For running a business, raising a loan from a financial institution is a commonly accepted habit which is not only cheap but also offers more stability. This loan also carries interest and regular payment of equated monthly instalments (EMIs). However, after the pandemic and the subsequent lockdown, there is a severe impact on the business. A large number of businesses are looming under great stress, and some of them are on the verge of winding up. At this juncture, it is very difficult to make regular payments of interest and the EMIs. If the situation persists, the loan account can be classified as a non-performing asset.
In this article, we will discuss the meaning, features and grounds of non-performing assets. Further, we will also shed light on how to recover the money, if the account is classified as NPA.
Non-Performing Asset (NPA)
Before understanding the meaning of NPA, it is important to go through the definition of assets. The term ‘asset’ means both the tangible as well as intangible property whose value increases or decreases with time. In other words, the asset may have positive or negative outcomes against the time value of money. For better understanding, it is important to note that tangible assets refer to those assets which have physical existence or can be touched whereas intangible assets don’t have a physical existence. A common example of intangible assets is goodwill.
In the regular course of business, the lender gives some money to the borrower on the promise to get it back after a stipulated period along with a regular interest, which can be monthly, quarterly or annually. So, from the perspective of the creditor, the loan advanced by him is an asset which has the capability of generating regular interest income.
Since the loan is an asset for the creditor, any default on the part of the borrower in the repayment of the principal amount or on the interest will make this asset a burden as it is not generating any income. So, the term ‘non-performing’ is used for those assets which do not produce any income and become an unnecessary burden. Thus, in a nutshell, it can be said that the non-performing assets refer to all such loans wherein the interest or the principal amount is not getting received, and they have become a liability on the books of the lender.
Legal Definition of a Non-Performing Assets
The aforesaid discussion about the meaning of Non-performing assets was just a snippet to get an overview of the subject. The law has provided a very comprehensive definition, including various necessary elements.
Definition of SARFAESI Act
The definition of non-performing assets is provided under Section 2(O) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The definition provides that a non-performing asset means an asset which has been classified by a bank or financial institution. For classifying an account as NPA, the following conditions must be satisfied –
- If the bank is under the authority or control of any other supervisory body, the order of classification must be made from that superior body.
- The guidelines floated by the Reserve Bank of India (RBI) about NPAs shall be given due consideration.
It is important to note that all the assets, which are classified as substandard or doubtful assets, shall be treated as Non-performing assets.
Definition of Non-Performing Asset by Reserve Bank of India (RBI)
As per the RBI Master Circular, a Non-performing asset is defined as a credit facility wherein the repayment of the principal amount and the interest is “past due” for a specific period. The period discussed above is 2 quarters in a financial year ending on March 31. This period mustn’t be concrete and subject to change by another circular.
When does a Loan become an NPA?
As discussed above, if the loan advanced by the lender is defaulted by the borrower, the next step for the lender is to declare the loan as a non-performing asset. Normally, a loan is classified based on the number of due days for the payment of interest. To simplify further, it can be said that, a loan will be declared as an NPA if –
- The payment of interest or the principal amount of the loan is due for more than 90 days about a term loan.
- The loan account is rendered ‘Out of order’ for a period exceeding 90 days in case of bank overdraft, cash credit, etc.
- The bill remains unpaid or overdue for a term exceeding 90 days in case of bills of exchange or bills discounted.
- Any other amount which is due for more than 90 days.
It is the responsibility of the banks to create a list of accounts, which are declared as NPA before the end of the financial year.
Classification of Non-performing assets
Normally, NPAs can be classified into 3 categories based on a master circular issued by the RBI. The categories are as follows –
It refers to those assets which are classified as NPA and remain unpaid for less than 18 months from the date of declaration. Since a lot of time has lapsed, their value is very minimal. This kind of assets signifies credit weakness as they are the biggest financial burden on the bank and it will suffer a substantial loss in the case of liquidation.
In these categories, those assets are included which are classified as non-performing assets for more than 18 months. They can be understood as an extension of the sub-standard assets. For banks, it is highly improbable to recover money against such assets.
It refers to those assets which are ascertained as ‘unrecoverable’ from the internal or the external auditors of the bank but didn’t completely write off from the books of accounts. It is a commonly accepted practice that the recoverable amount against loss assets is highly rare.
Consequences of Declaring an Asset as a Non-Performing Asset
After a loan account is declared NPA, it depicts the financial obligation or the burden of the bank to carry that loan on its books of accounts. Thus, the bank or the financial institutions initiate proceedings to get rid of such a burden. They have the following options available –
Institution of Civil Suit
The first and foremost step is the institution of a civil suit against the borrower. This suit will be governed by the provisions of Section 58 to 104 and Section 130 to 137 of the Transfer of Properties Act, 1882.
Further, If the amount of NPA is more than 20 Lakh rupees, the Bank is also entitled to file an original application before the Debt Recovery Tribunal by the provisions of the Recovery of Debts and Bankruptcy Act, 1993.
Recovery through Sale of Assets
As per the Narasimhan Committee, SARFAESI Act, 2002 was enacted by the Parliament. In this Act, stringent powers were conferred to the banks and financial institutions to recover their money. The banks can exercise the option of “auction sale” of a secured asset without any intervention from any court of law.
However, the borrower is also given the right to approach the Debt Recovery Tribunal by filing a securitization application against any illegal activities of the bank.
Initiating Insolvency Proceedings under Insolvency & Bankruptcy Code, 2016
In 2016, the Union Parliament completely overhauled the existing system by introducing the Insolvency & Bankruptcy Code, 2016. The code aims for timely resolution of corporate debtors while ensuring that the interest of other stakeholders doesn’t sacrifice. The code is not merely a recovery mechanism.
In this Code, a creditor can initiate insolvency proceedings against the corporate debtor against a minimum default of 1 crore rupees. The adjudicating authority is the National Company Law Tribunal which oversees the functioning of the Committee of Creditors (COC) formed by the financial Creditors of the Debtor.
The Code provides for a mandatory period of 180 days to resolve the debt of debtors through a resolution plan. If that doesn’t happen, the liquidation takes place, and the proceeds are distributed by Section 53 of IBC.
Effect of Non-Performing Assets on the Debtor
As soon as the loan account of the Debtor is declared as NPA, it loses its credibility in the market. The CIBIL score goes down substantially, and the debtor is not entitled to take any loan further. Further, in case of insolvency, the existing management is ousted from the position. Moreover, if liquidation happens, the estate of the debtor will be sold off to pay the creditor.
Effect of Non Performing Assets on Creditor
Talking about the impact of a creditor, it can be safely said that non-performing assets not only become a burden on the books of the account of a bank but also impacts the economy as a whole. To clear this bad asset, the bank needs to restructure the debt. The increasing number of NPAs hamper the credit growth of the country. With the larger corporate frauds happening in the country, banks are now reluctant to offer loans, which impacts the growth of the country considerably.
Non-performing assets (NPAs) refer to those assets which have been past due for more than 90 days without the payment of interest and principal amount. As per the RBI circular, NPAs can be divided into 3 categories. The banks have various legal recourse to deal with such bad assets. They can institute a civil suit, recovery proceedings or insolvency against the defaulting borrower. Non-performing assets substantially affect the supply of money in the market. The increasing number of NPAs hampers economic growth and vice-versa.