‘Khate mein likh lo’ - AQR 2.0 and NPAs (Part 1)

Written by - Vibhav Bhat and Yash Prashant Bhave

PGDM Finance- TAPMI, Manipal

A businessman inherited companies from his father early in his career. He turned his fortune into profits and made the spirits company inherited India’s biggest spirit maker and at the age of 28 he became a chairman. However, the other businesses failed and it crashed so hard it was difficult to sustain. He was investigated for irregularities in these businesses and alleged for siphoning funds out of them. He is none other than Vijay Mallya who was chairman of UB group and owner of now closed Kingfisher airlines. He cost the banking sector dearly and has become a poster boy of NPA in India.

What actually are NPA?

Giving out loans is one of the most important functions of a bank. When a bank gives out loans, it earns on the money it lends through the interest factor of lending. Hence, these act as assets for banks as it earns money.

Those assets (loans) whose interest or principal payment has been due for past more than 90 days are termed as non-performing assets. Further banks bifurcate these into categories of-

1. SMA (Special Mention Account)

2. Sub-standard

3. Doubtful

4. Loss.

Table - Classification of assets based on non-payment periods.

Banks when lending out know for a fact that their business is risky and some defaults are bound to happen. Hence, they make provisions for them based on certain risk factors and keep the amount aside to deal with these bad loans.

NNPA is achieved by subtracting these provisions from the gross NPA. This gives a much clearer picture of the risk of duress the bank is facing.

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Reasons for NPA

In 2015 the NPA outstanding on paper increased drastically as RBI tightened the norms for identification and performed AQR (Asset Quality Review). One of the major reasons for NPA in 2015 was due to global recession which affected local companies that could not repay their obligations.

Similarly, today due to global pandemic and reduced trade and business activity over the past 1 year has led to the diminished capacity of firms who had taken debt before the pandemic. They are not in a position to repay the loan. The government had extended a moratorium to help them out by holding them in the slabs of assets they were in before the start of the pandemic (SMA and others as discussed). However, post the moratorium (31 Aug 2021) banks need to identify immediately the accounts which have defaulted and classify them appropriately.

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Consequences of holding NPA

Banks need to take the onus and classify appropriately their assets. However, in reality, sometimes banks do not do so. Majorly banks showing NPA on their balances affect their operations.

If the NPA is too high RBI can impose restrictions on their lending activities. Also, investors of banks lose trust including depositors which in acute cases cause bank runs. Hence, banks take a calculated risk in this regard by not displaying true figures sometimes.

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Techniques banks used to deal with NPAs in 2015

Fig – Techniques banks do to deal with NPAs

Using techniques shown in image banks displayed a great performance but the ground reality was different which was uncovered by the AQR in 2015.

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Now with the base set we can discuss AQR in our upcoming article. Stay tuned to know more about banking sectors future post moratorium period and pandemic induced slowdown.

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