Review of Npa standards is urgently needed
Many of India’s business models have been disrupted due to a number of major political and structural changes undertaken over the past 5 years. While these changes bode well for the industry in the long term, they created temporary challenges, which was reflected in the economic downturn in recent quarters.
On top of that, the flow of credit has slowed down from both banks and non-bank financial corporations (NBFCs). The disruption, followed by the credit crunch, was a setback for entrepreneurship in India.
Banks have been the primary source of funding for most economic activities in India, whether through direct loans or indirectly through NBFCs. However, in recent years, banks have mostly dealt with their bad debt problem.
Currently, the provisioning standards, as set out in the RBI’s Non-Performing Assets (NPAs) guidelines, are quite strict and have blocked funds and choked the flow of credit for new ones. economical activities. The resulting capital drawdown becomes a major challenge and despite all government efforts, the rate of economic growth is not accelerating. It is therefore interesting to review the definition of the NPA and the associated rules in order to break the shackles of the financial sector.
Currently, the identification of NPAs in India is done on the basis of the number of days that the contributions of a loan asset remained unpaid. It becomes a huge strain on the borrower.
A default does not always have to be the fault of the borrower. In India, an entrepreneur working on a government project often has to take out a loan to complete the assignment. But if there is a delay on the part of the government in making payments, the entrepreneur may have difficulty repaying their loan. The resulting default instantly becomes public information and all avenues of access to funding are immediately closed. The entrepreneur, through no real fault on his part, is treated as an untouchable within the financial ecosystem.
In most jurisdictions, although the number of days is taken into consideration, it is not the only determining factor. For example, in the European Union, the “ability to pay” of a borrower is also taken into account. In the United States, the value of collateral is given sufficient importance. On the other hand, the criterion of the number of days of “delay” is mainly used for low-value loans, while for high-value loans, several qualitative and quantitative factors are also taken into account.
Restructuring of impaired account
Right now, delimiting an account as an NPA and subsequent write-offs results in higher provisioning and the bank has less money to offer for new loans. It also has an impact on the real value of the assets. So many companies are heading for liquidation. This leads to severe destruction of economic value and also kills entrepreneurship. It becomes a vicious cycle and something we just can’t afford in a capital-strapped country like ours. Where there are cash flow mismatches on a particular asset, the asset / customer should not be treated as an APN.
Ideally, under current economic conditions, for all bad loans where the borrower is a victim of the circumstances, the regulator (i.e. RBI) should allow the restructuring, as long as the asset generates cash flow. . A stress test for the asset should be performed and a provision should be made based on the value of the asset, collateral, net present value (NPV) of future cash flows and other quantitative factors and qualitative requirements. This would leave some space for the lender to consult with the defaulter and mutually agree to certain loan restructuring terms so that the borrower can deal with the problems encountered. It would be a more constructive approach because it would ensure the continuity of projects and businesses instead of suddenly stopping everything.
NBFC different from banks
The business model of NBFCs is very different from that of a bank. NBFCs typically engage in asset-backed lending and it is their expertise and ability to manage, monitor and process the underlying asset in a targeted manner that is why NBFCs have a much better track record in NPL. vis-à-vis the banks. . Therefore, NPL standards for banks should not be imposed on NBFCs. It is also interesting to note that NBFCs in India have already migrated to Indian Accounting Standards (Ind-AS), even before the banks. However, it is still not clear whether NBFCs should adhere to Ind-AS standards or RBI guidelines or follow both.
Ind-AS is a more transparent method of accounting and is aligned with internationally followed International Financial Reporting Standards (IFRS). In this context, the method of calculating provisions for doubtful debts is stricter, taking into account cash flows and the value of the asset. The regulations should be in terms of capital adequacy, and not in terms of provisioning, as this would be an obstacle to the revival of 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. A stress test of the asset should be performed and a provision should be made based on the value of the asset.
High level committee
To conduct an in-depth analysis and review of the current definition of NPA and its associated rules, a high-level committee consisting of representatives from government, RBI and industry may be established. The scope of this committee would be to examine global best practices and evolve NPA standards suitable for a developing country like ours. If we take a look at the NPA recognition standards for infrastructure projects, they are just not unlike any other asset class. Infra projects are much more complex and can be influenced by regulatory changes, court rulings, changes in tax rules, etc.
The author, Sunil Kanoria, is the co-founder of the SREI Group and former president of ASSOCHAM. Opinions expressed are personal
First publication: STI