Growing NPAs – An Unending Nightmare For The Indian Banking Sector

The rapid increase in Non-Performing Assets (NPAs) has become a grave concern for the Indian banking sector. Increased credit risk, deteriorating asset quality, low profitability and inefficient credit growth is subduing the performance of the sector at a large level. The issue of NPAs has surged in the last four to five years.

NPAs have an impact on a bank’s financials – net interest margins, profitability, return on assets, dividend payout etc. It also has an overall impact on credit flow and growth of the economy.

While there is no official ‘acceptable’ limit for an NPA, it is considered manageable if the banking industry in any country has bad loans within 3%. Compared with most BRICS members, India fares quite poorly: China’s NPAs stand at 1.75%, Brazil’s at 3.69%, South Africa’s at 2.83%, while India’s NPAs are at approximately 9.85%.

Causes for soaring NPAs in the country

• Poor law enforcement and faulty regulatory measures in checking the ingenuity of
• the borrower
• Lags in due diligence and analysis carried out by the banks before sanctioning a
• loan
• Inability of banks to declare defaulters as ‘wilful defaulters’

In general, unfavourable business conditions and the economic slowdown are largely the reasons for loans turning into NPAs. However, forensic audits of select NPA accounts have revealed various methods adopted by borrowers to defraud lenders and divert money, which results into loans becoming NPAs. Few such methods are listed below:

Term Loans / Project Finance

• No transparent policies for awarding large contracts; and majority were given to related parties
• Inflated / fictitious invoices and documents submitted by borrowers to avail loans
• Advances given to capex vendors without any corresponding work / invoices, and / or asset creation
• Companies with little and / or no adequate processes and compliances
• Uncertified billings made for projects to avail loan disbursements without any progress in actual work
• Most bank guarantees are given as a part of project finance, with failure to perform the work, bank guarantees are invoked by customers and turn into NPAs

Working capital (fund based & non-fund based) facilities

• Transactions executed with shell companies (customers and vendors) based on fabricated / false documents to show inflated turnover and avail higher credit limits
• Customer and vendor companies are controlled by borrower / group of persons related to the promoter and / or key management persons
• Control weaknesses were exploited by various stakeholders of the borrower company
• Inflated stock statements submitted to bank showing higher debtor and stock levels
• Round-tripping of funds between various working capital limits with member banks and diversion of funds

Standby letter of credit / Export bills discounting

• Lack of due diligence on borrowers and foreign vendors / customers before loan sanction
• Set of entities controlled by common directors and / or related entities
• Transactions are on false / fabricated documents which enables borrowers to divert / round trip funds
• Lack of transparency in delivery of goods or services
• Non-fund based facilities are not insisted to ensure timely payments of exports whereas imports are made basis LC / SBLC
• No credit assessment of the customers

Indian banks may now be at the beginning of a new NPA cycle. The impact of COVID-19 on the Indian economy, coupled with the economic slowdown prior to COVID-19 may cause another wave of bad loans.

Banks, with the guidance from the Ministry and regulators, are implementing mitigation measures, including but not limited to, forensic audit & IBC process for symptomatic cases i.e. NPA accounts and end-use monitoring of funds, cashflow monitoring, appointing agencies for specialised monitoring for asymptomatic companies. However, effective implementation of these measures with adequate skills and vision is critical to contain any further adverse impact on the Indian banking industry.