India and the problem of bad loans

Published
6th Jan, 2023

Context

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

About

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.

In 2009, the RBI brought out norms that set out categories of Non-Performing Assets (NPAs) and what banks must do as these bad loans age.
According to RBI, Bad loans are a problem, for, with time, there is less and less certainty that the loan would be paid back in full.

What is a Non-Performing Asset?

They are 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.

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 ever-greening 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.

A National Asset Reconstruction Company Ltd. (NARCL) was announced in the Union Budget for 2021-2022 to resolve stressed loans amounting to about Rs 2 lakh crore in phases.

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.