INTRODUCTION
Non-Performing assets are like termites that have been wrecking the India’s Banking and Financial System gradually and deliberately. Like, all other businesses banks and financial institutions must also run in a profitable basis, but NPAs chews through it up to its core. deeply disturbing the Banking System’s implementation and financial stability.
In the business of lending. the Bank lends money to the borrower with the promise of repayment of interest for the money lent along with the principal amount either monthly or in a yearly basis. And in that drive, the money lent becomes an asset for the Creditor for whom it generates income in the form of interest. When the borrower defaults in the payment of interest or instalment of the principal amount, it becomes a burden for the creditor in his book of records. And this is where the term ‘Non-performing Assets’ comes into play. Those assets which does not generate any income to the creditor are called as NPAs (Not performing any functions like generating income, but becomes a burden).
Non-performing assets are loans or advances in which the borrower fails to pay the principal amount or the interest. for a period of 90 days or more. It is a serious threat to India’s Banking and Financial System, since it reduces the Bank’s profitability and lending capacity. It lowers the availability of National credit to India’s National Financial Economy. In recent years, the banking system of India, especially the public sector banks seem to have an increase in the bad loans and stressed assets caused by the slowing down of economy and wilful default by the borrowers.
DEFINITION AND CLASSIFICATION OF NPAs
Definition of NPA as per the RBI norms:
“Master Circular Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances dated 1-4-2022 issued by Reserve Bank of India (RBI) provides for the definition of NPA and lays the criteria for the classification of an account as NPA.
Clause 2.1.1 of the Master Circular states that an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
Clause 2.1.2 states that an NPA is a loan or an advance where:
- interest and/or instalment of principal remains overdue for a period of more than 90 days in respect of a term loan;
- the account remains “out of order” as indicated at Para 2.2 below, in respect of an overdraft/cash credit (OD/CC);
- the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted;
- the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops;
- the instalment of principal or interest thereon remains overdue for one crop season for long duration crops;
- the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021
- in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment[1].”
Meaning of ‘Out of order’
An account is deemed to be ‘Out of order’ when,
- the borrower’s outstanding balance continuously remains more than the preferred limit or drawing power or,
- the balance is within the limit but,
- No deposits or credits have been made for more than 90 days,
- Or the deposits made are not enough to cover the interests charged.
Meaning of ‘Overdue’
Any amount due to the bank under any credit facility is ‘overdue’ when it is not paid within the stipulated due time fixed by the bank.”
Types of Non-Performing Assets
The NPAs are categorised into three types viz.,
- Sub-Standard Assets
- Doubtful Assets
- Loss Assets
Sub-Standard Assets
These are assets that remains non-performing for a period of less than or equal to 12 months. These kinds of assets will have a notable amount of credit weakness, that the Bank will suffer losses if the inconsistencies are not fixed.
Doubtful Assets
An asset is said to be a doubtful asset, if it has been remained in the sub-standard category for a period of 12 months. It has all the inconsistencies of a sub-standard category and additionally the probability of recovering the debt from the borrower is close to nothing even if the creditor tries to recover it.
Loss Assets
A Loss asset is a loan where the Bank or internal or external auditor or Reserve Banks inspection finds it uncollectible. Even though the bank has not completely removed it from their Book, they know that the chances of recovering the loan is low.
“Gross NPA and Net NPA
Banks are required to make their NPAs numbers public and to the RBI from time to time. NPA numbers for a bank will be mentioned in the standalone financial statements of a bank.
There are primarily two metrics that help us understand any bank’s NPA situation.
GNPA: GNPA stands for Gross Non-Performing Assets. GNPA is an absolute amount. It tells you the total value of gross non-performing assets for the bank in a particular quarter or financial year, as the case may be.
NNPA: NNPA stands for Net Non-Performing Assets. NNPA subtracts the provisions made by the bank from the gross NPA. Therefore, net NPA gives you the exact value of non-performing assets after the bank has made specific provisions”[2]
CLASSIFICATION OF NPA CAN BE QUESTIONED THROUGH WRIT
Where the bank is not correct in classifying the account as NPA, which is preliminary to initiate proceeding under the provisions of the SARFAESI act, the High Court does interfere with the action initiated by the bank as held in Sravan Dal Mill Pvt. Ltd. V. Central Bank of India[3]. Further interim relief may be granted to the borrower to regularise the account by continuing making payments.[4]
SIGNIFICANCE OF NPAs
“It is important for both the borrower and the lender to be aware of performing versus non-performing assets. For the borrower, if the asset is non-performing and interest payments are not made, it can negatively affect their credit and growth possibilities. It will then hamper their ability to obtain future borrowing.
For the bank or lender, interest earned on loans acts as a main source of income. Therefore, non-performing assets will negatively affect their ability to generate adequate income and thus, their overall profitability. It is important for banks to keep track of their non-performing assets because too many NPAs will adversely affect their liquidity and growth abilities.
Non-performing assets can be manageable, but it depends on how many there are and how far they are past due. In the short term, most banks can take on a fair amount of NPAs. However, if the volume of NPAs continues to build over a period of time, it threatens the financial health and future success of the lender”[5]
RBI GUIDELINES AND PRUDENTIAL NORMS
RBI plays a crucial role in determining how banks classify, identify and regulate non-performing assets. Through various guidelines and norms, it provided strict regulations for timely intervention and early resolution and to ensure transparency.
Income Recognition and Asset Classification (IRAC) Norms
The IRAC guidelines are the backbone of NPA identification. They direct banks to:
- Recognize income not on accrual basis, but only when they are actually received.
- Classify assets into four categories Standard, Substandard, Doubtful, and Loss Assets, based on the period of default and recovery likelihood of which three are recognised as non-performing.
- Declare an account as an NPA when the principal amount or interest is overdue for 90 days or more.
These rules ensure transparency and uniformity among the banking system and prevents bank from hiding bad loans.
Provisioning Norms
When loan becomes bad, the banks cannot just ignore it. They have to prepare for the expected loss and this is where the Provisioning comes into play.
Provisioning is a kind of risk planning, it means setting aside a portion of bank’s profit to compensate the loss that would be generated from the NPAs.
RBI specifies certain rules on how much to be provisioned for what type of loans depending on the type of asset, risk involved and location of the bank. By provisioning cleverly, banks can avoid lag and maintain their books clean. This also pressures banks to make buffers for future losses and protect the depositors and the financial system.
Prompt Corrective Action (PCA) Framework
The Prompt Corrective Action is a regulatory framework where the RBI tracks some indicators such as Capital Adequacy Ratio, Net NPA ratio, Return on Assets etc., to check whether the NPAs rise and capital of the bank falls below the safe limits. In such case, bank impose some restrictions like Limiting the lending power, ban on dividend payments, limits on branch expansion etc.
This framework is not to punish the bank, but works as an early prevention from further deterioration and stabilize it at an early stage.
CAUSES OF RISING NPAs IN INDIA
Structural reasons
These are deep-rooted, systemic issues were financial institutions and credit systems are designed and governed.
Poor Credit Appraisal:
Many lending institutions like banks lack vigorous systems to measure risks accurately. Inadequate due diligence, too much depends on the outdated financial ratios, and lack of sector specific analysis leads to risky loans being sanctioned without a clear repayment structure.
Inadequate Risk Management Frameworks:
Some Banking Institutions have poor internal controls making them prone to risks and concentration of sectoral over-exposure.
Political Interference:
Public Sectors Banks are often pressured to lend to politically favoured entities or companies, even when they are not commercially viable. This weakens the judicious banking decisions and undermines the accountability.
Economic reasons
These are external shocks and economic conditions which reduces the borrower’s ability to repay.
Economic Declines (e.g., COVID-19):
The pandemic caused a deep weakening in the consumer demand, disturbed supply chains and squashed cash flows. Businesses related to hospitality, Aviation, Manufacturing and retail, faced huge revenue declines, resulting in delayed and missed loan repayments.
Sectoral Slowdowns:
Certain sectors like infrastructure, steel and real estate faces prolonged financial slowdown which makes them difficult to repay the loans which in turn causes a great pile up of bad loans.
Currency and Interest Rate Volatility:
Businesses with foreign currency loans faces repayment burdens, when a sharp depreciation in the domestic currency takes place. Rising interest rates also makes the existing debts more expensive.
Operational reasons
These are related to the internal management of the Bank and the borrower.
Wilful Defaults:
Some borrowers wilfully and deliberately choose not to repay even when they have the financial capacity. They often took advantage of the slow legal systems and loopholes in the enforcement mechanisms. These happens especially in eminent corporate defaults
Inefficient Recovery Mechanisms:
Legal blocks, delays in insolvency resolutions and weak enforcement of recovery laws slow down the process of recovering loans. This reduces the warning effects of the future defaulters.
Lack of Monitoring Post-Disbursement:
Banks have the duty to monitor the borrowers. They have to check whether the loan amount is appropriated effectively and look for any financial distress, in which many banks fail to do so. Diversion of funds or misuse are often unnoticed until the borrower defaults.
“twin balance sheet problem (tbs)
Twin Balance Sheet Problem (TBS) refers to a two-fold problem for Indian economy which include:
Overleveraged Companies: Reasons such as stalled projects and poor demand, etc lead to inability of companies to pay off their debt. This leads to debt accumulation and rising NPAs.
Bad-Loan-Encumbered Banks: As companies fail to pay back principal or interest, banks are also in trouble. Rising Non-Performing Assets leads to reduced incomes from assets which necessitates increased provisioning and declining profits making banks risk averse and reluctant to lend.
40% of corporate debt is owed by companies who are not earning enough to pay back their interest payments[6].”
IMPACT OF NPas ON THE BANKS AND ECONOMY
Excessive focus on credit risk management
The most important business implication of NPAs is that they lead to credit risk management assuming priority over other aspects of the bank’s functioning. The bank’s whole machinery is thus pre-occupied with recovery procedures rather than on expanding business. A bank would be forced to incur carrying costs on non-income yielding assets[7].
High cost of funds due to NPAs
Quite often genuine borrowers face difficulties in raising funds from banks due to mounting NPAs. Either the bank is reluctant to provide the requisite funds to genuine borrowers or, if the funds are provided, they come at a very high cost to compensate the lender’s losses due to high NPAs. Therefore, corporations always prefer to raise funds through commercial paper where the interest rate on working capital charged by banks is higher[8].
Reduction on Profitability
Non-Performing Assets (NPAs) sewer a bank’s income. Since the bank’s primarily income is through interest on loans, when the borrowers stop paying, it collapses the revenue. At the same time banks have to pay interest to their depositors, so they end up losing money.
Capital Erosion
High NPAs lead to higher provisioning requirements (money set aside to cover potential losses). This reduces the capital base of banks’, weakens its ability to lend. Over the period of time, if bad loans keep rising, it makes the bank’s solvency doubtful.
Credit Crisis
Since banks losses its lending capacity due to capital erosion, they tighten the lending norms and reduce exposure to sectors which seems risky. This leads to reduction in the credit or lending, especially for small and medium businesses that rely mostly on the bank financing.
Operational Disruptions
NPAs eats up most of the time and resources of the bank. The costs of recovery efforts, legal proceedings and restructuring plans etc., shifts the bank’s focus from its core operations. Banks end up managing the problems instead of growing the business.
Investor Confidence Drops
High NPAs are the indication of poor asset quality and weak risk management. This reduces the investors’ confidence and trust over the bank which in turn pulls down the stock prices and increase the cost of capital. Institutional investors may drop out which further weakens the bank’s financial position.
Reputation Damage
A higher NPA ratio damages the credibility of a bank. Customers may hesitate to deposit or borrow. Partners and the foreign institutions may reduce their exposure. In extreme cases, this leads to regulatory intervention or even forced mergers.
Policy Pressure
Banks with high NPAs often face pressure from the regulatory bodies like RBI to clean up their books. This includes strict audits, asset quality reviews and guidelines under frameworks like IBC which leads to limitation in the bank’s autonomy.
Drag on the Economy
When multiple banks struggle with NPAs across the country, credit flows will be slow down. Investments inclines and GDP growth falls. Banking crisis can quickly grow into a wide-ranging economic crisis.
MEASURES TO CONTROL NPAs
India’s first Legal framework for controlling NPAs was followed by international practice as well as the recommendations of the “Tiwari Committee” and the “Narasimhan Committee” in 1981 and 1991 respectively.
“The RBI mandates the banks must follow the objective policy of income recognition, based on actual recovery, i.e., they must only recognise the income when it is received as payment from the customer, and conversely, must reverse any entries that are not backed by actual payment. It is worth mentioning that under mutual classification, income de-recognition happens rarely, which will change once automated processing comes into play. Banks are also advised to realistic repayment schedules based on the borrowers’ actual cash flow at the time of sanctioning loans. At times banks pressurize customers into accepting terms that are obviously not feasible and only end up increasing their non-performing loans.” The RBI is also keen that banking institutions establish appropriate internal systems, which will eliminate the tendency to defer NPA recognition, especially in the case of high value defaults[9]
Four R Resolution Approach
The Economic Survey 2015-16 has suggested ‘Four R (4R) Resolution Approach’ to comprehensively resolve the issues of rising Non-Performing Assets and Twin Balance Sheet problem.
The 4 Rs of the approach include:
Recognition: Banks must value their assets as far as possible close to true value as RBI has been emphasising.
Re-capitalisation: Once they do so, their capital position must be safeguarded via infusion of equity as the banks have been demanding.
Reform: Future incentives for the private sector and corporates must be set-right to avoid repetition of the problem, as everyone has been clamouring.
Resolution: The underlying stressed assets in the corporate sector must be sold or rehabilitated as the government has been desiring”[10]
LEGAL FRAMEWORKS
The banks or financial institutions have recourse to the provisions of the Recovery of Deits Due to Banks and Financial Institutions Act, 1993 (the RDDBFI or the DRT Act) (now Bankruptcy Code, 2016) and the Securitisation and Reconstruction of Financial Assets and Recovery of Debts Due and Bankruptcy Act, 1993 as amended by the Insolvency and Enforcement of Security Interest Act, 2002 (SARFAESI Act. 2002) for recovery of money These two enactments provide for cumulative remedies to secured creditor by means of an adjudicatory process.
Section 18 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) (the RDDBFI or the DRT Act) bars the jurisdiction of Civil Court where the debt as defined in section 2(g) of that Act exceeds Rs. 20 lakhs.
If the debt due to bank or financial institution (FI) is more than Rs. 20 lakhs the Debt Recovery Tribunal (DRT) is the only proper forum to entertain the application filed by the bank/Fl and the Civil Court cannot entertain such Civil Suits or claim for recovery of debt by the bank or FI. Further, the power and authority of the DRT has been provided in section 17 of the DRT Act[11].
Provisions under the rddbfi act, 1993 and sarfaesi act, 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act and The Recovery of Debts Due to Banks and Financial Institutions Act allows banks and financial institutions to enforce their security interest without the involvement of courts.
Debt Recovery Tribunals (DRTs)
The DRTs were formed by the RDDBFI Act to handle high-value NPA cases i.e., above 20 lakhs. The suits can be filed by the banks and the financial institutions against individuals and Partnership firms but not against the Companies. As, the DRTs follows the summary trail process; it must dispose the suit within 6 months of application. Parties who are not convinced with the decisions of DRT can appeal to the Debt Recovery Appellate Tribunal within 3 months from the order of the DRT. Both DRT and DRAT have the powers of the Civil Court, but will only follow the principles of Natural Justice. Even the Civil Courts are barred from entertaining such civil suits related to recovery of debts by the bank or financial institutions. The DRTs and Debt Recovery Appellate Tribunals (DRATs) provide a relatively fast-track route compared to regular civil courts, focusing solely on debt recovery matters.
Asset Reconstruction Companies (ARCs)
ARCs are institutions registered under the SARFAESI Act. These companies buy NPAs from the banks and financial institutions at a lower price and then attempt to recover the dues through various methods like restructuring of loans, settlement through Alternative dispute mechanisms etc. Banks transferring bad loans to ARCs banks can clean up their balance sheets and reduce stress.
Insolvency and bankruptcy code (ibc), 2016
The IBC provides a structured and time bound process for resolving insolvency among corporate debtors and individuals. Financial creditors can initiate the Corporate Insolvency Resolution Process (CIRP) in the National Company Law Tribunal (NCLT).
Unlike arbitration, which focuses on resolving disputes over specific debts between the parties, the IBC aims to rehabilitate the corporate debtor, not merely recovering outstanding debt. While debt recovery may occur incidentally, it is not the primary objective of the IBC[12].
Lok adalats and compromise settlements
Lok Adalats, which work under the Legal Services Authorities Act, 1987, provides an informal platform to settle disputes harmoniously. They deal with smaller loans and cooperative borrowers. Moreover, banks often use One-Time Settlement (OTS) schemes and compromise settlements where a part of the dues is recovered with some waiver on penalties or interest, especially in cases of distressed or small borrowers.
Credit information and wilful defaulter framework
Credit Information Companies CIBIL, Equifax and the RBI’s Wilful Defaulter Framework, though not explicitly a debt recovery tool, it acts as a preventive mechanism to restrict the Borrowers who were flagged as wilful defaulters from accessing credit and participating in capital markets in the future. This acts as a strong deterrent and encourages early repayment or settlement.
JUDICIAL PRECEDENTS
Swiss ribbons pvt. Ltd. And ors. Vs. Union of india (uoi) and ors.
In Swiss Ribbons Pvt. Ltd. v. Union of India (2019)[13], the Supreme Court reviewed the constitutional validity of key provisions of the Insolvency and Bankruptcy Code, 2016. The petitioners challenged the distinction between financial and operational creditors, the decision-making powers of the Committee of Creditors (CoC), the independence of the NCLT and NCLAT, and the retrospective application of the Code. The Court upheld the classification of creditors as reasonable, affirmed the CoC’s authority as constitutionally valid with limited judicial review, found the tribunal structure to be legally sound, and allowed retrospective application of the law. The judgment confirmed the IBC’s legitimacy and reinforced its role in streamlining insolvency resolution in India[14]
Whether opportunity of prior hearing required to classify at account as npa?
The Supreme Court vide its judgment dated 27-3-2023 in SBI v. Rajesh Agarwal1[15], has while dealing with the requirement of the opportunity of hearing to be given to the borrowers before classification of their account as fraud, held that the principles of Natural Justice, particularly the rule of Audi alteram partem, must be necessarily read into the Master Directions on Frauds to save it from the vice of arbitrariness. It has been observed by the Court that administrative proceedings which entail significant civil consequences must be read consistent with the principles of natural justice to meet the requirement of Article 14.
Whether an opportunity for a hearing or prior intimation needs to be given to the borrower before the classification of an account as NPA has been a bone of contention before various High Courts across the country and conflicting judgments have been passed by various High Courts[16]
In Stan Commodities (P) Ltd. v. Punjab & Sind Bank[17], the Jharkhand High Court has held that the borrower was entitled to be informed and to get an opportunity to explain or represent against the intended classification of his account as NPA. Similarly, the High Court of Punjab & Haryana in Amar Alloys (P) Ltd. v. State Bank of India[18] has held that notice was required to be issued to the borrower by the bank before classifying its account as NPA.
Contrary to these judgments, the Jharkhand High Court in Paritran Trust v. Punjab National Bank[19], after considering its earlier judgment in Stan Commodities[20], has held that no opportunity of hearing is required to be afforded to the borrower before classification of account as NPA.
Recently the Madhya Pradesh High Court (Jabalpur Bench) in Neelam Beverages v. State of M.P.[21] has, after considering the judgment in Paritran Trust[22] as well as Amar Alloys[23], held that no prior notice is required to be issued before classifying the account of a person as NPA[24].”
CONCLUSION
Non-Performing Assets (NPAs) are one of the most harmful threats to the Indian banking industry. NPAs not only diminish the bank’s profits, the capacity to lend, and threaten investor confidence, but also undermine the economy as a whole. India has made considerable progress in developing legal and regulatory frameworks to deal with bad loans such as the Agency for Research on Failure Assets (SARFAESI) Act, the DRT mechanism and more recently, the Insolvency and Bankruptcy Code (IBC). Even after all this, the challenge of tackling NPAs remains. The IBC is a revolutionary weapon against NPAs because it facilitates the speedy resolution of insolvency and provides more favourable recovery rates. Landmark judicial pronouncements such as Swiss Ribbons v. Union of India (2019), have established the constitutional validity of the IBC and further integrated its use into the Indian law. The battle against NPAs is not limited to recovery mechanisms, but requires, at minimum, good preventive actions including sound credit assessment and lending decisions, transparent lending processes and practices and strong governance at both public and private sector banks. Problematic issues, like political interference, ever greening of loans, and weak risk management increases the accumulation of NPAs. While the Reserve Bank of India’s developing prudential norms (including the IRAC norms and the Prompt Corrective Action (PCA) regime) are important, particularly for early detection and intervention, active enforcement of existing debt moratoriums and innovation of new guidelines are required. That said, the continuing change and development of approaches is worth consideration as immediate administrative “proactiveness”.
ABOUT THE AUTHOR:
Moveeka K, a Law Student at Government Law College, Coimbatore (an affiliated college under Tamil Nadu Dr. Ambedkar Law University, Chennai), is a Certified Legal Researcher from Manupatra and a Certified Legal Assistant holding an NSDC Skill India Certificate. An aspiring legal writer with keen interests in Company Law, Corporate Law, Banking (Finance) Law, Constitutional Law and any aspect of Intellectual Property Law. Enjoys researching and writing on emerging ways of legal writing on contemporary legal issues.
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[3] Sravan Dal Mill Pvt. Ltd. v. Cent. Bank of India, (2009) 13 SCC 692 (India).
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[10] Examining the Rise of Non-Performing Assets in India, PRS Legislative Research, https://prsindia.org/theprsblog/examining-the-rise-of-non-performing-assets-in-india?page=30&per-page=1 (last visited Aug. 2, 2025, 8:33 PM).