India and the problem of bad loans

In December 2022, Finance Minister has informed the Parliament that banks had bad loans worth Rs 10, 09,511 crore during the last five financial years.

What are Bad Loans?

• A bad loan is one that has not been ‘serviced’ for a certain period.
• Servicing a loan is paying back the interest and a small part of the principal — depending on the agreement between bank and borrower; to begin with so that over time, you pay back the principal as well as the interest accrued in the duration.

What is a Non-Performing Asset?

• Non-Performing Asset (NPA) is those kinds of loans or advances that are in default or in arrears.
• In other words, these are those kinds of loans wherein principal or interest amounts are late or have not been paid.
• These are also the kinds of loans where the lender considers the loan agreement to be broken and the receiver of the loan is unable to pay back the loan amount.

Types of NPA:

• Standard Assets: It is a kind of performing asset which creates continuous income and repayments as and when they become due. These assets carry a normal risk and are not NPA in the real sense of the word. Hence, no special provisions are required for standard assets.
• Sub-Standard Assets: Loans and advances which are non-performing assets for a period of 12 months fall under the category of Sub-Standard Assets.
• Doubtful Assets: The Assets considered as non-performing for a period of more than 12 months are known as Doubtful Assets.
• Loss Assets: All those assets which cannot be recovered by the lending institutions are known as Loss Assets.

When a loan is classified as NPA?

• Non-Performing Assets are basically Non-Performing Loans.
• In India, the timeline given for classifying the asset as NPA is 180 days. As against 45 to 90 days of international norms.

Why is there a need to recognise NPAs?

• In the banking system, the government and regulatory authorities need to have a good view of how healthy the financial system is.
• India became more aggressive in recognising loans as ‘bad’ in the 2014 to 2015 period.
• The periodic asset quality review was introduced. Further, the regulator stepped in to prevent evergreening of loans (i.e., lending more to an already stressed asset in the hope that it could be brought back to its feet).

What process does a bank undertake to recover NPA?

• The banks employ the Lok Adalats for settling the NPA loans. The Lok Adalats help in settling the NPA between the banks and defaulters.

Impact of NPAs on Financial Operations

• This reduces the profits of the banks.
• This reduces a bank or financial institution’s capital adequacy.
• The banks have become averse to giving loans and taking risks of zero per cent. Thus, the creation of fresh credit is debarred.
• The banks start concentrating on the management of credit risk instead of the bank becoming profitable.
• The funds happen to cost due to NPA.