The Battle against Non-Performing Assets

[Pranjal Doshi is an MCL Candidate, University of Cambridge]

The foundation of an enduring banking industry lies in robustly crafted recovery mechanisms. It promotes the stable existence of the borrower-lender relationship. Incongruously, non-performing assets (“NPAs”) have grown substantially in India from 9.2% (September 2016) to 10.2% (September 2017)[1], amounting to ₹8,36,782 crores (October 2017)[2]. India’s NPAs to total advances ratio was 9.8% (second quarter of 2017) as opposed to a dramatically better position of developed countries like USA (1.1%), or UK (1.0% – first quarter of 2017).[3] Due to rising NPAs (17.7% -1998)[4], the Korean economy experienced rapid unemployment and inflation.

Global experiences testify that the NPA crisis is distressing and warrants state intervention to prevent recession. The Government, therefore, is vindicated in revitalising the drained banks, instituting makeover reforms and affording special treatment to the public sector banks (“PSBs”) which undertake 70% of banking activities in India. However, before stifling credit supply to the corporate houses, banks’ performance ought to be evaluated.

I shall discuss the governmental measures to curb the menace of NPAs. Starting with the infusion of fresh capital into PSBs, I shall attempt to elucidate the provisions for debt recovery, appreciate the joint efforts of market regulators and conclude with a cross-country analysis.


Liberal loan advancements within the constriction of capital adequacy norms [Capital Adequacy Ratio – 9%], imposed by the Reserve Bank of India (“RBI”), coupled with rising NPAs, has depleted the capital structure of the banks and calls for additional capital – both for reinforcement and fresh loan grants. Additionally, the gap between the book and market value of PSBs’ shares has to be bridged. As a reformative measure, the government on October 2017, declared to instil ₹2,11,000 crores into the PSBs for improving their lending abilities.[5] The quantum is unprecedented and roughly amounts to 1.3% of India’s GDP.[6] The sale of liquidity-neutral recapitalisation bonds shall front-load capital injections and mitigate its fiscal implications, thereby saving the economy from falling into an inflationary trap.

Comments: The allocation should be on operational merits rather than on misplaced values of equality, as a major chunk of taxpayer’s money is being diverted to rescue the banking sector. For establishing financial discipline and deterring the incessant stress in the balance sheet (“B/S”), its imperative that the bank’s performance and infusion of funds have a reasonable nexus. Recapitalisation will trim the banks’ financials and invigorate their ability to expand credit. When the corporate earnings are low during an economic downturn, fleeting assistance in form of capital infusion aids banks in surviving the twinges of B/S hardships and the existing macroeconomic conditions make it a desirable measure.

Insolvency and Bankruptcy Code

A logical concomitant of capital injection is the Insolvency and Bankruptcy Code, 2016 (the “Code”), which drove India from rank 136 to 103 in the segment of ‘Resolving Insolvency’ in the World Bank’s Doing Business rankings. The Code revamps India’s corporate insolvency regime and boasts of lessening the NPAs and debt recovery delays. The Code permits banks to initiate a time-bound (270 days) insolvency resolution process on default of ₹1,00,000 or more. Subsequently, an insolvency professional (“IP”) is appointed to manage the business of defaulting company under the supervision of the Committee of Creditors (“COC”) and shall formulate a revival plan (selling off assets, liquidation etc.) backed by a 66% majority. The resolution plan will then be filed with the tribunal for approval failing which, the company shall be liquidated and the IP will act as the de-facto liquidator. The Code gives the banks two broad choices:

  • enforcement of the security interests for recuperation,
  • relinquishment of rights to the liquidation trust in lieu of proceeds.

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, (“SARFAESI”), enacted to mitigate banks’ plight, recognised their right to confiscate and sell the collateral-security for recovery purposes.

Comments: Legitimising the threat of bankruptcy is a boon for banks especially when the waterfall provision suggests that governmental dues will be paid only after all payments have been made to the secured and unsecured creditors. However, this process will only recover the remains, be it through resolution or liquidation. Also, liquidation of troubled companies is a herculean task in itself owing to lack of potential buyers, which prolongs the recovery process, thereby defeating the entire purpose of liquidation. The regime consisting of IP, COCs, tribunals and other stakeholders is at its nascent stage and is yet to build capacities. Having said that, the Government has finally acknowledged the issue of stressed assets and is working towards holistically improving financial discipline.

Asset Reconstruction Companies (“ARCs”), organised under SARFAESI, provide liquidity to the market of sick companies. However, the law permits taking control of debt-loaded companies only for realisation of money. Post recovery, management must be transferred to the original debtor. Owing to this condition, ARCs are reluctant to utilise the provisions of SARFAESI. 

Role of RBI & SEBI

During the 2007 economic boom, banks lent without responsible due-diligence, followed by negligent post-advancement surveillance, resulting in accumulation of NPAs. The RBI played an overarching role in cleansing the B/S by setting up a Central Repository of Information on Large Credits (“CRILC”), for monitoring of borrowers exceeding the exposure of ₹50,00,00,000.

Corporate Debt Restructuring (“CDR”) Scheme, a non-statutory voluntary framework, was floated for reformation of debts exceeding ₹10 crores. The ‘CDR Cell’ calls for rehabilitation plan, from Joint Lenders’ Forum (“JLF”), and puts up before the ‘CDR Empowered Group’, which then makes a decision on individual instances of debt restructuring. The group after approval directs the Cell to formulate a detailed action plan.

The Strategic Debt Restructuring (“SDR”) Scheme permitted the JLF to initiate the restructuring process for bank-overdue exceeding 60 days. SDR sanctioned taking control of the entity for reclamation of money and carved out three methods of restructuring:

  • Conversion of debt into equity (wholly or otherwise)
  • Promoters introducing more equity into the entities,
  • Transfer of promoter’s holding to a security trustee until revival of the company.

Post conversion, the JLF collectively becomes the majority shareholder and must hold 51% equity. Banks then transfer their holding on to a new promoter.

Large ticket loans (above ₹500 crores), demand significant write-off and provisioning norms. The Scheme for Sustainable Structuring of Stressed Assets (“S4A”) avows to tackle such loans. Banks shall convert the debt into sustainable and unsustainable portions, followed by conversion of unsustainable debt into equity. JLF must hire professionals to ascertain the sustainability of debt. Subject to the sustainable part being 50%, bankers can utilise S4A which provides an optional right of acquiring control/management. Conversion mandates reflecting the market/fair value of the equity on the B/S. The resolution plan is prepared by JLF and supervised by an overseeing committee.

However, from March 2018, all the aforementioned schemes that were hitherto the mainstay of corporate debt restructuring stand abolished, making the Code a primary legislation governing the process of recovery.[7]

The Securities and Exchange Board of India (“SEBI”), with a view to enable cleaning the NPA mess, granted exemptions to investors acquiring shares from the banks (under any restructuring schemes) from making an open offer. These relaxations are conditional upon the shareholders’ approval. Additionally, pursuant to conversion, banks are not obligated to make an open offer. If the open offer requirement is blindly imposed, the buyer becomes unwilling to purchase because an open offer significantly reduces the funds available for acquisition. SEBI not only incentivised the buyers but also streamlined the process of liquidation.

Comments: These schemes help in ascertaining the amount that has become a fool’s errand, thus manifesting the necessity of recapitalisation. Writing off 50% of the debt causes momentary discomfort but fosters recoveries by letting the banks transfer the holdings after conversion, provided ARCs act as saviours. However, these schemes ran their due course and have been terminated by the RBI.

After gaining control, banks are expected to recover the dues through sale arrangements within 18 months, failing which all relaxations will stand withdrawn and assets will become NPAs attracting high provisioning norms. These stipulations can prove to be counter-productive as it directly impacts the profit by reducing the capital. 

Comparative Analysis

Nations have undertaken several steps in the form of securitisation (Italy), tax-breaks (China), government-backed buyouts (Spain), to prevent the growth of NPAs. Ranging from 5% (Croatia)[8] to 20.4% (Latvia)[9], countries have designed various techniques to issue recapitalisation bonds to smoothen banks’ B/S. Recapitalisation has been done through equity acquisitions and unreciprocated cash injections.

Due to NPAs (1995: ¥ 42 trillion),[10] Japanese stock markets crashed, operations of major credit operatives were shut down, banks collapsed and credit ratings were downgraded. To attack undercapitalisation, the Japanese government went out of their way and used public capital to fund banks (1998-2008: around ¥ 42 trillion)[11], reflecting positive change in the stock markets (5% gains)[12], effective NPAs write-offs, and boosting SMEs lending.

In South Korea, the state-owned Korean Asset Management Company (“KAMCO”), along with an NPA-fund, detoxified the economy by bringing NPAs down, from 17.7% (1998)[13] to 0.5% (2004)[14]. When the market was illiquid, KAMCO purchased the NPAs and assisted in recovery of public deposits (2003: 39% recuperated[15]), which were utilised for reinvigorate the financial health. KAMCO helped develop a reliable investor base in the NPA segment, thereby facilitating the restructuring process.

Subsequent to the bursting of housing-bubble in 2008, the U.S. Treasury launched a Public-Private Investment Partnership, which established a privately managed fund aimed at cleansing of bank’s B/S.[16] Investment in the fund was done both by the Treasury and private-players which was insured/guaranteed for debt-financing to sponsor the acquisition of troubled loans. The success of the program is evident from the returns received by Treasury [2014: Receipt of $18.6 billion (initial investment) along with positive return of $3.9 billion][17].

In 2016, Italy devised a mechanism to securitise and guarantee NPAs (2017Q2: 16.4%[18]) in form of Special Purpose Vehicles (“SPV”). Subsequent to setting-up of SPVs for NPAs’ disposal, banks may opt for public guarantees followed by sale of these securitised NPAs in the capital market. Since the reform is fresh, it is difficult to assess the implications of the same.


The burden of economic upheaval caused by NPAs is borne by the government and society. Owing to the catastrophes of laissez-faire, monetary mind-set and slanted incentives, the responsibility of overcoming the paralysis cannot be left to the market forces. Hitherto, neither ARCs nor the banks have contributed towards diluting the NPAs.

A surreal mix of birth and death can be manifested by the 24 ARCs[19], which could only resolve three deals (under SDR & S4A) and acquire sheer 5% of the total NPAs (₹72,626 crores).[20] Learning from the global experiences (Korea’s KAMCO; Malaysia’s Danaharta), the Government should constitute a state-funded ARC to contain twin B/S conundrums (overleveraged companies and bad-loan-encumbered banks). While this mushrooms the debt-stock, yet it uncannily cements the Government’s fiscal position as it diminishes the quantum which is ultimately diverted for recapitalisation. This centralised entity, by subsuming the loan-resolution process and providing a single-window clearance for restructuring, shall smoothen the recovery.

Owing to the failures of RBI’s schemes, we should work towards a voluntary out-of-court centralised restructuring process, involving a disinterested central bank, which should only act as a coordinating pin between the creditors, simultaneously preserving market’s faith.

The focus needs to deflect from finding methods of capital infusion to sanitising the B/S and securing of assets. Instead of recapitalisation, a consortium between the Government and non-public ARCs should be floated, through capital contribution, for acquiring NPAs. Post-disposal, the Government must compensate the consortium (on pro-rata) for any shortfalls. The aforementioned arrangement will incentivise the ARCs to play an overarching role in subduing the NPAs.

Renascence of investments, disinfection of banks’ B/S, upgradation of asset-valuation techniques and development of credit capacity should become India’s top priority. Owing to recurring governmental interventions, the future seems brighter and reflects the government’s sobriety in striking the issue at its gut. The fight is not over and light exists at the end of NPA tunnel. 

Pranjal Doshi

[1] Reserve Bank of India, Financial Stability Report, (December,2017)

[2] LS, Deb, 22nd December, 2017, vol 1291, cols (b), (c)

[3] International Monetary Fund, ‘Financial Soundness Indicators’

[4] Raunaq Pungaliya, ‘NPL resolution: A Lesson from the Korean Experience’ (2017) Centre for Advanced Financial Research and Learning Policy Note

[5] Govt unveils Rs 2.11 lakh crore plan to strengthen PSU banks’ PTI News (New Delhi, 24 October 2017) <

[6] Sajjid Chinoy & Toshi Jain ‘Taking bank recapitalisation to its logical conclusion’, Livemint (New Delhi, 13 November 2017) < recapitalisation-to-its-logical-conclusion.html >


[8] Michael Andrews, ‘Issuing Government Bonds to Finance Bank Recapitalization and Restructuring: Design Factors that Affect Banks’ Financial Performance’ (2003) International Monetary Fund Policy Discussion Paper

[9] Id  (Michael Andrews, ‘Issuing Government Bonds to Finance Bank Recapitalization and Restructuring: Design Factors that Affect Banks’ Financial Performance’ (2003) International Monetary Fund Policy Discussion Paper )

[10] Ulrike Schaede, ‘The 1995 Financial Crisis in Japan’(1996) The Berkeley Roundtable on the International Economy Working Paper No. 85

[11] Takeo Hoshi, Anil K Kashyap ‘Will the U.S. bank recapitalization succeed? Eight lessons from Japan’, (2010), Journal of Financial Economics 97

[12] Fabio Panetta, Thomas Faeh, Giuseppe Grande, Corrinne Ho, Michael King, Aviram Levy, Federico M Signoretti, Marco Taboga and Andrea Zaghini, ‘An assessment of financial sector rescue programmes’, (2009) Bank of International Settlement Papers No 48

[13] Raunaq Pungaliya, ‘NPL resolution: A Lesson from the Korean Experience’ (2017) Centre for Advanced Financial Research and Learning Policy Note 

[14] International Monetary Fund, ‘Financial Soundness Indicators’

[15] Dong He, ‘The Role of KAMCO in Resolving Nonperforming Loans in the Republic of Korea’, (2004) International Monetary Fund Working Paper 04/172

[16] U.S. Department of Treasury, ‘Treasury Department Releases Details on Public Private Partnership Investment Program’ (2009) 

[17] U.S. Department of Treasury, ‘Public-Private Investment Program’ programs/ppip/Pages/default.aspx

[18] International Monetary Fund, Financial Soundness Indicators’ 

[19] Reserve Bank of India, ‘List of Asset Reconstruction Companies (ARCs) registered with the bank as on November 30, 2017’

[20] Ministry of Finance, Government of India, Economic Survey 2016-17 (January 2017) 88


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