Module 6

Non Performing Assets

1. Meaning
2. Types
3. Recovery
4. Identification
5. Solution
 Meaning
 A non performing asset (NPA) is a loan or advance for which the principal or
interest payment remained overdue for a period of 90 days.
 The account remains 'out of order', in respect of an Overdraft / Cash Credit
(OD/CC) and all other loan products being offered as an overdraft facility,
including those not meant for business purposes and/or which entail interest
repayments as the only credits.
 Out of Order means
 i. the outstanding balance in the CC/OD account remains continuously in excess
of the sanctioned limit/drawing power for 90 days, or
 ii. the outstanding balance in the CC/OD account is less than the sanctioned
limit/drawing power but there are no credits continuously for 90 days, or the
outstanding balance in the CC/OD account is less than the sanctioned
limit/drawing power but credits are not enough to cover the interest debited
during the previous 90 days period. The aforesaid ‘previous 90 days period’ is
inclusive of the day for which the day-end process is being run.
 Meaning
 The bill remains overdue for a period of more than 90 days in the case of bills purchased
and discounted.
 A credit card account will be treated as non-performing asset if the minimum amount
due, as mentioned in the statement, is not paid fully within 90 days from the payment due
date mentioned in the statement.
 In respect of all direct agricultural advances
 a) A loan granted for short duration crops will be treated as NPA, if the installment of
principal or interest thereon remains overdue for two crop seasons.
 b) A loan granted for long duration crops will be treated as NPA, if the installment of
principal or interest thereon remains overdue for one crop season.
 RBI Latest notification on NPA
Causes of NPA
Impact of NPA on Banks
 Financial Stability : Reduction in Interest income, large
provisions for losses, impair stability and liquidity.

 Constrained Lending Capacity : Reduction in lending

capacity and adoption of more cautious approach for
disbursing loans.

 Regulatory adherences : Breach of NPA Management lead to

penalties, constrains and regulatory interventions.

 Investor Trust : Prolonged increase in NPA erodes investors

trust leading to downgrading of institution.
Classification of Assets (Loans)
 SMA and NPA
As per RBI notification issued on May 2023.

1. Process of Identification of NPA is ongoing process. Once any loan turn

into NPA the bank should identify it NPA and make necessary provision
at the end of each calendar quarter in its books, i.e. end of March,
June, September, December.

2. SMA is an account which is exhibiting signs of incipient stress resulting in

the borrower defaulting in timely servicing of her debt obligations,
though the account has not yet been classified as NPA. As early
recognition of such accounts enables banks to initiate timely remedial
actions to prevent their potential slippages into NPAs.

3. classification of borrower accounts into SMA categories are applicable

for all loans, including retail loans, other than agricultural advances
governed by crop season based asset classification norms, irrespective
of size of exposure
 SMA and NPA
As per RBI notification issued on May 2023.

4. Banks are required to identify incipient stress in the account by creating three sub-
categories under the Special Mention Account (SMA) category as given in the table
below:
SMA Sub-Categories Principle or interest or any other amount is
wholly or partially overdue for
SMA - 0 Up to 30 days
SMA - 1 More than 30 days and up to 60 days
SMA - 2 More than 60 days and up to 90 days

5. In case of revolving credit facilities like cash credit, the SMA sub-categories will be as
follows:
SMA Sub-Categories Outstanding balance remains continuously in
excess of the sanctioned limit or drawing
power, whichever is lower, for a period of
SMA - 1 More than 30 days and up to 60 days
SMA - 2 More than 60 days and up to 90 days
Classification of Asset
 Banks should classify their assets into the following broad
groups, viz. –
 (i) Standard Assets
 (ii) Sub-standard Assets
 (iii) Doubtful Assets
 (iv) Loss Assets
Standard Assets Standard asset is one which does not
disclose any problems and which does not carry more
than normal risk attached to the business. Such an asset
should not be an NPA.

Sub-standard Assets : An asset would be classified as

sub-standard if it remained NPA for a period less than or
equal to 12 months. In other words, such assets will have
well defined credit weaknesses that jeopardise the
liquidation of the debt and are characterised by the
distinct possibility that the banks will sustain some loss, if
deficiencies are not corrected.
 Doubtful Assets : An asset is required to be classified as
doubtful, if it has remained NPA for more than 12 months. A
loan classified as doubtful has all the weaknesses inherent as
that classified as sub-standard, with the added
characteristic that the weaknesses make collection or
liquidation in full, on the basis of currently known facts,
conditions and values, highly questionable and improbable.

 Loss Assets : A loss asset is one where loss has been

identified by the bank or internal or external auditors or by
the Cooperation Department or by the Reserve Bank of
India’s inspection but the amount has not been written off,
wholly or partly. In other words, such an asset is considered
un-collectible and of such little value that its continuance as
a bankable asset is not warranted although there may be
some salvage or recovery value.
 Recovery of NPA
 The normal course of action for Banks to recover its NPA is to sell of the collateral
security offered by the borrower at the time of taking loan.
 There are different types of securities that can be adopted by the lenders or
banks depending upon the collateral involved and the circumstances as below.
 Pledge : for Movable property, possession is taken be lender at the time of
disbursing the loan eg. Gold Jewelry.
 Hypothecation : On Movable Asset, Possession remain with borrower eg. Car
Loan.
 Mortgage : Immovable Properties Eg. Housing Loan
 Lien : The lender get right to hold the property till amount due to him is not
repaid. However it does not give him right to sell the property.
 Assignment : Charge on Current Assets or Fixed Assets. It transfer rights of that
assets to Bank Eg. a bank can finance against the book debts. In such a case,
the borrower assigns the book debts to the bank.
 Biggest Problem is to obtain Possession of the Collateral and Selling it off to
Recover the amount.
 Recovery of NPA / Management of NPA
 Narasimham Committee I and II, along with the Andhyarujina Committee
suggested the enactment of legislation which empowers banks and financial
institutions to take possession of the securities and sell them without the
intervention of courts.
 The following steps are taken to curb the rising number of NPAs in the country:
• Securitization & Reconstruction of Financial Assets & Enforcement of Security
Interest Act 2002 (SARFAESI Act)
• Assets Reconstruction Companies (ARC)
• DRTs and DRATs
• Lok Adalats
 Insolvency and Bankruptcy Code
 Securitization & Reconstruction of Financial Assets & Enforcement of
Security Interest Act 2002 (SARFAESI Act)
 Snapshots
• The SARFAESI Act 2002 was approved by the parliament as per the
recommendations of the above committees.
• The SARFAESI Act empowers financial institutions to take possession of the
collateralized assets, manage assets, sell, or lease a part or all of the business of
the borrower.
• The Act only covers secured borrowers and it is applicable to cases where
security interest for securing the repayment of any financial asset is more than
INR 1 lakh.
• The SARFAESI Act is not applicable on agricultural loans.
 Objectives of SAFASEI Act
• Efficient or rapid recovery of non-performing assets (NPAs) of the banks and FIs.
• Allows banks and financial institutions to auction properties (say,
commercial/residential) when the borrower fails to repay their loans.
 How SARFAESI Act, 2002 Works

 SARFAESI Act, 2002 provides power to a bank or financial institution to seize the
property of a defaulting borrower.
 If the loan borrowers make any default in repayment of a loan or a loan
installment, the financial institution can classify the account as Non-Performing
Asset (NPA).
 The banks or financial institution can issue notices to the defaulting borrowers to
discharge their liabilities within 60 days period.
 When the defaulting borrower fails to comply with the bank or financial institution
notice, then the SARFAESI Act gives the following recourse to a bank:
• Take possession of the loan security
• Lease, sell or assign the right to the security
• Manage the same or appoint any person to manage the same.
 The Act also provides for the establishment of ARCs, regulated by the RBI, to
acquire assets from banks and other financial institutions.
 Methods of Recovery Under SARFAESI Act, 2002
 The SARFAESI Act provides the following three methods of recovery of the Non-
Performing Assets (NPAs):
• Securitisation
 Securitisation is the process of issuing marketable securities backed by a pool of
existing assets such as home or auto loans. An asset can be sold after it is converted
into a marketable security. A securitisation or asset reconstruction company can raise
funds from only the Qualified Institutional Buyers (QIBs) by forming schemes for
acquiring financial assets.
• Asset Reconstruction
 Asset reconstruction empowers asset reconstruction companies. It can be done by
managing the borrower’s business by selling or acquiring it or by rescheduling
payments of debt payable by the borrower as per the provisions of the Act.
• Enforcement of security without the interruption of the court
 The Act empowers banks and financial institutions to issue notices to individuals who
have obtained a secured asset from the borrower for paying the due amount and
claim to a borrower’s debtor to pay the sum due to the borrower.
 SARFAESI Act snapshots
 Asset Reconstruction Companies (ARC) / Bad Banks
• The asset reconstruction companies in India are formed as per the provisions of
the Securitization and Reconstruction of financial assets and enforcement of
the Security Interest Act of 2002.
• The Committee on banking sector reforms (Narasimham Committee II)
recommended setting up of ARCs to transfer NPAs from the banks.
• The ARC companies are formed for the acquisition of NPAs of the banks and
financial institutions.
• The Reserve Bank of India issues various guidelines to regulate the functioning
of the ARCs.
• ARCs are specialized financial institutions designed to purchase Non-
Performing Assets (NPAs), or bad loans, from banks and financial institutions.
• Their primary goal is to help banks clean up their balance sheets. This allows
banks to focus on their core business of lending and taking deposits rather than
managing stressed assets.
How ARC Work
1. Acquisition of NPAs: ARCs acquire NPAs from banks at a discounted price.
The discount reflects the risk and uncertainty associated with recovering the
bad loan.
2. Resolution strategies: ARCs use various strategies to recover value from the
acquired NPAs. These strategies include:
1. Restructuring: Renegotiating loan terms with the borrower to make
repayment more manageable.
2. One-time settlement (OTS): Negotiating a lump sum payment with the
borrower that is lower than the outstanding loan amount.
3. Sale of assets: Selling the underlying assets (collateral) pledged against
the loan.
4. Legal action: Initiating legal proceedings against the borrower for
recovery.
3. Profit generation: ARCs earn profits by recovering more than they pay for
NPAs.
 How ARC Work

1. Qualified Buyer: Qualified Buyers include Financial Institutions, Insurance companies,

Banks, State Financial Corporations, State Industrial Development Corporations, trustee or
ARCs registered under SARFAESI and Asset Management Companies registered under SEBI
that invest on behalf of mutual funds, pension funds, FIIs, etc. The Qualified Buyers (QBs)
are the only persons from whom the ARC can raise funds..
 DRT & DRAT
• Prior to the enactment of the SARFAESI Act, the Recovery of Debts due to
Banks and Financial Institutions (RDDBFI) 1993 was in existence and is still
implemented.
• The RDDBFI Act established debt recovery tribunals (DRTs) with original
jurisdiction and Debts Recovery Appellate Tribunal (DRATs) with appellate
jurisdiction to deal with NPAs of both secured and unsecured borrowers.
• It deals with loan amounts of INR 20 lakh or more without resorting to regular
court for speedy recovery of money and disposal of cases.
• A person/ entity aggrieved by orders of the DRT can appeal against its
orders to the DRATs.
• DRTs and DRATs are established by the Central Government and consist of
one person each referred to as the Presiding Officer of the Tribunal and the
Chairperson of the Appellate Tribunal respectively.
 There are 39 DRTs and 5 DRATs at present
 Proceedings of DRT
• Banks need to make an application to the DRT which has jurisdiction in the region in which
the bank operates and pay the required fees.
• The defendant shall present a written statement of his defense before the first hearing and
set up a counter-claim during the hearing.
• The Tribunal may, after giving the applicant and the defendant an opportunity to be
heard, pass such interim or final order.
• The interim order passed against the defendant can restrict him from disposing or
transferring his property without the prior assent of the Tribunal.
• DRT after hearing both the parties and their submissions would pass the final judgment
within 30 days from hearing. DRT will issue a Recovery Certificate within 15 days from the
date of judgment and pass on the same to the Recovery Officer.
• The Tribunal may direct the conditional attachment of the whole or any portion of the
property specified by the applicant.
• The Tribunal may also appoint a receiver and confer him all powers to defend the suit in
the court and to manage the property.
• Where a certificate of recovery is issued against a company registered under the
Companies Act, 1956 the Tribunal may order the sale proceeds of such company to be
distributed among its secured creditors.
 Recovery under DRT
 Recovery Certificate : A recovery certificate is a document issued by the Debt
Recovery Tribunal (DRT) to a creditor after a debtor is ordered to pay a debt. The
DRT issues the certificate after hearing all parties and passing a final order. The
certificate authorizes the creditor to recover the amount specified in it.
 After Receiving Recovery Certificate the Recovery Officer proceed to recover
amount of debt specified in the certificate by one or more of the following modes.
 Attachment and Sale of Movable or Immovable Property
 Taking possession of the property offered as security or any other property of the
borrower and appointing receiver of the property to sell them.
 Arrest the borrower and his detention in prison.
 Appointing receiver for management of movable or immovable assets of the
borrower.
 The order of DRT can be challenged by filing an appeal in DRAT within 45 days
and order of DRAT can be challenged only in high court or supreme court.
DRT & SARFAESI Act, 2002
• SARFAESI ACT enabled banks and financial institutions covered under the
Act for recovery of secured debts from the borrowers without the
intervention of the Courts at the first stage.

• When a loan is classified as a Non-Performing Asset (NPA), a notice is sent

to the borrower. If the borrower fails to comply with it, then the creditor is
entitled to take ownership of the secured asset including the right to
transfer the asset.

• The transition into DRTs happens when the collateral asset is not sufficient
enough to fulfill obligations to the creditors. In such cases, the creditors
may file an application to the DRT for the recuperation of the rest of the
part of the dues.
 Lok Adalats
 Lok Adalats are formed under the Legal Service Authority Act of 1987 to provide a
means by which banks can be assured of asset recovery.
 Apart from fighting it out in the tribunal, banks also try to engage in out-of-court
settlements.
 It offers an out-of-court settlement for recovery dues and serves as a dispute
resolution mechanism. Cases pending in court or at a pre-litigation stage can be
compromised or settled amicably through Lok Adalats.
 The Lok Adalats are conducted by the State Legal Service Authorities for ensuring
speedy settlements.
 There is no provision for an appeal against the verdict made by Lok Adalat.
 RBI GUIDELINES ON LOK ADALTS To make increasing use of the forum of Lok Adalts to
settle banking disputes involving smaller amounts, RBI during April 2001 advised bank
and financial institutions to follow the following guidelines for implementation:
 AMOUNT Cases involving an amount up to Rs. 30 lakh may be referred to Lok Adalats
 IBC (Insolvency & Bankruptcy Code)
 The IBC or Insolvency and Bankruptcy Code is a bankruptcy law that was passed in
2016 by the Parliament.
 The prime objective of the IBC is to protect corporate indebted individuals in
trouble.
 It includes individuals, companies, and partnership firms.
 The Code indicates a time-bound bankruptcy determination handle, counting any
case, which must be completed in 330 days.
 The Insolvency and Bankruptcy Board of India (IBBI) guides the IBC procedures.
 Objectives of the bankruptcy code:
Better managing of conflicts between debtors and creditors
Set a boundary between deception and commercial failure
To maximize the value of assets of interested persons.
To promote entrepreneurship
To increase the availability of credit.
 How IBC Works
 Resolution Process for Corporates.
 How IBC Works
 Application on default: Any financial or operational creditor(s) can apply for
insolvency on default of debt or interest payment
 Appointment of IP: IP to be appointed by the regulator and approved by the
creditor committee. IP will take over the running of the Company. From date of
appointment of IP, power of Board of directors to be suspended and vested in the
IP. IP shall have immunity from criminal prosecution and any other liability for
anything done in good faith.
 Moratorium period: Adjudication authority will declare moratorium period during
which no action can be taken against the company or the assets of the company.
Key focus will be on running the Company on going concern basis. A Resolution
plan would have to be prepared and approved by the Committee of creditors.
 Credit committee: A credit committee of creditors will be constituted. Related
party to be excluded from committee. Each creditor shall vote in accordance to
voting share assigned if 75% of creditor approve the resolution plan same needs to
be implemented.
 Liquidation : In case resolution plan is not agreed upon company goes into
liquidation and the IP acts as Liquidator.
Snapshot of IBC Success
 Case of Bhushan Steels Ltd.
 This is to be considered as biggest success of IBC code since its introduction
 The company went into Insolvency with outstanding liabilities of ₹ 56,000crore.
 The case of Corporate Insolvency Resolution Process(CIRP) was admitted against the
Company under the Insolvency & Bankruptcy Code, 2016 in the Principal Bench of the
National Company Law Tribunal (NCLT) in July 2017.
 The Resolution Professional and team also conducted the resolution process which
resulted in the resolution plan of Tata Steel Limited being submitted for the consideration
of the Adjudicating Authority i.e., NCLT.
 The NCLT approved the resolution plan in May 2018.
 As per the approved plan the Bhushan Steel was taken over by Tata Steel Ltd. and
renamed it as Tata Bhushan Steel Ltd.
 Tata Steel subscribed to 72.65% of the equity share capital of TBSL for an aggregate
amount of Rs 158.89 crore and provided additional funds aggregating to Rs 35,073.69
crore to TBSL by way of debt/convertible debt. The remaining 27.35% of TBSL’s share
capital will be held by TBSL’s existing shareholders and the financial creditors who
received shares in exchange for the debt owed to them.