Non-performing Assets (NPAs): The only asset Robert Kiyosaki’s rich dad wouldn’t want anyone to acquire
In this post, I will talk about the genesis of NPAs, its impact on the Indian economy, and the way forward to establish a robust mechanism for secured loans.
Twin balance sheet problem
Before understanding how a loan becomes an NPA we need to look at an important term known as the “twin balance sheet” problem. This involves two parties, let’s break it down:
- Firms: To fund huge capital intensive projects, firms apart from using the promoter’s equity as the mode of financing tend to raise money by taking loans from banks at a certain rate of interest. As soon as the loan is processed this gets entered in the “liabilities” column of the firm’s balance sheet.
- Banks: Since they have given out loans to these big firms, the loan amount gets added in the asset column of their balance sheet as they are going to earn interest till the time the entire amount is written off from the investee’s book.
When the firms are unable to pay back the loan amount (both interest and principal), the asset (one of the revenue streams for banks) becomes a “liability” for the bank. This is referred to as the “twin balance sheet” problem where both firms and banks are cash strapped.
What are the Non-performing assets?
In simple terms, the assets which now have stopped generating income for the banks are termed as non-performing assets.
Here is a more technical 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.”
Below are some figures to see how grave the problem of NPA has been.
Banks classify NPAs further into the following categories:
- Sub-standard assets: Assets that remain NPA for less than or equal to 12 months.
- Doubtful assets: Assets that remain NPA for more than 12 months.
- Loss assets: Assets that can no longer be recovered by banks.
Main reasons behind the NPAs
The increase in NPAs can be attributed to both external and internal (Indian banking industry) factors. Let’s look at both of these factors separately.
External Factors
- The Housing crisis of 2007–09: In the early 2000s, the Indian economy was booming as a result of which businesses were granted large loans based on mere extrapolations of the recent growth figures. But when the global economy stagnated during the housing crisis, the repayment capacity of these firms drastically decreased.
- Red Tapism: The Majority of the loans were given to projects in sectors such as telecom, power, infrastructure, mining, steel, and aviation which required environment and land acquisition clearances from the government. Due to the delay in these approvals, the timeline of the projects suffered.
Internal Factors
- Increased lending: Bankers too were very optimistic about the Indian economy and started lending out capital to big corporations without proper vettings such as looking at the credit score, future growth of the firms, and outsourcing of due diligence to the third parties.
- Refusing to acknowledge the bad loans: Instead of raising a red flag for the defaulted loans banks choose to give out fresh loans so that the borrowers can repay the interest on the older loans. This is commonly referred to as “evergreening of loans” which later impaired the Indian banking industry.
Public Sector Banks (PSBs) vs Private Sector Banks (PVBs)
It has been frequently argued that weak management and corruption in the PSBs led to the rise of NPAs. Let’s look at some figures to understand the actual reason behind the stressed situation of PSBs.
The gross NPA to gross loans ratio table shows that NPAs were present among all the major commercial banks but PSBs were worst hit because of enjoying a greater market share (refer to the total banking sector assets graph) in the banking industry.
Impact of NPAs on the Indian economy
Refer to the aforementioned infographic: As the number of NPAs increased, banks became cash strapped leading to a decrease in their capacity to float money in the market. This closed debt option as a mode of financing for businesses to launch their new projects. Without new projects and business opportunities, fewer people got a chance to participate in the labor force, hence slowing down the overall economic growth.
Measures taken so far by the government
Some of the major steps taken by the GoI and RBI are mentioned below:
Conclusion
Post the steps taken by the RBI and GoI, as of September 2019 gross NPA ratio has improved to 9.10% from 11.20% YoY. To avoid more NPAs in the future following steps must be undertaken:
- Leverage data and technology to red flag bad loans before they reach a state of loss assets.
- Due diligence of loans should not be outsourced to third parties and should be diligently taken care of by the bank officials.
- Measures such as an AQR should be done on a regular basis to identify any hidden NPAs.
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