Banking Ordinance on NPA

Who will be the target of the RBI’s entrance into the NPA’s?

An amendment to the Banking Regulation Act (Section 35A) was proposed by the Cabinet to grant the RBI the power to intervene in bad loan cases to solve the Non Performing Assets crisis. This was approved by President Pranab Mukherjee on the 5^th of May, 2017.  The number of bad loans has risen sharply, especially in the public sector. A loan given by a bank is treated as an asset. When the bank stops receiving principle or interest on it for a specified period of time, then such a loan is termed as a Non Performing Asset for the bank.

The NPA problem is confined to 50 large loan defaulters. RBI will create a timeline of 6-9 months for banks to deal with their big bad loan accounts, after which it will intervene in the case.

What does Haircut mean in Finance?

In banking, a Haircut is the difference between the amount of loan granted by a bank and the market value of the asset used as loan collateral. The value of the Haircut indicates the bank’s perceived risk of loss from the asset falling in value or being sold.

What’s the impact of the scheme?

More than Seven Lakh Crore worth loans in India are classified as Non-Performing Assets as of December 2016, which is 10% of all the loans given. This results in substantial loss of money to the banks. In such a case, a mechanism for resolution of stressed assets (bad loans) of banks had to be taken.  The loopholes in the earlier schemes adopted like Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR), etc which were introduced to improve and restore liquidity, led to the introduction of the new amendment.   

Involvement of the RBI is seen as a positive and bold step for speedy recovery of NPA. The proposed amendment to the Banking Regulations Act states that if banks are unable to meet the deadline set by RBI to resolve big bad loan accounts, then RBI has the power to give directions to the banks to tackle this situation and take punitive actions. However, this intervention may create pressure on large scale industries. 

Assessment

This amendment empowers the RBI to provide more haircuts to the bank, especially in cases where banks cannot go ahead due to policy constraints. In may be a big relief for bankers who are currently shying away from taking tough decisions. On the other hand, giving power to Central Bank to take commercial decisions may result in a case of micromanagement as constant intervention may result in a negative connation. The details of the amendment are not disclosed completely, hence it is difficult to assess how the number of bad loan cases will go down, but it would definitely help to tackle bad loans effectively.