The RBI defines “non-performing asset” (NPA) as an asset, including a leased asset, which has ceased to generate income for the bank. An NPA was earlier also defined as a credit facility for which the interest and/or instalment of principal has remained “past due” for a specified period of time. An amount due under any credit facility was treated as “past due” when it had not been paid within 30 days from the due date. It was decided to dispense with “past due” concept with effect from March 31, 2001. With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the “90 days’ overdue” norm for identification of NPAs, from the year ending March 31, 2004.
As of March 31, 2018, provisional estimates suggest that the total volume of gross NPAs in the Indian economy stands at Rs 10.35 lakh crore. About 85% of these NPAs are from loans and advances of public sector banks. For instance, NPAs in the State Bank of India are worth Rs 2.23 lakh crore.
In the last few years, gross NPAs of banks (as a percentage of total loans) have increased from 2.3% of total loans in 2008 to 9.3% in 2017. This indicates that an increasing proportion of a bank’s assets have ceased to generate income for the bank, lowering the bank’s profitability and its ability to grant further credit.
Escalating NPAs require a bank to make higher provisions for losses in their books. The banks set aside more funds to pay for anticipated future losses; and this, along with several structural issues, leads to low profitability. Profitability of a bank is measured by its Return on Assets (RoA), which is the ratio of the bank’s net profits to its net assets. Banks have witnessed a decline in their profitability in the last few years, making them vulnerable to adverse economic shocks and consequently putting consumer deposits at risk.
Some of the factors leading to the increased occurrence of NPAs are external, such as decreases in global commodity prices leading to slower exports. Some are more intrinsic to the Indian banking sector.
A lot of the loans currently classified as NPAs originated in the mid-2000s, at a time when the economy was booming and business outlook was very positive. Large corporations were granted loans for projects based on extrapolation of their recent growth and performance. With loans being available more easily than before, corporations grew highly leveraged, implying that most financing was through external borrowings rather than internal promoter equity. But as economic growth stagnated following the global financial crisis of 2008, the repayment capability of these corporations decreased. This contributed to what is now known as India’s Twin Balance Sheet problem, where both the banking sector (that gives loans) and the corporate sector (that takes and has to repay these loans) have come under financial stress.
When the project for which the loan was taken started underperforming, borrowers lost their capability of paying back the bank. The banks at this time took to the practice of ‘evergreening’, where fresh loans were given to some promoters to enable them to pay off their interest. This effectively pushed the recognition of these loans as non-performing to a later date, but did not address the root causes of their unprofitability.
Further, recently there have also been frauds of high magnitude that have contributed to rising NPAs. Although the size of frauds relative to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high profile fraudsters being penalised.
Among the major public sector banks, State Bank of India (SBI) had the highest amount of NPAs at over Rs 1.86 lakh crore followed by Punjab National Bank (Rs 57,630 crore), Bank of India (Rs 49,307 crore), Bank of Baroda (Rs 46,307 crore), Canara Bank (Rs 39,164 crore) and Union Bank of India (Rs 38,286 crore).
Among private sector lenders, ICICI Bank had the highest amount of NPAs on its books at Rs 44,237 crore by the end of September, followed by Axis Bank (Rs 22,136 crore), HDFC Bank (Rs 7,644 crore) and Jammu and Kashmir Bank (Rs 5,983 crore).
The disruptions by the Coronavirus pandemic have further deteriorated the health of the Indian banking industry. India’s NPA ratio is one of the highest among comparable countries and further, it is expected to reach 11%-11.5% by the end of the current fiscal year 2020-21, according to a report by Care Ratings. The FY21 GNPA numbers would move significantly ahead from the current 8.5 percent level, but would be lower due to the one-time restructuring scheme, the report added. However, it is estimated that the additions to the GNPAs would primarily take place from SMA 1 and SMA 2 corporate loans under moratorium and not eligible for restructuring.
Lower-rated corporates not eligible for the restructuring scheme already stressed companies which could face liquidity constraints in a challenging economy, and banking exposure to unsecured personal loans are also the reasons for higher bank NPAs this fiscal. The Reserve Bank has permitted a one-time restructuring of loans across three segments – corporate loans, MSME loans, and personal loans.
However, before the loan restructuring was announced by RBI, a Financial Stability Report released in the month of July showed that the gross NPA ratio of all SCBs may increase from 8.5 percent in March 2020 to 12.5 percent by March 2021 under the baseline scenario. It had added that if the macroeconomic environment worsens, the ratio may further escalate to 14.7 percent under the very severely stressed scenario.
On the projection of skyrocketing NPAs, RBI Governor Shaktikanta Das had said that the country’s financial system is sound but lenders should desist from extreme risk aversion during the Covid-19 pandemic and beyond. Shaktikanta Das added that the top priority right now for banks and financial intermediaries should be for augmenting capital levels and improve resilience. He had also underlined that financial sector stability is a prerequisite for giving confidence to businesses, investors, and consumers. Thus, banks have to remain extremely watchful and focused.

—The writer is from Waghama Bijbehara and is currently studying for a Masters in Financial Economics at Madras School of Economics, Chennai. [email protected]

Fahid Fayaz Darangay