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Understanding Non-Performing Assets
An asset becomes non-performing when it ceases to generate income for the bank. The assets of the banks which don’t bring any return are called Non-Performing-Assets (NPA) or bad loans. Bank’s assets are the loans and advances given to customers. If debt or don’t pay either interest or part of principal or both, the loan turns into bad loan.
An asset becomes non-performing when it ceases to generate income for the bank. The assets of the banks which don’t bring any return are called Non-Performing-Assets (NPA) or bad loans. Bank’s assets are the loans and advances given to customers. If debt or don’t pay either interest or part of principal or both, the loan turns into bad loan.
According to RBI, terms loans on which interest or installment of principal remain overdue for a period of more than 90 days from the end of a particular quarter is called a NPA.
In terms of agriculture / farm loans, the NPA is defined as:
For short duration crop agriculture loans such as paddy, Jowar, Bajra etc. If the loan (installment / interest) is not paid for two crop seasons, it would be termed as a NPA.
For long duration crops, the above would be one crop season from the due date.
Gross NPA: Gross NPA is the amount which is outstanding in the books, regardless of any interest recorded and debited.
Net NPA: Net NPA is the Gross NPA less interest debited to borrower account and not recovered or recognized as income.
Categories of NPA’s:
Banks are required to classify NPA further into the following three categories based on the period for which the asset has remained non-performing and the reliability of the dues:
Special Mention Account: If the borrower does not pay dues for 90 days after end of a quarter; the loan becomes an NPA and it is termed as Special Mention Account.
Substandard Assets: A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months.
Such an asset 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 would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, 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 the RBI inspection but the amount has not been written off wholly. 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 recovery value.
Provisioning Norms
Provisions are balance sheet items representing funds set aside by a company as assets to pay for anticipated future losses. The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements.
Provisioning Coverage Ratio
For every loan given out, the banks to keep aside some extra funds to cover up losses if something goes wrong with those loans. This is called provisioning. Provisioning Coverage Ratio (PCR) refers to the funds to be set aside by the banks as fraction to the loans.
Provisioning for Substandard Assets:
15 per cent of outstanding amount in case of Secured loans
25 per cent of outstanding amount in case of unsecured loans.
Provisioning for Substandard Assets:
Up to one year: 25 per cent of outstanding amount in case of Secured loans; 100 per cent of outstanding amount in case of Unsecured loans
1-3 years: 40 per cent of outstanding amount in case of Secured loans; 100 per cent of outstanding amount in case of Unsecured loans
More than 3 years: 100 per cent of outstanding amount in case of Secured loans; 100 per cent of outstanding amount in case of unsecured loans.
Loss assets:
Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.
Debts Recovery Tribunal is also the appellate authority for appeals filed against the proceedings initiated by secured creditors under Sub-Section (4) of Section 13 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002.
Any person aggrieved by an order of the DRT can appeal to the Debts Recovery Appellate Tribunal within 30 days of date of receipt of the order. The borrower has to deposit 50 per cent of the amount claimed by the secured creditor, before filing an appeal.
The Appellate Tribunal can reduce the deposit requirement to 25 per cent of the amount claimed, after recording the reasons for such a concession.
SARFAESI Act, 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002, allow banks and financial institutions to auction properties, both residential and commercial, when borrowers fail to repay their loans. It enables banks to reduce their NPA’s by adopting measures for recovery or reconstruction.
The Act provides three alternative methods for recovery of non-performing assets,
Securitisation - This is a process where financial assets (dues from a borrower) are converted into marketable securities (security receipts) that can be sold to investors.
Asset Re-construction - The Act uses the term ‘asset re-construction’ for the acquisition of any right or interest, of any bank or financial institution, in any financial assistance, by any securitization company or Re-construction Company, for the purpose of realization of such financial assistance.
Enforcement of Security Interest - In the normal course, court intervention is required for sale of property and realization of money due from a defaulter. SARFAESI Act has made provisions for banks and financial institutions to take possession of securities given for financial assistance and sell the same in the event of default.
Asset Reconstruction Companies (ARCS)
An Asset Reconstruction Company (ARC) is a company that is set up to do exactly what the name suggests — reconstruct or re-package assets to make them more saleable. Arcs are centralised agencies for resolving bad loans created out of a systematic crisis. The assets in question here are loans from banks, card companies, financial institutions etc.
Arcs buy up distressed assets from banks and other financial institutions, re-package them and then sell them in the market.NPAs can be assigned to arcs by banks at a discounted price, enabling a one-time clearing of the balance sheet of banks of sticky loans. At the same time, the ARC can float bonds and recover dues from the borrowers directly.
Arcs can have several alternate structures. They can either be publicly or privately owned or a combination of both, and can be either separately capitalised units or wholly-owned subsidiaries. ARCIL is the first Asset Reconstruction Company in India.
When to sell NPA?
A bank can sell NPA from its books to asset reconstruction companies such only if it has remained NPA for at least two years.
These sales are only on Cash Basis and the purchasing bank/ company would have to keep the accounts for at least 15 months before it sells to other bank.
Once the NPA is purchased, it is classified as Standard for a period of 90 days.
Indradhanush
Indradhanush aimed to revamp the functioning of public sector banks so that psbs can compete with the Private Sector Banks. The mission is a brainchild of PJ Nayak committee. It is launched by Ministry of Finance under the Department of Financial Services. The Indradanush is regarded as one of the big steps after the nationalisation of banks in 1970s.
The mission includes the seven key reforms of appointments, board of bureau, capitalisation, de-stressing, empowerment, framework of accountability and governance reforms.
De-stressing: The government will concentrate on distressing the banks’ bad loans. An institutional mechanism will be brought to manageNPAs.
Under the plan, asset reconstruction companies will also be strengthened to deal with bad loan situation. Moreover, the government has also resolved to set up a Bank Investment Committee, which will act as a holding company for shares on behalf of the government.
Meanwhile, RBI has now come out with new category of borrower called Non-Cooperative borrower.
A non-cooperative borrower is a borrower who does not provide information on its finances to the banks. Banks will have to do higher provisioning if they give fresh loan to such a borrower.
Banks Board Bureau
Finance minister Arun Jaitley last year announced the plan to set up a seven-member Banks Board Bureau as part of the government’s Indradhanush programme to revamp the functioning of the state-run banks.
The board is an attempt to separate the functioning of the banks from the government by creating another entity in between to act as a link between the two.
The announcement of the Banks Board Bureau comes at a time when state-run banks are struggling with high levels of bad debt and huge losses on account of higher provisioning.
Functions:
The Bureau will recommend for selection of heads - Public Sector Banks and Financial Institutions and help Banks in developing strategies and capital raising plans.
Scheme for Sustainable Structuring of Stressed Assets' (S4A), RBI
Giving much relief to the debt-laden banks the Reserve Bank of India (RBI) has announced a scheme for sustainable structuring of stressed assets (S4A) for resolution of bad loans of large projects.
Under this banks will be allowed to rework stressed loans under the oversight of an external agency, thereby ensuring transparency while also protecting bankers from undue scrutiny by investigative agencies.
Banks will be allowed to convert up to half the loans held by corporate borrowers into equity or equity-like securities
In simple terms, a bank can determine the amount of debt that it thinks a firm can service with its current cash flows. This proportion of debt must not be less than half the loans or funded liabilities of the company.
Once the sustainable level of debt has been determined, banks can convert the rest of the debt into equity or quasi-equity instruments.
Debt Recovery Tribunal (DRT)
Before 1993, the only way out for the banks to recover the bad loans is to approach civil courts. Due to huge pendency of cases, decades used to pass for adjudicating these issues.
The Debts Recovery Tribunals have been established by the Government of India under RDDBFI Act (Recovery of Debts due to Banks and other Financial Institutions Act, 1993) for expeditious adjudication without being subjected to the lengthy procedures of usual civil courts, appears to cause more pain than gain for banks.
According to RDDBFI Act, 1993 drts must be disposed off cases within 6 months.
SARFAESI Vs DRT
Under SARFAESI Act the banks can approach only against charged assets,where as the Debt Recovery Tribunals can also go against the uncharged assets of the borrower
under SARFAESI Act banks can auction commercial and residential properties,where as DRT’S along with commercial and residential properties it can march against Agricultural lands
DRT’s are quasijudicial bodies where as banks donot exercise such power.
under DRT’s auction can be done by taking symbolic possesion of the property,whereas under SARFAESI Act actual possesion is needed to auction the property
Insolvency and Bankruptcy Code, 2015
The Insolvency and Bankruptcy Code passed by the Parliament is a welcome overhaul of the existing framework dealing with insolvency of corporates, individuals, partnerships and other entities. It paves the way for much needed reforms while focussing on creditor driven insolvency resolution.
Background
At present, there are multiple overlapping laws and adjudicating forums dealing with financial failure and insolvency of companies and individuals in India. The current legal and institutional framework does not aid lenders in effective and timely recovery or restructuring of defaulted assets and causes undue strain on the Indian credit system.
Recognising that reforms in the bankruptcy and insolvency regime are critical for improving the business environment and alleviating distressed credit markets, the Government introduced the Insolvency and Bankruptcy Code Bill in November 2015, drafted by a specially constituted 'Bankruptcy Law Reforms Committee' (BLRC) under the Ministry of Finance.
The Code:
The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms). The Government is proposing a separate framework for bankruptcy resolution in failing banks and financial sector entities.
One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation. The Code creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and liquidation.
Key Highlights:
Corporate Debtors: Two-Stage Process
To initiate an insolvency process for corporate debtors, the default should be at least INR 100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government). The Code proposes two independent stages:
Insolvency Resolution Process, during which financial creditors assess whether the debtor's business is viable to continue and the options for its rescue and revival; and Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.
The Insolvency Resolution Process (IRP)
The IRP provides a collective mechanism to lenders to deal with the overall distressed position of a corporate debtor. This is a significant departure from the existing legal framework under which the primary onus to initiate a reorganisation process lies with the debtor, and lenders may pursue distinct actions for recovery, security enforcement and debt restructuring.
The Code envisages the following steps in the IRP:
Commencement of the IRP
A financial creditor (for a defaulted financial debt) or an operational creditor (for an unpaid operational debt) can initiate an IRP against a corporate debtor at the National Company Law Tribunal (NCLT).
The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency proceedings.
Moratorium
The NCLT orders a moratorium on the debtor's operations for the period of the IRP. This operates as a 'calm period' during which no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can take place against the debtor.
Appointment of Resolution Professional
The NCLT appoints an insolvency professional or 'Resolution Professional' to administer the IRP. The Resolution Professional's primary function is to take over the management of the corporate borrower and operate its business as a going concern under the broad directions of a committee of creditors.
This is similar to the approach under the UK insolvency laws, but distinct from the "debtor in possession" approach under Chapter 11 of the US bankruptcy code. Under the US bankruptcy code, the debtor's management retains control while the bankruptcy professional only oversees the business in order to prevent asset stripping on the part of the promoters.
Therefore, the thrust of the Code is to allow a shift of control from the defaulting debtor's management to its creditors, where the creditors drive the business of the debtor with the Resolution Professional acting as their agent.
Creditors Committee and Revival Plan
The Resolution Professional identifies the financial creditors and constitutes a creditors committee. Operational creditors above a certain threshold are allowed to attend meetings of the committee but do not have voting power. Each decision of the creditors committee requires a 75 per cent majority vote.
Decisions of the creditors committee are binding on the corporate debtor and all its creditors. The creditors committee considers proposals for the revival of the debtor and must decide whether to proceed with a revival plan or liquidation within a period of 180 days (subject to a one-time extension by 90 days).
Anyone can submit a revival proposal, but it must necessarily provide for payment of operational debts to the extent of the liquidation waterfall.
The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh finance, sale of assets, haircuts, change of management etc.
Liquidation
Under the Code, a corporate debtor may be put into liquidation in the following scenarios:
A 75 per cent majority of the creditor's committee resolves to liquidate the corporate debtor at any time during the insolvency resolution process;
The creditor's committee does not approve a resolution plan within 180 days (or within the extended 90 days);
The NCLT rejects the resolution plan submitted to it on technical grounds; or
The debtor contravenes the agreed resolution plan and an affected person makes an application to the NCLT to liquidate the corporate debtor.
Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending legal proceedings against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the liquidation estate.
Priority of Claims
After the costs of insolvency resolution (including any interim finance), secured debt together with workmen dues for the preceding 24 months rank highest in priority. Central and state Government dues stand below the claims of secured creditors, workmen dues, employee dues and other unsecured financial creditors.
Under the earlier regime, Government dues were immediately below the claims of secured creditors and workmen in order of priority.
Upon liquidation, a secured creditor may choose to realise his security and receive proceeds from the sale of the secured assets in first priority. If the secured creditor enforces his claims outside the liquidation, he must contribute any excess proceeds to the liquidation trust.
Further, in case of any shortfall in recovery, the secured creditors will be junior to the unsecured creditors to the extent of the shortfall.
Insolvency Resolution Process for Individuals/Unlimited Partnerships
For individuals and unlimited partnerships, the Code applies in all cases where the minimum default amount is INR 1000 (USD 15) and above (the Government may later revise the minimum amount of default to a higher threshold). The Code envisages two distinct processes in case of insolvencies: automatic fresh start and insolvency resolution.
Under the automatic fresh start process, eligible debtors (basis gross income) can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified threshold, allowing them to start afresh.
The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a bankruptcy order.
Institutional Infrastructure
The Insolvency Regulator
The Code provides for the constitution of a new insolvency regulator i.e., the Insolvency and Bankruptcy Board of India (Board). Its role includes: (i) overseeing the functioning of insolvency intermediaries i.e., insolvency professionals, insolvency professional agencies and information utilities; and (ii) regulating the insolvency process.
Insolvency Resolution Professionals
The Code provides for insolvency professionals as intermediaries who would play a key role in the efficient working of the bankruptcy process. The Code contemplates insolvency professionals as a class of regulated but private professionals having minimum standards of professional and ethical conduct.
In the resolution process, the insolvency professional verifies the claims of the creditors, constitutes a creditors committee, runs the debtor's business during the moratorium period and helps the creditors in reaching a consensus for a revival plan. In liquidation, the insolvency professional acts as a liquidator and bankruptcy trustee.
Information Utilities
A notable feature of the Code is the creation of information utilities to collect, collate, authenticate and disseminate financial information of debtors in centralised electronic databases. The Code requires creditors to provide financial information of debtors to multiple utilities on an ongoing basis.
Such information would be available to creditors, resolution professionals, liquidators and other stakeholders in insolvency and bankruptcy proceedings. The purpose of this is to remove information asymmetry and dependency on the debtor's management for critical information that is needed to swiftly resolve insolvency.
Adjudicatory authorities
The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals from NCLT orders lie to the National Company Law Appellate Tribunal and thereafter to the Supreme Court of India. For individuals and other persons, the adjudicating authority is the DRT, appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme Court.
In keeping with the broad philosophy that insolvency resolution must be commercially and professionally driven (rather than court driven), the role of adjudicating authorities is limited to ensuring due process rather than adjudicating on the merits of the insolvency resolution.
By: Balalatha Mallavarapu
