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
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. 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. 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:
- 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.
- 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
- 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
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
- 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
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 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
Lok AdalatsThe 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
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.
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.
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:
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
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.
- 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
Section 9 of the SARFAESI Act gives measures for asset reconstruction
- The proper management of the business of the borrower;
- Changing or taking over the management of the business of the borrower;
- The sale or lease of a part or the whole of business of the borrower;
- Rescheduling the payment of debts payable by the borrower;
- Enforcement of security interest in accordance with the provisions of
the SARFAESI Act;
- Settlement of dues payable by the borrower;
- 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.
- 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
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:
- take possession of the secured assets of the borrower including the
right to transfer by way of lease, assignment or sale for realizing the
- 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
- 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
- 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.
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:
- take possession of such asset and documents relating thereto; and
- 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.
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, 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.
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.
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.
- Data has been taken from statista website.
- Definition as per July 1, 2009 master circular of RBI.
- Supra note 2.
- Supra note 2.
- Data taken as reported by the Lok Adalat website.
- Section 12(1) of Insolvency and Bankruptcy Code, 2016
- Section 12(2) of Insolvency and Bankruptcy Code, 2016
Award Winning Article Is Written By: Mr.Aditya Mandar Shendye
Authentication No: OT027882897840-4-1020