Resolutions for Non-Performing Loans

A Non-Performing Loan (NPL) or Non-Performing Asset (NPA) is a loan where the borrower has failed to make scheduled interest or principal payments for a specified period, typically 90 days or more in India. It is a critical indicator of credit risk and asset quality for a bank. Once classified as an NPA, the loan ceases to generate income for the lender, who must then set aside capital as provisions to cover potential losses. High levels of NPAs weaken a bank’s profitability, erode its capital base, constrain its ability to lend, and pose a systemic risk to the financial system.

Resolutions for Non-Performing Loans:

1. Restructuring & Rehabilitation

Under RBI guidelines like the Prudential Framework for Resolution of Stressed Assets, banks can work with viable borrowers to renegotiate loan terms. This involves modifying the original contract by reducing interest rates, extending the repayment tenure, or granting a moratorium on principal/interest payments. The goal is to revive a borrower’s cash flow and return the account to a performing status. It requires a techno-economic viability study and must be done before the account becomes an NPA to avoid mandatory provisioning. This is a preventive, co-operative resolution.

2. Enforcement of Security (SARFAESI Act)

For secured NPAs, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 is a powerful tool. It allows banks and financial institutions to take possession of secured collateral (e.g., property, plant) without court intervention after issuing a 60-day notice. They can then manage, lease, or sell the asset to recover dues. This significantly speeds up recovery compared to civil courts. However, it applies only to secured loans above a threshold and the borrower can appeal to the Debt Recovery Tribunal (DRT).

3. Insolvency & Bankruptcy Code (IBC) Process

The Insolvency and Bankruptcy Code, 2016 is the primary statutory mechanism for resolving large corporate NPAs. Upon default, financial creditors can initiate a Corporate Insolvency Resolution Process (CIRP) at the National Company Law Tribunal (NCLT). A moratorium is imposed, and a Resolution Professional takes over management. Creditors evaluate resolution plans from potential buyers/investors. The plan offering the best recovery is approved. If no viable plan emerges within a strict timeline (max 330 days), the company is liquidated. The IBC aims for value maximization, not just recovery.

4. Sale to Asset Reconstruction Companies (ARCs)

Banks can sell NPAs, typically at a discount, to Asset Reconstruction Companies (ARCs) licensed by the RBI. The ARC pays via Security Receipts (SRs) (15% minimum cash). ARCs specialize in recovery through restructuring, management change, or asset sale. This allows banks to clean their balance sheets immediately, receive capital relief, and focus on fresh lending. For the ARC, the profit is the difference between the purchase price and the amount ultimately recovered. This mechanism transfers the resolution burden to specialized entities.

5. Debt Recovery Tribunals (DRTs)

Debt Recovery Tribunals (DRTs) are specialized quasi-judicial bodies established under the Recovery of Debts Due to Banks and Financial Institutions (RDBF) Act, 1993. They adjudicate recovery suits filed by banks for NPAs. The process is faster than civil courts but can still face delays. DRTs can pass recovery certificates, attach borrower assets, and appoint receivers. They are a key judicial channel for recovering larger dues, especially for unsecured loans or cases where SARFAESI is not applicable.

6. One-Time Settlement (OTS) Schemes

A One-Time Settlement (OTS) is a negotiated, lump-sum payment from the borrower to the bank to settle the entire outstanding debt at a mutually agreed discount. Banks have discretionary OTS schemes for smaller NPAs. It provides finality and quick closure for both parties, avoiding lengthy legal processes. The borrower is freed from debt, and the bank recovers a portion of its dues while saving on legal costs and management time. It’s often used for retail and small business NPAs where other resolutions are not cost-effective.

RBI’s Prudential Framework for Stressed Assets:

1. Objective & Scope: Early Recognition & Resolution

The framework’s primary objective is to ensure timely identification and resolution of stressed assets before they become NPAs. It applies to all regulated lenders (banks, NBFCs, co-ops) for loans over a specified threshold (₹10 crore as of recent guidelines). It mandates a prudent, principle-based approach rather than rigid restructuring schemes. The focus is on viable entities, ensuring resolution plans are based on realistic cash flow projections and not merely deferring losses. Its scope covers corporate, personal, and MSME loans, aiming to preserve the economic value of the underlying business or asset.

2. Trigger & Review Period for Incipient Stress

The framework is activated at the first sign of stress. Lenders must report all borrowers with aggregate exposure ≥ ₹10 crore to the Central Repository of Information on Large Credits (CRILC). A Review Period begins the day a borrower defaults on any entity’s loan. During this 30-day period, lenders must engage with the borrower to assess viability and formulate a preliminary resolution plan (PRP). This forces proactive engagement at the earliest possible stage, moving away from the old system where recognition often came too late for effective revival.

3. Implementation of Resolution Plan

If the borrower is found viable, lenders must implement a Resolution Plan (RP) within 180 days from the Review Period start date. The RP can include restructuring, change in ownership, or sale of assets/stake. The RP must be approved by lenders holding 75% by value and 60% by number in the consortium. For single lenders, internal approvals suffice. The RP must be ratified by all lenders and should aim for a sustainable debt structure (e.g., ensuring the Debt Service Coverage Ratio is >1.00 post-implementation). This ensures a collective, time-bound decision-making process.

4. Prudential Norms & Provisioning Post-Resolution

Upon implementation of a viable RP, asset classification benefits are provided, but with prudent safeguards. Accounts classified as Standard can be upgraded subject to the borrower meeting certain conditions. However, lenders must make a minimum provision of 5% on the residual debt, even if the account is upgraded. Additional provisioning is required if the plan involves a change in ownership or deep restructuring. These norms ensure that banks set aside capital against potential future losses from restructured assets, strengthening their balance sheets.

5. Escalation to Insolvency (IBC) in Case of Failure

If a viable RP is not implemented within 180 days, lenders have no option but to initiate insolvency proceedings under the IBC. They must file an insolvency application with the NCLT within 15 days of the 180-day deadline. This mandatory linkage to IBC acts as a powerful disciplinary tool, creating a credible threat for non-cooperative borrowers and preventing indefinite “evergreening” of loans. It underscores that resolution is the primary goal, but failing that, a time-bound legal process must follow to ensure closure.

6. Reporting & Disclosure Requirements

The framework imposes stringent reporting obligations on lenders. They must submit detailed, timely information on large exposures, defaults, and resolution progress to CRILC. Furthermore, they must make appropriate disclosures in their financial statements regarding policies for identification and resolution of stressed assets, including the provisions held. This transparency enables supervisory monitoring by RBI and informs market participants, enhancing market discipline and ensuring accountability in the resolution process.