India is facing a growing problem of non-performing assets (NPA) which is dangerous as it is a symptom of an ailing banking sector which in-turn affects the economy of India as well. In the Financial Year of 2017 the value of Non- performing assets for the private sector banks stood at approximately 940 billion rupees.

This figure almost doubled in 2018 as the value of NPA's was at approximately 1.86 trillion rupees and in the financial year of 2019 this figure stood at approximately 1.84 trillion rupees[1]. In 2020 the problem is set to get even worse as a report of the RBI revealed that the gross non-performing assets ratio (which is the figure acquired by dividing net NPA by the total advances given by the bank) of commercial banks could worsen to as high as 14.7 per cent at the end of financial year 2020-21, from 8.5 per cent in March 2020, if the economic impact of the pandemic is severe.

The gross non-performing assets ratio is a measure of the overall quality of a bank's loan book and this report clearly shows that the banks could get even more stressed resulting in more problems and hardships for the banking sector. The increase in the NPAs has many adverse effects on the banking institutions as it impacts the bank's profitability, return on assets, net interest margins etc. and it also has an impact on the flow of credit as well as the growth of the economy as a whole. Therefore, it is important to understand what exactly a Non-Performing Asset is, how it works, the impact it has and the steps taken by the government to solve this problem.

What Is A Non-Performing Asset?

The Non-performing assets better known as NPA's are broadly defined as a classification for loans or advances that are in default or in arrears[2]. To further understand this definition, it is pertinent to understand what is meant by a loan in arrears and a loan in default. A loan is in arrears when interest payment or principal is late or missed and a loan is in default when the lender considers the agreement of loan to be broken and it is not possible for the debtor to meet his obligations.

This is the general definition of a non-performing asset over the world, however each country has its own procedure and requirements to declare an asset as non-performing. In India for an asset to be classified as an NPA the borrower should have the principal or interest on the loan or advance given by the lender overdue for a period of 90 days.

The NPAs are further classified into three categories depending on the period for which the asset has remained non-performing and the reasonability of the dues.

The three categories into which NPAs are classified are as follows:

1. Sub-Standard Assets:
   A sub-standard asset was first defined as one which was classified as NPA for a period not exceeding two years. However, on 31 March 2005 the RBI changed the duration to 12 months and therefore a sub-standard asset now was that which has remained an NPA for a period less than or equal to 12 months. In such cases, an asset will have well defined credit weaknesses which means that the borrower is unable to cover his total liabilities/exposure which will jeopardize the liquidation of the debt and there is a distinct possibility that the banks will sustain some loss if the shortcomings are not corrected.[3]
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2. Doubtful Assets:
   A doubtful asset was first defined as one which remained as an NPA for a period exceeding two years. However, on 31 March 2005 the RBI changed the duration to 12 months and therefore a doubtful asset was that which remained an NPA for a period exceeding 12 months. When a loan is classified as doubtful, the assets have all the same weaknesses that were found in assets classified as sub-standard but also with the added aspect that the weaknesses make collection or liquidation in full of the borrower on the basis of the existing facts, conditions and values highly uncertain and improbable.[4]
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3. Loss Assets:
   A loss asset is one where a loss has been identified by the bank or by the internal or external auditors or by the RBI inspection but the amount has not been written off completely. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.[5]
   
   These are the three categories in which NPAs are classified as. The RBI has provided guidelines to banks to efficiently and fairly classify assets as non-performing. These guidelines in a nut shell state that classification of assets into above categories should be done by considering the degree of well-defined credit weaknesses and the extent of dependence on collateral security (for example promoter guarantee, shares, real estate etc.) for realization of dues.
   
   

   The guidelines also state that for efficient classification banks may:

   • establish appropriate internal systems to eliminate the tendency of delay or postponement in the identification of NPAs, especially in respect of high value accounts.
     
   • fix a minimum cut off point to decide what would constitute a high value account depending upon their respective business levels. The cut-off point should be valid for the entire accounting year.
     
   • fix Responsibility and validation levels for ensuring proper asset classification.

The guidelines also state that the system established by the banks should ensure that doubts in asset classification due to any reason are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per existing guidelines. Therefore, this describes in short what an NPA is and how they should be classified by the banks. Now it shall be discussed as to what is to be done once an asset has been classified as an NPA by the bank.

Recovery Mechanisms

Recovery mechanism is a process of carrying out the recovery procedures and mechanisms required to restore the financial assets in the event of failure to repay by the borrower. An NPA as explained above is an asset that has ceased to generate income and returns which if not dealt with correctly and promptly can be detrimental to the bank and therefore the recovery of NPAs plays an important role to sustain the banking industry.

Mainly recovery is done through the following aspects:

1. Lok Adalats

   The Lok Adalat is one of the alternative dispute redressal mechanisms set up by the government. It is a forum where disputes or cases pending in the court of law or at pre-litigation stage are settled mutually. Lok Adalats have been given statutory status under the Legal Services Authorities Act, 1987. Under the said Act, the decision made by the Lok Adalats is deemed to be a decree of a civil court and is final and binding on all parties and no appeal against such an award lies before any court of law.
   
   If the parties are not satisfied with the award of the Lok Adalat though there is no provision for an appeal against such an award, however they can initiate litigation by approaching the appropriate court by filing a case by following the required procedure exercising their right to litigation. The jurisdiction of the Lok Adalats is in cases/disputes of less than 10 lakh rupees in value.
   
   The persons deciding the cases in the Lok Adalats are called the Members of the Lok Adalats and they have the role of statutory conciliators only and do not have any judicial role. Therefore, they can only persuade the parties to come to a conclusion for settling the dispute outside the court in the Lok Adalat and shall not pressurize or coerce any of the parties to compromise or settle cases or matters either directly or indirectly.
   
   The Lok Adalat cannot decide the matter referred to it on its own but instead it is to be decided on the basis of the compromise or settlement between the parties. The members shall assist the parties in an independent and impartial manner in their attempt to reach amicable settlement of their dispute. Mobile Lok Adalats are also organized in various parts of the country which travel from one location to another to resolve disputes in order to facilitate the resolution of disputes through this mechanism.
   
   As on 30.09.2015, more than 15.14 lakhs Lok Adalats have been organized in the country since its inception. More than 8.25 crore cases have been settled by this mechanism so far.[6]
   
   

2. Debt Recovery Tribunals (DRTs)

   The Recovery of Debts Due to Banks and Financial Institutions Act,1993 (RDDBFI Act) made provisions for speedy redressal to lenders and borrowers through filing of Original Applications also known as OAs in the Debt Recovery Tribunals (DRTs) and appeals in Debts Recovery Appellate Tribunals (DRATs). Therefore, under the RDDBFI Act the DRTs and DRATs have been established to help provide for the need of speedy redressal for banks against NPAs.
   
   The DRT also has the power to decide upon the applications filed against the secured creditors by the borrower or mortgager for the action taken by them under the Securitization Act. As of today, the government has established 39 DRTs and 5 DRATs, which are single Member Tribunals. The problem plaguing the DRTs like several other debt recovery mechanisms is that they are slow to work out on pending disputes as the process is very long which results in a high number of pending cases.
   
   

3. Sarfaesi Act

   The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 better known as the SARFAESI Act was formed after the considerations carried out by committees constituted by the government to examine the reforms and changes that are needed in the banking and legal systems for better functioning of the debt recovery mechanisms.
   
   The main purpose of this Act is to provide speedy recovery of defaulted loans and help reduce the mounting stress on the banks due to the increase in NPAs. The act provides the banks and financial institutions with a mechanism to better recovery of assets by enabling them to take possession of securities and sell them to reduce the burden of the Non-Performing Asset.
   
   

   The Act aims to achieve recovery of NPAs through three major ways which are the following:

   1. Securitization:
      The Section 7 of the SARFAESI Act gives an outlook of what exactly happens in securitization, it states that any securitization company or reconstruction company, may, after acquisition of any financial asset offer security receipts to qualified institutional buyers, (other than by offer to public) who are those who have expertise and sound knowledge to evaluate and make their investment in the Capital Markets, for subscription in accordance with the provisions of those Acts.
      
      A securitization company or reconstruction company may raise funds from the qualified institutional buyers by formulating schemes for acquiring financial assets and shall keep and maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired out of investments made by a qualified institutional buyer and ensure that realizations of such financial asset is held and applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme. The main advantage of securitization is that it allows the institutions to raise finances by selling assets or income streams.
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   2. Asset Reconstruction:
      In Asset Reconstruction the Securitization companies or Reconstruction Companies buy the NPAs from the banks and take measures to recover the bad loans from the borrower by carrying certain functions according to the powers vested in them by the Act.
      
      Section 9 of the SARFAESI Act gives measures for asset reconstruction such as:
      
      1. The proper management of the business of the borrower;
      2. Changing or taking over the management of the business of the borrower;
      3. The sale or lease of a part or the whole of business of the borrower;
      4. Rescheduling the payment of debts payable by the borrower;
      5. Enforcement of security interest in accordance with the provisions of the SARFAESI Act;
      6. Settlement of dues payable by the borrower;
      7. Taking possession of secured assets in accordance with the provisions of the SARFAESI Act.
         
         Thus, Asset Reconstruction helps the banks reduce the burden of NPAs on banks as when a Securitization company or Reconstruction Company takes over the NPA the banks and financial institutions can get returns on the NPA which reduces the stress of bad loans on banks and other institutions.
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   3. Enforcement of Security Interests:
      The Section 13 of the SARFAESI Act makes provisions for enforcement of security interests it states that notwithstanding anything contained in section 69 or section 69A of the Transfer of Property Act, 1882 any security interest created in favour of any secured creditor may be enforced, without the intervention of court or tribunal, by such creditor in accordance with the provisions of this Act.
      
      Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:
      
      1. take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset;
      2. take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset;
      3. appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;
      4. require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.
         
         The section 14 of the SARFAESI act is another provision to help the secured creditors, it states that chief metropolitan magistrate or district magistrate shall assist the secured creditor in taking possession of the secured asset.
         
         The secured creditor can for the purpose of taking possession or control of any secured asset make a request in writing to the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction any such secured asset or other documents relating to the secured asset may be situated or found, to take possession of the said asset or documents and the Chief Metropolitan Magistrate or the District Magistrate shall on such request being made to him:
         
         1. take possession of such asset and documents relating thereto; and
         2. forward such assets and documents to the secured creditor.
            
            The section goes further to state that for the purpose of securing compliance with the provisions the Chief Metropolitan Magistrate or the District Magistrate may take or cause to be taken such steps and use, or cause to be used, such force, as may, in his opinion, be necessary. It also states that no act of the Chief Metropolitan Magistrate or the District Magistrate done in pursuance of this section shall be called in question in any court or before any authority.
            
            

4. Insolvency And Bankruptcy Code (IBC)

   Before the Insolvency and Bankruptcy Code, 2016 came into force there were multiple laws and institutions that were overlapping in jurisdiction and functioning which lead to a lot of confusion in dealing with the insolvency and bankruptcy proceedings against individuals and companies. There was no legal framework which provided an efficient procedure to help the debt recovery process in India which was hurting the banks and other financial institutions and affecting the flow of credit. To overcome these hurdles the government introduced the Insolvency and Bankruptcy Code Bill in 2015 which was then passed in 2016 and came into force.

There were first 4 forums which dealt with matters of insolvency and bankruptcy which were the High court, Board for Industrial and Financial Reconstruction (BIFR), Debt Recovery Tribunal (DRT) and Company Law Board (CLB), upon the enforcement of the IBC the burden of these forums was reduced as now all the matters in relation to the code were to be filed in the National Company Law Tribunal (NCLT). The main purposes of the IBC is to provide speedy remedies for the banks against NPAs and also to reduce the burden of the long pending cases in courts.

The IBC has made a provision for the formation of the Insolvency and Bankruptcy Board of India which is responsible for implementation of the Code that consolidates and amends the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of the value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders. The IBC also makes provisions to make a formal Insolvency Resolution Process (IRP).

The IRP can be initiated by a corporate debtor who has defaulted on dues or by the creditors. When the IRP is initiated the creditors' claim should be dealt with within 180 days[7], during which time they will hear proposals for revival and decide on the future course of action. Within those 180 days, 75% of financial creditors must agree to a revival plan.

If this minimum threshold is not met, the firm automatically goes into liquidation. The resolution professional shall file an application to the Adjudicating Authority to extend the period of the corporate insolvency resolution process beyond one hundred and eighty days, if instructed to do so by a resolution passed at a meeting of the committee of creditors by a vote of 75% of the voting shares[8].

The Government issued an ordinance which is the Insolvency and Bankruptcy Code ordinance of 2020 in which the government suspended the operation of sections 7, 9 and 10 of the code to prevent defaulting corporates that are under stress due to the disruptions caused by the coronavirus pandemic and keep them from being pushed into insolvency. The Insolvency and Bankruptcy code basically helps in the dealing of debt recovery from the NPAs which helps the banks to efficiently recover their debt and be free from the burden of the NPA which keeps the banks and financial institutions healthy and free from excessive stress.

Conclusion
There is a growing problem of NPAs in India which is hurting the banking sector and also the economy of India as a whole as it is affecting the availability of credit and India is witnessing more and more of its banks crumbling under the pressure. The Government has realized this problem and has taken steps to ensure that the banks can keep up and the economy has credit available.

However, the steps taken by the government have not completely dealt with this problem and so the government needs to keep pushing for reforms in the banking sector and in the legal systems governing the sector to help the economy in India not only to survive but thrive and grow over time.

The courts are still facing the problem of increase in number of pending cases as the current set up of courts made to deal with the problem of debt recovery is not efficient and also does not have enough man power available to deal with the high influx of debt recovery cases.

This problem is going to get much worse in 2020 as owing to the coronavirus pandemic the country was in lockdown and so were the courts and therefore the cases had kept piling up as the courts were not functioning and also because a lot of the Micro Small and Medium enterprises (MSMEs) have not been able to survive the cash crunch during the pandemic and hence there will be more cases of debt recovery filed than the usual average. However, as mentioned above the government has taken certain steps to combat this problem but still the solution is only temporary.

The government not only needs to support the banking industry but also the MSMEs and other companies to prevent them from being pushed into insolvency as this too will help control the problem. If India aspires to maintain the healthy and fast-growing economy it had before the pandemic the government needs to take more drastic and long-lasting steps to keep the growth sustainable.

End-Notes:

1. Data has been taken from statista website.
2. Investopedia.
3. Definition as per July 1, 2009 master circular of RBI.
4. Supra note 2.
5. Supra note 2.
6. Data taken as reported by the Lok Adalat website.
7. Section 12(1) of Insolvency and Bankruptcy Code, 2016
8. Section 12(2) of Insolvency and Bankruptcy Code, 2016
   
   Award Winning Article Is Written By: Mr.Aditya Mandar Shendye
   
   

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