Reserve Bank of India Circular of 01.10.2021, reiterates Prudential Norms for Asset Classification for Banks. The concept of NPAs is an imported formula imposed on indian banks without foresight and vision. It has been copied from efficient economies of Europe and the Americas, where citizens enjoy social security to fall back upon during tough times. 

In India, the situation is challenging as every home has to fend itself without any social security. Child education fee, emergency hospitalisation and social customs like dowry force Indians to invariably divert cash flows from committed repayments year on year and it is impossible for most Indians to pay all 12 EMIs of a loan in a year. The policy should essentially capture the Indian ethos, social customs and lifestyle to arrest NPAs to heal the bleeding local banks and corporates. 

As per the RBI Circular cited above, a non performing asset (NPA) is a loan where; interest and/or instalment of principal remains overdue for a period of more than 90 days. Interest realised on NPAs may be taken to the income account. provided the credits are not out of fresh/additional credit facilities. 

Significant instructions of fresh RBI Circular are :

Substandard Asset

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 debt and there is a possibility that the banks will sustain some loss, if deficiencies are not corrected. 

Doubtful Asset 

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 weaknesses inherent in substandard assets, with the added characteristic that the weaknesses make collection highly 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.

No Weightage to Security /Guarantee 

The availability of security or net worth of the borrower/guarantor should not be taken into account for treating an advance as NPA. If arrears of interest and principal are paid by an NPA borrower, the account should be treated as performing and may be classified as ‘standard’ accounts. 

Overdue Derivatives Also NPA 

The overdue receivables representing positive mark-to-market value of a derivative contract will be treated as a non-performing asset, if these remain unpaid for 90 days or more. In case over dues arising from forward contracts and swaps and options become NPAs, all other funded facilities shall also be classified as nonperforming assets following the principle of borrower-wise classification as per the existing asset classification norms.

Current Credit Exposure as NPA 

In cases where the contract provides for settlement of the current mark-to-market value of a derivative contract before its maturity, only the current credit exposure (not the potential future exposure) will be classified as a non-performing asset after an overdue period of 90 days.

Asset Classification As Per Security

Erosion in the value of security can be reckoned as significant when the realisable value is less than 50 per cent of the value assessed by the bank or accepted by RBI at the time of last inspection. Such NPAs may be straightaway classified as doubtful.If the realisable value of the security, as assessed by the bank/approved valuers/RBI is less than 10 percent of the outstanding in the borrowal account, the existence of security should be ignored and the asset should be straightaway classified as loss asset. 

Fraud Accounts 

Banks should provide for the entire amount due to the bank immediately upon a fraud being detected. While computing the provisioning requirement, banks may adjust financial collateral eligible under Basel III Capital Regulations - Capital Charge for Credit Risk (Standardised Approach), available with them with regard to the account declared as fraud.

Haste in Implementing Asset Classification Norms

In all of the above instructions, the Regulator has gone running to Basel and brought in  international guidelines, although Indian borrowers are still perfecting the art of walking in an aspirational Indian economy infested with challenges. It is a known fact that most of the countries in Europe and Americas had not accepted the Capital Adequacy Norms of Basel for decades to protect their Banks and Customers in contrast to what we have  done in India. This “holier than thou” approach has immobilised the economic wheels of the country by vilifying many businesses. It will be beyond; FY 2027-28 that India’s GDP touches $ 5.00 trillion mark. 

Five Steps RBI Should Takes to Defray NPA Pains

1. Capture Indian Ethos of Debt Servicing

Indian Society celebrates loudly; both family and religious functions. Liberal dowry and gifts exchanging is deep rooted. Large savings are spent on the occasion of birth and the death in the family. Every penny is galvanised to empower children with education. The size of the Indian family is also big. As such a family can pay only nine EMIs in a year. It would be realistic if repayments/interest servicing is carved for nine months every year to meet Indian aspirational priorities and ethos. This would curb NPAs.

2. Net Off Value of Collateral Before Declaring NPA Outstanding Amount

RBI instructions permit netting off the value of collateral security from outstanding loans while making provisions on NPAs. No such netting is available while calculating the level of outstanding NPA. Entire loan is shown as NPA. What then is the use of taking Collateral Security? Huge outstanding loans despite the underlying bluechip collaterals give a wrong impression of the picture and demean the already depressed borrowers and banks. The value of collateral should be netted off from the loan before declaring the NPA amount. Where security value is higher than outstanding NPA amount such accounts to be closed in SARFAESI action and declared as Loans Under Collection in bank balance sheets to give a true picture of possible loss to banks as practiced under NPA norms worldwide.

3. Don’t Withdraw Forward / Hedging Facility from Export/ Import NPAs 

Indian banks withdraw from a Sub Standard Importer Exporter NPA is the hedging facility. This escalates the finance cost and completely upsets his business plan of importing and exporting on long term contracts due to uncertainty in Forex rates. All hedging facilities should continue for NPAs.

4. Don’t Crystallise PCFC/FCNR(B) Exposure at Card Rates into INR

The worst punishment given to Importer/Exporter on becoming NPA is converting the entire Packing Credit/PCFC/FCNR(B) into INR at Card Rates. In addition, heavy OD interest is charged shooting up the cost from 3.5% pa (LIBOR+250 bps) to 10.5% pa. This acts as a poison pill for Forex customers in almost all cases. Crystallisation should be done at PC/PCFC/FCNR(B) contracted rates as exports are Valued Lendings.

5. Do Not Convert Export / Import Proceeds at Card Rates  

Every dollar received through exports in an NPA account is converted into rupee at a margin of 12 paise a dollar rather than 01 paise a dollar hurting the exporter deeply. Export proceeds be converted at minimum margin.

If above five changes are brought in by RBI in Prudent Asset Classification Norms, the NPAs shall be less and India’s cherished dream of becoming a $ 5.0 trillion economy will be accomplished in near future. 

(Mr. Hargovind Sachdev has over 39 years of banking experience having occupied senior positions in UCO Bank, United Bank of India, State Bank of Patiala, State Bank of Travancore & State Bank of India where he headed the Central European Credit Desk at Frankfurt, Germany from 2006 to 2011 covering 15 countries of Central Europe.)