Collection Strategies to Reduce NPAs

Due to Covid, and various other economic factors, the banking sector has been facing severe problems with the rising level of Non-Performing Assets (NPAs). However, collection strategies are crucial to reduce NPAs and maintain a positive balance sheet.

What are NPAs? 

NPAs are loans and advances given by banks or other financial institutions that are in default. NPAs occur when borrowers cannot repay the loan amount and interest on time. The loan amount is classified as a non-performing asset when the interest or installment of the principal remains overdue for a certain period of time, as specified by the Reserve Bank of India (RBI).  

How do Banks identify their Assets as non-performing assets?

Assets mean anything valuable owed by an entity. Here, the bank is the entity, and its assets are interesting in the loan amount that a borrower pays to them. This interest amount is the only source of income for the bank. Whenever the borrower cannot pay the interest amount, that asset for the bank becomes a non-performing asset. Reserve Bank of India identifies the non-Performing assets as loans and advances overdue for more than 90 days. That the borrower has missed three consecutive EMI of the loan amount. 

Classification of Non-Performing Assets

Depending upon how long the assets have not generated any income for the Bank and remain NPAs, it is further divided into three categories:

1. Sub-standard Assets: The assets that have remained NPA for less than 12 months or are equivalent to 12 months. 
2. Doubtful Assets: Doubtful assets are those assets that are remained NPA for more than 12 months. 
3. Loss Assets: An asset is a loss asset when it is “uncollectible” or has little value, and its continuance as a bankable asset is not suggested. In these assets, there are still some recovery values left, as the value has not been written off. 

Loans collection strategies of Banks and Financial Institutions to reduce NPAs

A Bank’s efficiency is not only reflected in the size of its balance sheet, but in the level of return it’s generating on its assets. The banking sector has been facing severe problems with the rising level of NPA. Therefore to take control over the NPAs, the RBI and banks have devised the following loan collection strategies. 

1. Preventive management
2. Curative management 

Preventive management:

Preventive management is the loan collection strategy in which banks or financial institutions shall take preventive measures to stop assets from becoming non-performing assets. In this management, they have to follow the following to reduce NPAs. 

1. Early Warning Signals: A lending body has to assess the credit risk before sanctioning the loan. All the financial, operational, Banking, management, and external factors must be evaluated before granting the loan.  It also analyzes the borrower’s balance sheet, income expenditure statement, cash flow statement, and default in payments statements. 

2. Management-related warning signals: the following things should be kept in mind to minimize the risk, such as lack of cooperation from key personnel, change in management, ownership or critical personnel, desire to take undue risks, family dispute, poor financial control, fudging of financial statements, diversion of funds. 

3. Willful Defaulters: Reserve Bank of India has classified willful defaulters as defaulters who have the capacity of funds to honor the obligation but he is utilizing the funds for another purpose.  Such defaulters have required information from SEBI and RBI. RBI has also issued guidelines to take legal measures such as criminal proceedings with such people when necessary. 

Curative Management:

Curative management is the other loan collection strategy used by banks. This measure gives legal guidelines to lending bodies to recover money from borrowers. RBI has made enactments to recover the amount through legal proceedings in the following manner. 

1. One-Time Settlement Schemes: One Time Settlement scheme (OTS) is a loan collection strategy used by banks and financial institutions concerning borrowers who cannot pay their loans. In this scheme, the borrower and the lender agree on a lump sum payment that is less than the total outstanding debt. In exchange, the bank agrees to forgive the remaining portion of the debt and close the NPA account.  However, RBI has issued some guidelines concerning OTS, and they should be kept in mind while doing OTS with the borrower. 
2. Lok Adalats: Lok Adalat is one of the alternate resolution mechanisms banks and financial institutions use to recover the loan amount. They are organized by National Legal Service Authority (NALSA) and provide a speedy and cost-effective way to settle disputes outside the traditional court system. Banks use Lok Adalat to negotiate a settlement with the borrowers in case of loan default. If a settlement is reached, it is legally binding and enforceable in a court of law. It is an opportunity for borrowers who may not have the resources to pursue legal actions to negotiate and settle the matter with the lender. 

3. Debt Recovery Tribunals (DRTs): Debt Recovery Tribunals are a legal forum that banks and Financial Institutions can use as a loan collection strategy. The DRT is established under the Recovery of Debt due to the Bank and Financial Institution Act of 1993. It provides a speedy and effective way to recover debts. Whenever a lender has a loan in default, they can file a case in the DRT to recover the debt amount. This authority hears the matter, examines the evidence, and passes an order to recover debt, which includes attachment and sale of assets, the appointment of a receiver, etc.  

4. Securitization under SARFESI Act: Securitization is the loan collection process by which banks and Financial Institution get the authority to sell their assets to investors. SARFESI Act provides a legal framework for lenders to recover loans by taking possession of the collateral, securing the loan, and selling it to recover the outstanding amount. This act gives power to the lender to take possession of the borrower’s securities and sell them without the court’s intervention. 

5. Asset Reconstruction Company (ARC): An asset reconstruction company is a specialized Financial Institution that involves the purchase and management of non-performing assets or bad loans from banks and financial institutions. ARCs are commonly used as loan collection strategies for banks as they have the expertise and resources to manage and recover the NPAs. When a bank sells an NPA to an ARC, the ARC pays the bank a percentage of the loan’s face value, and in return, the ARC takes full responsibility for recovering of loan. Further, ARC takes various methods to recover the loan amount, such as negotiation, taking legal actions, or selling the collateral. 

6. Corporate Debt Restructuring: This is another loan collection strategy used by the lender when a borrower is failed to meet its obligations. The process involves renegotiating the terms of loans with the borrower, such as extending the repayment period, reducing the interest rate, or converting a portion of the debt into equity. The main objective of corporate debt restructuring is to help borrower address their financial difficulties and improve their ability to repay the loan, as well as protect the lender’s interest. 

Conclusion

It is very essential for a Bank or any other financial institution to reduce its NPAs. RBI is using the above loan collection strategies to take control over NPAs as much as possible. With the above strategies, technology-based platforms are also helping to keep a check on borrowers. These technical platforms help reduce inconsistencies in secured and unsecured personal lending and improve the experience of the borrower as well. This platform also helps in closely monitoring customer data and tracking collection processes through live time dashboards. In the few years, tech platforms have provided insights and empowered collection agents with better performance and improved results.