Review of NPA norms is need of the hour

Many of India’s business models have faced disruptions due to a number of major policy and structural changes undertaken in the last 5 years. While those changes augur well for the industry in the long run, they did create some temporary challenges, which has been reflected in the economic slowdown in the last few quarters.

On top of that, the flow of credit has slowed down from both the banks and the Non-Bank Financial Companies (NBFCs). The disruptions, followed by the credit crunch, have been a setback for the spirit of entrepreneurism in India.

Banks have been the primary source of funds for most economic activities in India, whether it is done through direct lending, or indirectly through NBFCs. However, in the last few years, the banks have been mostly busy dealing with their bad loan problem.

Presently, the provisioning norms, as given in the non-performing asset (NPA) guidelines issued by RBI, are quite stringent and have locked up funds and stifled the flow of credit for new economic activity. The resultant draught of capital is becoming a major challenge and despite the government’s best efforts the economic growth rate is not picking up. It is, therefore, worthwhile to review the NPA definition and the associated rules in order to break the shackles for the financial sector.

At present, NPA identification in India is done on the basis of how many days the dues for a loan asset have remained unpaid. This becomes a huge constraint for the borrower.

A default need not always be because of the borrower’s fault. In India, a contractor working on a government project often has to take a loan for carrying out the assignment. But if there is a delay on part of the government to make its payments, the contractor may find it difficult to service his loan. The resultant default instantly becomes public information and all avenues for accessing finance close immediately. The contractor, for no real fault of his own, gets treated like an untouchable within the financial ecosystem.

In most jurisdictions while the number of days is taken into consideration, that is not the only determining factor. For example in European Union, a borrower’s ‘ability to pay’ is taken into consideration as well. In United States, the value of collateral is given adequate importance. In addition, the ‘past due’ number of days criterion is essentially used for loans of small-ticket size, whereas for large-ticket loans, several qualitative and quantitative factors are also taken into consideration.

At present, demarcating an account as NPA and subsequent write-offs result in higher provisioning and that leaves the bank with less money to offer for fresh lending. This also impacts the real value of assets. So many businesses are heading for liquidation. This is resulting in serious destruction of economic value and also killing the spirit of entrepreneurship. This is becoming a vicious cycle and something which we cannot simply afford in a capital-starved country like ours. When there are cash-flow mismatches on a particular asset, the asset / customer should not be treated as an NPA.

Ideally, under the present economic conditions, for all impaired loans where the borrower is a victim of circumstances, the regulator (i.e. RBI) should allow restructuring, as long as the asset is yielding cash flows. Stress-test for the asset should be done and provision should be carried out according to the value of the asset, the collateral, the net present value (NPV) of future cash flows and other necessary quantitative as well as qualitative factors. This would allow the lender some space to consult the defaulter and mutually agree on certain terms of restructuring the loans so that the borrower can come to terms with the problems faced. This would be a more constructive approach as this would ensure continuity of the projects and enterprises instead of bringing everything to a grinding halt.

The NBFCs’ business model is very different compared to that of a bank. NBFCs typically indulge in asset-backed lending and it is their expertise and ability to manage, monitor and deal with the underlying asset in a focused manner that is the reason behind NBFCs having a far better track-record in NPLs vis-à-vis banks. Therefore, the NPL norms for banks should not be imposed on NBFCs. It is also worth noting that the NBFCs in India have already migrated to the Indian Accounting Standards (Ind-AS), even before the banks. However, there is still no clarity on whether NBFCs have to adhere to Ind-AS norms or RBI guidelines or follow both.

The Ind-AS is a more transparent method of accounting and is aligned with the globally followed International Financial Reporting Standards (IFRS). Under this, the method of calculating provisions for bad loans is more stringent by taking into account the cash flows and the value of the asset. Regulations should be in terms of capital adequacy, and not in terms of provisioning as that would be a roadblock to fuelling fresh economic activity. For an NBFC, if there are cash-flow mismatches on a particular asset, the asset / customer should not be treated as an NPL. Stress-test for the asset should be done and provision should be carried out according to the value of the asset.

To carry out an in-depth analysis and review of the present NPA definition and its associated rules, a high-powered committee with representatives from Government, RBI and Industry may be set up. The scope of this committee would be to look into the global best practices and evolve NPA norms suitable in a developing nation like ours. If we look at the NPA recognition norms for infrastructure projects, they are simply no different from those of any other asset class. Infra projects are far more complex and can get influenced by regulatory changes, judicial pronouncements, changes in taxation rules, etc.