As big a country as India, it is unfortunate that it still lists in the developing countries category even after being the hotspot for laborers. There are a plethora of reasons for such a wretched scenario but the one that awes me most is the banking system. The big scams are all results of loopholes in the banking system. It is a result of poor law enforcement, the incapability of banks to declare willful defaulters, and many such reasons that revolve around it.
Defining NPAs
NPAs or Nonperforming assets are included on a loan originator or similar financial organization’s income statement. The creditor will compel the debtor to sell any assets secured as terms of the loan contract after extended years of no payments. Unless no assets were guaranteed, the borrower can treat the asset like a bad debt and resell that to a collection company at a rebate.
Non-performing assets are debts in the monetary system that have been due for ninety days in terms of principle or interest.
Categorization of NPAs
It is categorized into three types by RBI –
Substandard NPAs
These are the assets whose loan repayment or interest payment is overdue for 1 year.
Doubtful NPAs
These are assets that have had their installments in the substandard category during the previous twelve months.
Loss assets
Whilst there might be minimal salvage or recovery potential, they are regarded as escheatment and of such low worth that their continued existence as a bankable asset is not merited.
The causes behind the rise of NPAs
NPAs are caused by a variety of reasons.
- Banks funding to people, organizations, and other entities are likely to be fraudulent and pose a substantial risk.
- Banks are not reducing their risks by determining their equity and credit risk reserves adequacy at any particular time.
- Facilitator of businesses that divert their money afield.
- Banks are attempting to fund initiatives that are not feasible.
- Public sector banks began to experience severe capital shortages and losses in the early 1990s. The objectives they set for their business did not reflect the critical importance of these business objectives.
- The lenders had so limited control over how they priced their services, which sectors they offered them to, and how much money they spent for their profitability. Owing to political influence, banks were required to finance a priority sector, especially agriculture.
- Inadequate infrastructure for collecting and disseminating financial info amongst financial institutions; and
- Because of flaws in the present debt collection procedure, insufficient statutory measures on insolvency, and challenges with repossession and the implementation of court rulings, adequate restoration from elusive and delinquent debtors has been hampered.
The Effects of Nonperforming Assets on Operations
- It lowers the bank’s profit margins.
- It has an impact on the capital sufficiency of the bank.
- As a result, banks are reluctant to make mortgages and accept minimal risk. As a result, no new reward is generated.
- Rather than focusing on keeping the banking system more lucrative, banks begin to focus on the administration of credit hazards.
- Because of the NPA, loans are more expensive.
The real-life scenario of NPAs and their impact on the economy
This is due to lingering legal action, the high default rate at present is 52% because of the Insolvency and Bankruptcy Code and failed habit of saving by banks along with poor law enforcement.
For those who aren’t aware of the Insolvency and Bankruptcy Code, don’t worry we got you covered. To put it in simple words, the code was envisioned with the goal of integrating and modifying the statutes regulating the restructuring and insolvency settlement of corporations, partnering companies, and private professionals in a time-bound fashion in order to maximize the worth of their assets, encourage entrepreneurialism, and increase credit supply.
In India, MSEs or mid-size enterprises are deprived of loans as the stock markets and banks prefer to lend to large firms instead of them. They are basically the enterprises that keep the number of employees below a certain number and the capital invested falls under the range.
In India, it is kept from Rs 25 Lakhs to 10 crores for manufacturing industries, and for the service industry, it is kept from Rs 10 Lakhs to 5 crores. But we should acknowledge the fact that the share of MSEs is higher in exports of the country however it has been in a tailspin due to asking the global currency market for the loans instead of the domestic market.
This is because the domestic market doesn’t provide them with it, given that both the equity market and banking system of India prefer large firms over MSEs. Added to this even if they are ready to lend, they charge a very high rate of interest on the loans offered. This compels MSEs to depend upon the global market.
This situation leads to a currency crisis at times with the MSE which decreases the revenue of these firms thereby even if they try to increase their share in exports the effect becomes negligible.
The solution
To overcome this, Gourishankar S Hiremath suggests the use of the Capital bond market where securities are issued by the government. He believes that these markets will help MSEs to get domestic help at low rates of interest which will reduce the defaulter rate thereby causing a decline in NPAs.
Also, he suggests the enforcement of IBC on both the banking system and capital bond market. IBC is an Insolvency and Bankruptcy code that enables the lender to use the personal assets of the debtors in case he fails to repay the loan back. This will increase the confidence of banks in MSEs and they can get domestic help which will, in turn, increase the exports of the country.
The economy by the incoming Capital bond Market in greater play will be insulated by the triple crisis that is debt, banking, and currency crisis. This will also reduce the NPAs in the economy and improving the assessment of the same.
