He who is quick to borrow is slow to pay
Indian as well as the global economy has grown at a fast pace after WW-II. The globe has witnessed a phenomenon we often call industrialization, globalization, urbanization. The world has become co-operative at times and competitive during others. With such surge in the growth of the economy, we are now encountering issues like global warming, climate change, epidemics and what not.
With the advent of a new millennia, the world has encountered the issue of Non-Performing Assets or as they are commonly called – ‘NPAs’. As the name suggests, NPAs are those assets that don’t give returns anymore and are more of a liability due to their non-performance. For a layman, to understand NPA an example can be – Ram and Rajesh are best friends. Ram borrows Rs. 200 from Rajesh for a time period of 2 months at an interest rate of 5% per month. He pledged his watch costing Rs.150. In this case, Ram has given Rs. 200 to Rajesh, which were earlier a part of his assets. He was of the view that his asset is in safe custody of Rajesh and when Rajesh shall return the money, he will earn more assets in the form of interest money. Rajesh defaulted and never repaid Ram either the principal amount of Rs.200 or the interest. Consequently, Ram holds on to Rajesh’s watch so that he can get back his Rs. 150 but he will not be able to recover his Rs. 50 or the interest. This puts Ram in losses and Rajesh has thus, become a non-performing asset for Ram. This is what an NPA means on a basic level.
In the legal sense, Section 2(o) of The Securitization and Reconstruction of Financial Assets And Enforcement of Security Interest Act, 2002 has defined NPA’s as: “Non-Performing Asset” means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset…” Hence, non-performing asset means a borrowed or a tangible asset which has been declared by a financial institution as a lost one. Large corporations and industries have approved loans for projects and investments based on their recent growth and performance. When the project or asset for which the loan is taken stops giving returns, borrowers lose their capacity of paying back the financial institution or bank from which the loan was taken.
Through the medium of this article, the author seeks to outline the history, current scenario and legal status of the NPAs.
History of Debt Recovery Laws
Laws regarding debt and debt recovery have been in the ethos of India since the Vedic Age. The Smritis, Shrutis and many ancient books have provisions envisaged in them regarding debt recovery. One such reference is from the Narada Smriti –
The verse states that- “If a man does not repay what he has borrowed for use, and a debt, as well as what he has promised, that sum may be increased from its original amount. If it is allowed to increase more, until it has amounted to a hundred (times) ten million, it must then stop. The debtor shall become, in each successive birth, a horse, an ass, a bullock, and a slave.”
Furthermore, there was an intricate system of ‘Hundis’ which is a bill like instrument. The practice dates back to the 6th century. The system was developed mainly to repay the value of goods bartered in trade. Some of its variants are the Sahyog Hundi, Dhani-jog Hundi etc. Even the British recognized the Hundi system as a homegrown ritual.
The Mughal period marks a prominent phase of the medieval history of India. In this time there was a decline in banking as taking interest in Islam was considered a sin.
In the modern world, the inception of NPAs and piling of debt began in the year 2000. The economy was booming and banks gave loans to big corporations and conglomerates on the basis of their growth rates rather than the assets they held. These corporations invested in projects and assets which did not give returns and thus, repayment of the debt became a big issue.
Identification and Classification of Assets
NPAs have to be identified on an ongoing basis according to RBI guidelines. The banks have to take records of recovery into account before classification of an asset or borrower as NPA. Some deficiencies like the non-availability of adequate drawing power, non-submission of the stock statements are not adequate grounds for classification of an asset as NPA.
Vide notification dated July 1st, 2014, Reserve Bank of India classified assets and the NPAs based on these assets into 4 kinds. This was done in order to identify and understand the structure of NPAs. For some debtors, the situation could be temporary where the market and economy impacted their ventures for the time being. Following are the classifications and the basis of such classifications-
- Standard Assets- These assets are normal assets. As per RBI notification, these carry normal and reasonable risks of the investment or business.
- Sub Standard Assets- These assets are the ones which have remained NPA for a period of 12 months. As per RBI notification, – “such assets will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.” This criterion has been in effect since 31st March, 2005.
- Doubtful Assets- These assets are very similar to sub-standard assets; however, its current balance sheet and statistics make its liquidation more doubtful than the sub- standard assets.
- Loss Assets- After due scrutiny and analysis by a financial institution, external auditors or by the Reserve Bank of India, the chance of recovery or liquidation of such asset is uncollectable and unwarranted.
Banks have to report the number and amount of NPAs to the regional office of RBI at the end of every financial year.
Factors Causing Assets to Turn into NPAs
There are various socio-economic factors, both internal and external that affect the assets in various ways and cause bad loans. Some of these are-
- Diversion of Funds- Banks depute funds as loans to conglomerates and industries for the purpose of a certain project or venture, that it finds to be productive. When such funds are dispersed by the banks, they are often diverted to other purposes such as expansion or helping a sister company or concern.
- Business failures– The loans are dispersed for certain projects and purposes. These projects are based on hypothesis by the analysts regarding availability of raw material, labor costs, marketing etc. These hypotheses are based on the current market growth rate and a prediction of the future. The market being an unpredictable and uncontrollable factor often changes and thus such hypothesis become void.
- Some Internal Factors are–
– Poor marketing strategies.
– Failure of product
– Sudden changes in law and policy
– Strained labor relations
– Non-compliance of legal requirements.
External and uncontrollable factors include recession in the market, exchange rate fluctuation, accident and natural calamity (Example- Covid-19) etc. Banks have also been responsible for NPAs as their intricate and detailed paperwork and formalities often results in loss of business for businessman as sanction of such loan takes time.
Laws Catering to NPAs
Prior to the advent of Insolvency and Bankruptcy Code (IBC), there existed a spider’s web of laws which were employed for security and recovery of debt. The insolvency and bankruptcy of corporations were governed by various and multifarious laws like The Recovery of Debts due to Banks and Financial Institutions Act, 1993, the Companies Act, 1956, The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and the Sick Industrial Companies (Special Provisions) Act, 1985, whereas individual bankruptcy was covered by the Provincial Insolvency Act, 1920 and by the Presidency Towns Insolvency Act, 1909.
However, The Insolvency and Bankruptcy Code (IBC), enacted in May 2016 by the government, was a game changer to resolve the twin balance-sheet problem. The law was constituted after Banking Law Reforms Committee in 2014, which gave its report in 2015 recommending a complete overhaul of the legal and institutional framework governing insolvency. The committee proposed moving from a “debtor-in-possession” to a “creditor-in- control” model. With the advent of this law and its evolution through implementation it has become a legal weapon for subjugating the problem of NPAs. Under the IBC Bad loan recovery in the 2018 fiscal year was almost Rs. 70,000/- crores. This was almost posting a 43% recovery rate and was double the amount recovered from the Debts Recovery Tribunals or the Lok Adalats, according to a report from ratings firm Crisil.
Furthermore, the SARFESI Act, 2000 also contains provisions to ‘seize and detest’ the assets of the defaulter without interference of the court. Under the SARFESI Act – “A Bank or a Financial Institution can send a legal notice to the borrower to pay back her liabilities within 6 days from the date of notice. If the borrower is unable to do so, the Bank or Financial Institution (FI) can exercise all its rights under the SARFAESI Act.”
- RBI banks have contained NPAs at 9.1% in the fiscal year 2019.
- Capital buffers have been strengthened by recapitalization to the tune of Rs 2.7 lakh crore, including the budgetary allocations for FY20 and the abatement of stress has rekindled bank credit inflows, which are getting broad- based.
- In fiscal year 2019, the value of non-performing assets of private banks across India amounted to over 1.8 trillion Indian rupees. This was much lesser in fiscal year 2017, amounting to about 9.3 billion rupees.
- Indian public sector banks collectively owed over seven trillion Indian rupees as non- performing assets at the end of fiscal year 2019. This value was much higher at around nine trillion rupees in the previous fiscal year, indicating a slow but slight relief for India’s economy in terms of non-paying assets at public banks.
With the advent of IBC, the problems of NPAs have decreased strategically. However, they still pertain and persist in our economic system. The measures have to be stronger in order to curb the occurrence of the issue rather than addressing it after the damage is done. Loans need to be accounted on the collateral held, which is the basic principle of credit-debit system, rather than growth showing balance and stock sheets. The world currently engulfed under the scare of COVID-19 realizes how a destabilized economy can hamper further systems and organizations of the society. After averting the crisis, it is our duty to rethink our strategies, our lifestyle and our attitude towards economy.
 The Securitization and Reconstruction of Financial Assests And Enforcement of Security Interest Act, 20021 (54 of 2002)
 Debts in ancient India, available at https://taxguru.in/corporate-law/debts-ancient-india.html (last visited on 18-05-2020)
 Id. At 2
 The evolution of lending system, available at https://www.faircent.com/the-evolution-of-lending-system-the- real-story (last visited on 18-05-2020)
 RBI/2014-15/25 UBD.BPD. (PCB) MC No.3 /09.14.000/2014-15, (RBI MASTER NOTIFICATION DATED- JULY 01, 2014)
 How Insolvency and Bankruptcy Reforms Are Helping Clean Up the NPA Mess, available on – https://swarajyamag.com/economy/how-insolvency-and-bankruptcy-reforms-are-helping-clean-up-the-npa-mess
 Bad Is Turning Good- From SICA to IBC-The Journey of Bad Loans in India available on https://www.livelaw.in/bad-is-turning-good-from-sica-to-ibc-the-journey-of-bad-loans-in-india/