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Breaking Bad


The burning question – What is NPA?

An asset with a bank becomes a non-performing asset (NPA) if, as per the current RBI regulations, interest and/or principal on a loan remains unpaid for 90 days. Depending upon the nature of the security available / recoverability, banks are required to make provisions for these NPAs ranging from 15 to 100%. The sharp increase in NPAs over the years can be largely attributed to (1) A sustained economic slowdown for over a decade now (2) Unscrupulous lending by banks & Financial Institutions without proper assessment of actual funding requirements and its end use (3) Lack of monitoring (4) Somewhat ineffective legal system & insolvency process. This has resulted in the evaporation of lakhs of crores of public money over a period of time. The graph below gives an idea of the growing NPA menace in the Indian Banking System.

As evident, there has been a steady surge in the gross NPAs over the past 9 years. The gross NPAs crossed the Rs 10 lakh crore mark for a brief period in March 2018. For FY19, the absolute gross NPAs stood at Rs 9.36 Lakh crores (around 5% of the GDP).

Still not boggled by the huge numbers?

To put the gravity of the issue into a better perspective, as per CRISIL estimates, India will permanently lose 4% of its GDP as a result of COVID-19. Scared of doing the math? At Rs 200 Lakh crore of GDP, India stands to lose Rs 8 Lakh crore permanently. The actual impact on loan recovery will be known post the end of the 6-month loan moratorium in September 2020, and the results are less likely to be encouraging.


Apart from the implementation of stringent loan monitoring mechanism and agile recovery process, there is another option which could give the banks a partial relief – A Bad Bank.

When a lot of junk we don’t need (old furniture, old car, age-old computer, etc.) gets accumulated in our homes, we have two choices – Sell them at a discount, write off the losses, and start with a clean slate. If we don’t, we incur expenditure on maintenance and storage which is at times higher than the fair value of the asset. The bad bank idea is somewhat equivalent to the first choice.

Let’s consider an example- XYZ Bank had given a loan of Rs 1000 crores to a company – PQR Ltd for a tenure of 10 years. Now, after 2 years, it is found that the company is not able to pay the balance loan of say 800 crores and it turns into NPA. In this situation, XYZ has two options – (a) sell this Loan to a bad bank at an agreed value which could essentially be at discount, or (b) let the loan continue in its balance sheet, while making the necessary attempts to recover it.

You might think, why would banks bother to sell their NPLs at discounts and incur losses? Well, if they don’t:

  1. Significant management bandwidth, which otherwise is supposed to be used to do core business, will get choked in managing the stressed assets.

  2. Banks would have to make provisions until either the loan is recovered, or a complete loss is recognized. This would have a domino effect on the net profits of the banks, their ability to grow further, their market valuation, among others. This could also impact the prospects of further capital raising by the banks.

  3. Higher NPAs in the bank’s balance sheet would mean a higher perceived risk by the market, lower credit ratings, and hence, the banks would have to pay higher interest for its fixed income instruments (Bonds/Fixed Deposits/Certificates of Deposits, etc.), leading to a higher cost of funding.

Put simply, A bad bank is supposed to relieve the banks from this tedious process of loan resolution and recovery, and give the management adequate bandwidth to carry on business as usual.