account of misrepresentation and fraud.
   • Specialized monitoring agencies combining financial and domain knowledge have been deployed for the effective monitoring of loans above 250 crores.

Reasons for the persistence of the NPA crisis in the Indian banking sector -

1. Slow Progress in NPA Resolution: According to the Insolvency and Bankruptcy Board of India as of September 2021, out of the 4,376 cases admitted under the IBC, only 484 cases have been resolved, with a recovery rate of around 42%. This indicates that a significant number of cases are still pending resolution.
2. Sector-specific Challenges: Several sectors continue to face NPA-related issues, hampering the overall resolution process. For instance, as of March 2021, the power sector accounted for around ₹1.02 lakh crore ($14 billion) of NPAs.
3. Economic Slowdown and Pandemic Impact: According to a report by the Reserve Bank of India (RBI), the gross NPAs of banks are projected to increase to 9.8% by March 2022 from 7.48% in March 2021, reflecting the impact of the pandemic.
4. Governance and Regulatory Challenges: Weak corporate governance practices e.g. Poor project appraisal management by banks and inadequate regulatory oversight have contributed to the persistence of the NPA crisis. For example, the Punjab National Bank (PNB) fraud involving Nirav Modi and Mehul Choksi highlighted the need for stricter monitoring and governance mechanisms.
5. Evergreening of Loans: It includes bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments; use of internal or office accounts to adjust borrower’s repayment obligations; renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans etc.

Way Forward

1. Creation of Bad Bank to acquire and manage non-performing assets (NPAs) from commercial banks, so that they can focus on their core lending activities.
2. Governance reforms:
   1. Implementing the recommendations of the Nayak Committee i.e.The Bank Board Bureau would be responsible for appointing whole-time directors in PSBs. This would help to ensure that the directors are appointed on merit and not on political considerations and reduction of government stake to less than 50 per cent etc.
   2. Term lengths: The terms of bank chairpersons must align with the life of the loan, which would allow defaults to be detected and penalties to be meted out as required.
   3. Credit appraisal, monitoring: Basic principles of credit appraisal and monitoring are obviated in PSBs and must be sharpened, to diagnose defects of capital, business purpose and character.
3. Penalize for wrongdoing: Although vigilance mechanisms exist, lax enforcement means that wrongdoing is rarely penalized. For instance, the Chairman of Syndicate Bank who was bribed by the promoters of Bhushan Steel was in jail for barely a few months and has not been convicted as yet.
4. RBI governance and regulation: RBI lacks supervisory capacity to conduct forensic audits and this must be strengthened with human as well as technological resources.
5. Diagnostics for willful default through market intelligence; funds flow analysis; and financial analysis. In this regard, the use of Artificial Intelligence for the supervision of financial transactions could prevent financial fraud.
6. Preventing Evergreening of Loans: Wherever significant evergreening in a bank is detected by the RBI, penalties should be levied through cancellations of unvested stock options and action should be taken against the erring officers e.g. the Chairman of the audit committee be asked to step down from the board, as was suggested by PJ Nayak committee.

So, in order to address the NPA crisis in India we need to create a vibrant secondary market for NPAs to determine the price of NPAs in a transparent manner and the internal and concurrent audit systems of banks need to be strengthened so that red flag risks could be identified in real time.