An exploratory study on the effect of non-performing assets on the Indian economy

Abstract

Banks are vital in any financial system of an economy due to their role in credit intermediation, transmission, process, payment and settlement systems. Banks provide capital to various sectors such as automobiles, infrastructure, steel, industrial, healthcare, technology and so on. In developing countries like India they perform additional role of carrying out social initiatives undertaken by the government. Hence, it is of great importance for the economy to be stable and prosper, the banking system must be stable.i This is reenforced by the global economic crisis of 2008. Even though the banking sector in India showed great resilience courtesy RBI regulations in place, when compared to that of the developed counterparts in the world. However, the biggest challenge for the Indian banks was the NPAs, in particular for the PSU banks.ii The progress and stability of the banking system is evaluated based on profitability and its assets. The banking system in India serves the government social agenda. Achieving social agenda resulted in hampering the productivity of the Indian banking sector. Analysing the Indian banking industry, we find that there was presence of several drawbacks which had manifested itself over the several years that resulted in reduced productivity of the banks. iii Deterioration of asset quality is the most significant contributor for hampering the development off the banking sector. The asset quality of a bank has a prime implication on its performance.iv Non-Performing Assets (NPAs) are a result of the reduction in asset quality.v

Banking involves inherent risk due to financial intermediation.vi The loans are a source of income for the bank but the same might turn into bad loans resulting in no fetching of income. The performance and quality of loan portfolio determine the strength of the banking system. NPAs indicate the advance for which repayment of principal or interest or both are due for more than 90 days. Thus defaulting loans are NPAs. This is the definition as per Bloomberg NPA calculation; however, the RBI along with the standard criteria, includes the agricultural NPL as that loan for which repayment has not happened for 1 or 2 crop seasons depending on the type of the group. This CCS is an attempt to examine and understand the various facets of NPA in Indian banking sector and explore the effect of NPA on some of the economic variables. The report starts with literature review, identifies gaps and proceeds on to explain the methodology adopted, discussion on results obtained and finally ends with conclusion.