12. Non-performing Assets of Indian Banking: An Evolutionary Journey

Following Mohan (2011), we use the term North Atlantic Financial Crisis (NAFC), in contrast to the more widespread usage of the global financial crisis (GFC). It has been conscious and has been prompted by (a) the origin of the crisis, and (b) its lack spread across the globe beyond the North Atlantic.

For the bulk of our analysis, we consciously avoid 2020–21 because of the Covid19-related complications.

This discussion follows RBI Circular on “Prudential Norms on Income Recognition, Asset Classification and Provisioning—Pertaining to Advances” of August 30, 2001 (DBOD No. BP.BC/20/21.04.048/2001-2002) (RBI, 2001); available at https://​m.​rbi.​org.​in/​scripts/​BS_​ViewMasCirculard​etails.​aspx?​Id=​449&​Mode=​0 (accessed in May 2021).

Treatment of an agriculture loan is, however, slightly different and in the case of an advance granted for agricultural purpose, it is classified as an NPA if “interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half years”.

RBI Master Circular on Wilful Defaulters of July 2, 2007; available at https://​www.​rbi.​org.​in/​Scripts/​BS_​ViewMasterCircul​ars.​aspx?​Id=​3670&​Mode=​0.

This period was marked by presence of “lazy bankers”; see Mohan (2002) for details. It is pertinent to turn to RBI’s Report on Currency and Finance, 2007, which noted, “Bank credit, after witnessing an erratic pattern in the first half of the 1990s, showed a deceleration from 1996–97 to 2001–02….. Several factors, both on the demand and the supply sides, contributed to the contraction of credit. On the supply side, introduction of prudential norms relating to income recognition, asset classification and provisioning in the mid-1990s made banks cautious. Application of norms revealed large gross NPAs with banks…. Banks, therefore, became wary of enlarging their loan portfolio. The relatively high level of NPAs, in particular, had a severe impact on weak banks. Banks’ capacity to extend credit was also impaired due to little headroom available in the capital adequacy ratio ….. Banks found risk-adjusted returns on government securities more attractive. Hence, despite lowering of statutory pre-emption in the form of SLR, banks continued to invest in government securities, far in excess of the requirements. …. On the demand side…the corporate sector faced intense competition during the latter part of the 1990s. The focus of the corporate sector, thus, shifted from expanding capacity to restructuring and the industrial sector slowed down significantly. …Increased competition also forced corporates to restructure their balance sheets, whereby they increased their reliance on retained earnings and reduced their borrowings.”

The performance of recovery under the SARFAESI Act was not impressive. One of the major drawbacks of the Act is that it is not applicable to unsecured creditors. There were implementation-related issues. Some of the loopholes were, in principle, plugged in the Insolvency and Bankruptcy Code, 2016.

Banks were initially required to mark to market 30% of their investment portfolio in 1992–93—the proportion was gradually raised to 75% in 1999–2000.

Insofar as low growth during the initial years of this period is concerned, Mohan (2019) notes, “There was… some loss of the growth momentum in the latter half of the 1990s in the wake of the East Asian financial crisis, setbacks to the fiscal correction process, deterioration in the quality of fiscal adjustment, slowdown in agriculture growth affected by lower than normal monsoon years, some slackening in the pace of structural reforms, monetary tightening to contain inflation, and excessive enthusiasm and optimism with regard to investment plans in domestic industry following deregulation, some of which went awry” (p. 12).

RBI’s Report on Currency and Finance, 2007–08 noted, “Major factors that contributed to the acceleration in credit growth were pick-up in economic growth, improvement in asset quality of the credit institutions, moderation in inflation and inflation expectations, decline in real interest rates, rising income of households and increased competition with the entry of new private sector banks (as detailed in the subsequent sections). The removal of restrictions on retail credit and project finance by banks also created new sources of credit demand”.

See Mohan and Ray (2019) for details of India’s stimulus package following NAFC.

The word regulatory forbearance has been used repeatedly in this paper. A priori it could be interpreted in two senses, viz., (a) the regulator knows what was going on when there were periodic bouts of excessive lending particularly by public sector banks to dubious credits but held back on pointing out the dangers involved; and (b) the regulator is taking overall stability of the banking sector and ramifications for the financial sector as a whole, but chooses not to rattle markets by blowing the referee's sharp whistle in a situation where growth and perceived lack of credit could be a concern. We have primarily used the word regulatory forbearance in the sense of (b). Of course, regulatory forbearance of various shape and form tended to take place in various periods in Indian banking.

This is except in the case of direct advances to the agricultural and SME sectors which shall continue to attract provisioning of 0.25%, as earlier.

The AQR used off-site data extensively and compared the quality of these loan assets against applicable Reserve Bank norms. The banks were advised about the position that emerged from the review, along with a recommendation to adjust impairments in their books appropriately.

RBI Circular on “Resolution of Stressed Assets—Revised Framework”, No. DBR.No.BP.BC.101/21.04.048/2017-18, available at https://​www.​rbi.​org.​in/​scripts/​NotificationUser​.​aspx?​Id=​11218&​Mode=​0. In the revised framework, a strict deadline of 180 days was put in place; during this period. A resolution plan must be implemented, failing which stressed assets must be referred to the National Company Law Tribunal (NCLT) under IBC within 15 days.

The original PCA framework was introduced in December 2002 as “a structured early intervention mechanism along the lines of the FDIC’s PCA framework”. Subsequently, the RBI reviewed the framework in line with the recommendations of the Working Group of the Financial Stability and Development Council (FSDC) on Resolution Regimes for Financial Institutions in India (January 2014) and the Financial Sector Legislative Reforms Commission in March 2013 (Acharya, 2018).

The role of the commodity price fall in the generation of NPAs has been documented and analyzed in Kumar et al. (2022).

Of course, the macro and sectoral impact of a general fall in commodity prices could differ. As India is a net importer of several crucial commodities including oil, a general fall in commodity prices could be beneficial to the economy, but for the importing firms, it could have deleterious effects and may lead to NPA formation. Besides, if steel prices fall that may be bad for companies like Bhushan Steel but should be good for the construction industry and home sales. Hence, the initial fall in supply could be counterbalanced to some lesser extent.

This observation needs reconsideration in light of the recent severe banking stress exhibited in the United States. Even some relatively large banks have shown inadequate interest rate risk management in the presence of rapidly tightening of monetary policy by the US Federal Reserve in 2022–23. Hence there may be a legitimate role for banking regulators to stave off such potential financial instability through relevant regulation, analogous to macroprudential regulation.

Note that data sources for Tables 12.8 and 12.9, on the one hand and Table 12.11, on the other are distinct and, hence, strictly speaking, data are not comparable between these tables. While Tables 12.8 and 12.9 are derived from data collected under the especially collected Basic Statistical Returns, Table 12.11 is from the statutory returns of sectoral deployment of gross bank credit.

Later in 2012, in another auction of 2G spectrum (in both GSM and CDMA bands), the government received bids worth a total of Rs. 9,4 billion, far lower than its target of Rs. 280 billion from the sale of 2G spectrum in the GSM band. Subsequently, in March 2013 too response to the spectrum auction was poor.

These loans were restructured in 2012, with a three-year moratorium for the principal amount of Rs. 430 billion.

The names of the following corporate groups, viz., Adani Group, Essar Group, GMR Group, GVK Group, Jaypee Group, JSW Group, Lanco Group, Reliance ADAG, Vedanta Group, and Videocon Group have been reported in the House of Debt report of October 2015 (see, https://​plus.​credit-suisse.​com/​rpc4/​ravDocView?​docid=​V4pSWN1AF-WElY95). In March 2007, “these groups owed the Indian banking system a total of Rs. 99,300 crore, or around 5.7% of the total loans given out by the Indian banking system. In March 2012, the loans had jumped to around Rs. 5,39,500 crore” (Kaul, 2020). Later it reached Rs. 7,335,45 crore in 2014–15. Chart 12.6 reports updated numbers from the Economic Survey, 2016–17.

In response to the Lok Sabha Question No. 1551, the Minister of State in the Ministry of External Affairs [Gen. (Dr.) V. K. Singh (Retd)], listed 41 names on December 19 2018. Specifically, he replied, “According to the information provided by the ED, the list of people involved in financial irregularities and facing criminal investigation and who fled the country or are living abroad are as follows: (i) Shri Vijay Mallya; (ii) Shri Christian Michel James; (iii) Shri Nirav Modi; (iv) Shri Mehul Choksi; (v) Shri Ashish Sureshbhai Jobanputra; (vi) Mrs. Priti Ashish Jobanputra; (vii) Shri Ramachandran Viswanathan; (viii) Shri M.G. Chandrasekhar; (ix) Shri Sanjay Bhandari; (x) Shri Nitin Jayantilal Sandesara; (xi) Shri Chetan Jayantilal Sandesara; (xii) Smt. Dipti Chetan Sandesara; (xiii) Shri Hiteshkumar Narendrabhai Patel; (xiv) Shri Deepak Talwar; (xv) Smt Deepa Talwar; (xvi) Shri Sunny Kalra; (vii) Smt Aarti Kalra; (viii) Shri Sanjay Kalra; (xix) Smt Varsha Kalra; (xx) Shri Jatin Mehta; (xxi) Shri Lalit Modi; (xxii) Shri S. Harpal Singh Dutta; (xxiii) Shri Ritesh Jain (xxiv); Shri Mugundhan Ganyam; (xxv) Shri Pushpesh Kumar Baid; (xxvi) Shri Nitish J. Thakur; (xxvii) Smt. Purvi Modi; (xxviii) Shri Mihir Rashmi Bhansali; (xxix) Shri Aditya Nanawati; (xxx) Shri Sunil Verma; (xxxi) Shri Neeshal Deepak Modi; (xxxii) Shri Nehal Modi; (xxxiii) Shri Maiank Mehta; (xxxiv) Shri Jayesh Indervadan Shah; (xxxv) Shri Deepak Krishnrao Kulkarni; (xxxvi) Shri Deepak Modi; (xxxvii) Shri Subhash Shankar Parab; (xxxviii) Shri Rajiv Saxena; (xxxix) Shri Rajesh Gajera; (xl) Shri Carlo Valentino Fernando Gerosa; (xli) Shri Guido Ralph Haschke”; available at https://​www.​mea.​gov.​in/​lok-sabha.​htm?​dtl/​30788/​QUESTION_​NO1551_​FINANCIAL_​ABSCONDERS_​ABROAD.

In the context of the political economy of financial sector corruption, Majumdar (2016) commented, “Firms borrowed more because banks willingly lent them more, irrespective of project or business viability”.

Two recent books do exciting analyses of the relevant issues for India; see Kaul (2020) and Bandopadhyay (2020) for select cases of corruption and interferences in Indian banking.

Shri Viond Rai, the first Chairman of BBB reportedly mentioned in a letter to the Finance Ministry, “The bureau, as a body of experts on public sector banking, would be able to provide greater utility to the FM on matters relating to the governance and performance of PSBs, if there were to be greater organic linkage and dialogue with the finance ministry. At present, the body is merely functioning as an appointment board” (Business Standard, October 20, 2018, available at https://​www.​business-standard.​com/​article/​finance/​rai-alleges-communication-breakdown-between-banks-board-bureau-and-govt-118031901218_​1.​html).

RBI Circular on “Resolution of Stressed Assets—Revised Framework”, number RBI/2017-18/131 DBR.No.BP. BC.101/21.04.048/2017-18, available at https://​www.​rbi.​org.​in/​scripts/​BS_​CircularIndexDis​play.​aspx?​Id=​11218.

Earlier schemes included CDR, JLF, SDR, S4A, flexible restructuring and others.

More recently, on April 3, 2019, however, the Supreme Court has effectively struck down the February 12, 2018 circular; the Bench assailed the circular as ultra vires to the provisions of the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934 in the Dharani Sugars and Chemicals Ltd. v. Union of India case.

In commenting on the paper, Dr. C. Rangarajan put forward the idea of relating credit growth to the growth of nominal GDP. After all, credit growth disproportionate to nominal income growth could generate NPAs. We have shown conclusively that much of the large corporate NPAs that arose in the 2010s were in fact the result of large lending in the post 2009 period.

Recognizing that the second wave of the pandemic could pose difficulties in loan servicing, the RBI announced Resolution Framework 2.0 allowing “restructuring of loans taken by individuals, small businesses and MSMEs with an exposure cap of ₹25 crore”. There were other measures as well, viz., fresh lending to MSMEs was allowed equivalent exemption from the Cash Reserve Ratio (CRR); and banks were also allowed to utilize 100% of countercyclical provisioning buffer for making specific provisions for NPAs.