Basic Outline of Narasimhan Committee I & II Recommendations

The first Narasimhan Committee (Committee on the Financial System – CFS) was appointed
by Manmohan Singh as India's Finance Minister on 14 August 1991,[1][5] and the second one
(Committee on Banking Sector Reforms)[6] was appointed by [Link][7] as Finance
Minister in December 1997.[8] Subsequently, the first one widely came to be known as
the Narasimham Committee-I (1991) and the second one as Narasimham-II Committee(1998).[9]
[10]

The purpose of the Narasimham-I Committee was to study all aspects relating to the structure,
organisation, functions and procedures of the financial systems and to recommend improvements
in their efficiency and productivity. The Committee submitted its report to the Finance Minister
in November 1991 which was tabled in Parliament on 17 December 1991.[6]
The Narasimham-II Committee was tasked with the progress review of the implementation of the
banking reforms since 1992 with the aim of further strengthening the financial institutions of
India.[4] It focussed on issues like size of banks and capital adequacy ratio among other things.
[9]
M. Narasimham, chairman, submitted the report of the Committee on Banking Sector Reforms
(Committee-II) to the Finance Minister Yashwant Sinha in April 1998.[4][9]
Autonomy in Banking
Reform in the role of RBI
Stronger banking system
Non-performing assets
Capital adequacy and tightening of provisioning norms
Entry of foreign banks
Recommendations of Narasimhan Committee 1
The Narasimhan Committee 1 report presents the following recommendations on the financial
system:
 Reduction in SLR and CRR- During 1991, both Statutory Liquidity Ratio
(SLR) and Cash Reserve Ratio (CRR) were extremely high. Due to this, bank resources
were not available for government use. The committee recommended reducing the SLR
and CRR from 38.5 per cent to 25 per cent and from 15 per cent to 3 to 5 per cent,
respectively.
 Reorganization of the Banking sector- The Narasimhan Committee 1 recommended
reduction in the number of public sector banks. The committee suggested mergers and
acquisitions increase the bank’s efficiency. The Committee recommended nationwide the
national recognition of 8 to 10 banks.

1
  Establishment of the ARF Tribunal- During the 1991 economic crisis, banks’ bad debts
and Non-Performing Assets (NPA) were concerning. The committee recommended
setting up an Asset Reconstruction Fund (ARF) to take over the proportion of bad and
doubtful debts from banks and financial institutions.
 Removal of Dual Control- At that point, the banking sector in India was regulated by the
RBI and the Ministry of Finance. The committee proposed RBI be the sole primary
regulator of banking in India.
 Stop the Directed Credit Program- The committee recommended eliminating government
interest rate controls as they were not profitable.
 Interest Rate Determination- The committee highlighted that the interest rates should be
determined based on market forces and not by the Government, which was earlier the
case.
 More Freedom to Banks- To improve the workings of banks, the Narasimhan Committee
1 recommended that every bank be free and autonomous to carry out its work. Over-
regulation and over-administration should be avoided, and the selection of the Chief
Executive and board of directors should be made solely on merit.
Narasimhan Committee 2 Recommendations
The Narasimhan Committee 2 was formed in 1998 and suggested banking sector reforms. The
recommendations by the Narasimhan Committee 2 are as follows:

Robust Banking System- The Committee recommended merging major public sector banks to
boost trade.
NPAs and the Concept of Narrow Banking- High Non-Performing Assets (NPAs) were a
problem back in 1998, so the Committee recommended Narrow Banking Concept where the
banks could put their funds in short-term and risk-free assets. The recommendations led to the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002.
Role of RBI- The Narasimhan Committee 2 recommended that RBI be the regulator. But, at the
same time, they should not have ownership in any bank.
Capital Adequacy Ratio- The committee proposed the government should increase the Capital
Adequacy Ratio norms.
Foreign Exchange- The Committee recommended that the foreign exchange open position limits
carry 100% risk weight. The Committee also proposed that the minimum start-up capital for
foreign banks should be increased to $25 million from $10 million.

2
Principles of Bank Lending
The “Principles of Good Lending” refer to the fundamental guidelines and practices that banks
and financial institutions follow to ensure responsible and prudent lending. These principles help
institutions manage the risks associated with lending, protect the interests of depositors and
maintain the stability and integrity of the financial system. Adhering to these principles is crucial
for ensuring that loans are granted in a manner that is safe, profitable and beneficial to both the
lender and the broader economy.
Importance of Principles of Good Lending
These principles of good lending are vital for ensuring that lending is done in a way that supports
sustainable economic growth while protecting the financial health of the lending institution and
the interests of depositors. By following these principles, banks can avoid excessive risk-taking,
contribute to financial stability and foster trust and confidence among their clients and the
broader financial community.
What are the Principles of Good Lending?
1. Principle of Fund Safety
The cornerstone of prudent banking practices is the principle of fund safety. This principle
underscores the necessity for banks to exercise caution and diligence in disbursing depositors’
funds. Ensuring the safety of these funds involves rigorous creditworthiness assessments and
judicious allocation of resources to borrowers who demonstrate a strong capacity for repayment.
The primary objective is to protect depositors’ interests and maintain the integrity of the banking
system.
Banks must conduct comprehensive due diligence to evaluate the financial health, business
viability and repayment capacity of potential borrowers. This process involves analysing
financial statements, reviewing credit histories and assessing the economic environment in which
the borrower operates. By adhering to stringent credit assessment protocols, banks can minimise
the risk of default and safeguard depositors’ funds.
2. Principle of Profitability
Profitability is integral to the sustainability of a bank’s lending operations. Banks incur various
costs, including interest on deposits, operational expenses and provisions for non-performing
assets (NPAs). To ensure viability, lending rates must be carefully calibrated based on several
factors, such as borrower creditworthiness, the nature of the collateral provided and prevailing
market conditions.
Banks must strike a balance between offering competitive lending rates to attract borrowers and
ensuring that these rates cover the associated costs and yield a reasonable profit margin. This
balance is crucial in a competitive banking environment where economic liberalisation and

3
globalisation have heightened competitive pressures. A focus on profitability ensures that banks
can continue to operate effectively and expand their lending portfolios.
3. Principle of Liquidity
Effective liquidity management is essential for banks to meet their financial obligations promptly
and sustain their lending activities. While profitability is paramount, banks must also ensure that
they maintain adequate liquidity to address unforeseen contingencies and meet withdrawal
demands from depositors.
Liquidity management involves maintaining a portfolio of liquid assets that can be quickly
converted to cash without significant loss of value. This includes holding government securities,
high-quality corporate bonds and other marketable securities. By striking a balance between
profitability and liquidity, banks can ensure financial resilience and maintain depositor
confidence.
4. Principle of Purpose
Lending must be directed towards socially and economically beneficial purposes to foster
inclusive growth and development. Banks have a responsibility to evaluate loan proposals based
on their intended use, ensuring that funds are utilised for productive activities that contribute to
economic advancement.
Banks are encouraged to support priority sectors such as agriculture, small-scale industries and
rural economies. These sectors are often underserved and play a critical role in promoting
employment generation and sustainable development. By channelling funds to these areas, banks
can contribute to broader economic objectives and support the development of a good and
inclusive financial system.
5. Principle of Risk Spread or Diversification.
Diversification of lending portfolios is a key strategy for mitigating risks and enhancing
resilience against adverse economic conditions. By lending to a diverse range of borrowers
across different industries and regions, banks can minimise the impact of sector-specific
downturns and maintain a balanced risk profile.
Prudent risk management practices involve spreading lending risks across various sectors,
including retail, corporate and agricultural segments. This diversification helps to buffer the bank
against economic shocks that may affect specific industries or regions. Additionally, banks must
continuously monitor and assess the risk profile of their lending portfolios to identify emerging
risks and take proactive measures to address them.
6. Principle of Security

4
 Security or collateral, serves as a safeguard for lenders, providing a secondary source of
repayment in the event of borrower default. However, a thorough creditworthiness assessment
extends beyond collateral to encompass borrower integrity, capacity and capital.
Banks must evaluate various types of security, including personal guarantees, tangible assets and
financial securities. The value and liquidity of the collateral are critical factors in determining its
effectiveness as a risk mitigation tool. Furthermore, adherence to regulatory guidelines ensures
that lending decisions are based on comprehensive risk assessments and due diligence.
7. Principle of National Interest, Suitability etc.: Even when an advance satisfies all good
principles, it may still not be suitable. The advance may run counter to national interest. The
Central Bank may have led a directive prohibiting hacks to alwa particular type of advance.
8. Principle of Ideal Advance: Ideal Advance is "one which is granted to a reliable customer for
an approved purpose in which the customer has adequate experience, safe in the knowledge that
the money will be sd to advantage and repayment will be made within a reasonable period from
trading receipts or knows maturities due on or about given dates"

Regulatory Frameworks and Guidelines on Principles of Good Lending

Across the financial landscape, banks and financial institutions operate within a framework of
regulatory guidelines designed to promote responsible lending practices. In India, the Reserve
Bank of India (RBI) has delineated the Fair Practices Code for Lenders, which serves as a
guiding document for banks.
The Fair Practices Code outlines the minimum standards that banks must adhere to when dealing
with borrowers. These standards include transparent communication, fair and non-discriminatory
treatment and clear documentation of loan terms and conditions. By adhering to these guidelines,
banks can foster trust and confidence among borrowers and contribute to the stability of the
financial system.
Credit Risk Assessment and Principles of Good Lending
A robust credit risk assessment process is fundamental to the principles of good lending. Banks
must employ a combination of quantitative and qualitative methods to evaluate the
creditworthiness of potential borrowers. This involves analysing financial ratios, reviewing
historical credit performance and assessing the borrower’s business model and market position.
Quantitative analysis includes assessing financial metrics such as the debt-to-equity ratio, interest
coverage ratio and cash flow projections. These metrics provide insights into the borrower’s
financial health and ability to service debt. Qualitative analysis, on the other hand, involves
evaluating the borrower’s management team, competitive position and market dynamics.
Monitoring and Review

5
Continuous monitoring and periodic review of lending portfolios are essential to ensure ongoing
compliance with the principles of good lending. Banks must establish robust monitoring systems
to track the performance of loans and identify early warning signs of potential defaults.
Monitoring involves regularly reviewing financial statements, conducting site visits and
engaging in ongoing communication with borrowers. This proactive approach enables banks to
identify issues early and take corrective actions to mitigate risks. Additionally, periodic portfolio
reviews help banks to reassess the risk profile of their lending activities and make necessary
adjustments to align with changing market conditions.
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Ethical Considerations with Lending Practices
Ethical considerations play a crucial role in shaping lending practices. Banks have a
responsibility to conduct their lending activities with integrity, fairness and transparency. This
involves treating all borrowers equitably, providing clear and accurate information about loan
terms and conditions and avoiding predatory lending practices.
Ethical lending practices foster trust and confidence among borrowers and contribute to the long-
term sustainability of the banking system. By adhering to high ethical standards, banks can build
strong relationships with borrowers and enhance their reputation in the market.
Conclusion
The principles of good lending provide a comprehensive framework for banks and financial
institutions to manage lending risks effectively and support economic growth. By adhering to
these principles, banks can safeguard the interests of depositors, maintain financial stability and
contribute to the development of a robust and inclusive financial system.

6
The principles of fund safety, profitability, liquidity, purpose, risk spread and security are
fundamental to sound lending practices. In addition, regulatory frameworks, robust credit risk
assessment processes, continuous monitoring and ethical considerations play a critical role in
ensuring responsible lending practice
Forms of Advances:
1. Loans
2. Cash credit
3. Overdraft
4. Bills discounted
5. Letter of credit

1. Loans: banker advances a lump sum money for a certain period at an agreed rate of
interest

A. Secured loans

B. Unsecured loans

A. Secured

Loans made on the security of tangible assets like land, building,goods ,documents of title of
[Link] loan's provide safety to [Link] the security bank should ensure that
market value of security must not be less than the amount of loan granted.
Following are 2 types of securities
 Primary security -Security deposited by borrower himself as cover for the loan
 Collateral security-Securities deposited by third party to secure advances
B. Unsecured

Loans given by bank without any tangible securities are called unsecured [Link] is given on
cuastomers integrity financial position and rpayment capacity. It is also given on basis of third
parties gaurentee.
The various Loans offered by Banks in India are mentioned as under:

7
 i. Personal Loans Personal Bank Loans are the credits which a bank offers to its customer
to meet his instant personal requirements
ii. Home LoansBank provides loan for constructing new house and renovating existing
house. It is offered in fixed or floating interest rate.
iii. Bank Loans against PropertyProperty Loan or Loan against property is a kind of loan
which is allowed by the bank on the condition of keeping the customer's current assets
as a security with them.
iv. Education Loans-provide assistance to fund child's education and higher studies when
all other
v. Auto loans-Loans provided to buy vehicles
2. Cash credit: it is an arrangement which the customer is allowed to borrow money up to
a certain limit. Customer can withdraw the money as and when they need. Interest is
charged on the amount withdrawn, entire amount need not be withdrawn it could be
withdrawn [Link] is an advance made by bank against hypothecation or pledge of
goods or against guarantee of certain persons.
3. Overdraft: It is an arrangement between the banker and his customer by which the
latter is allowed to withdraw over and above his credit balance in current account up to
an agreed limit. interest is charged only for withdrawn amount.
Difference between cash credit and over draft

Over draft Cash credit

temporary arrangement and is usually for Permanent arrangement and long term on
a very short period. regular basis

allowed in current account only needs opening a separate cash credit

account.

rate of interest on overdraft is relatively rate of interest is higher

lower

Risky for banker More safe for banker

Securities are not required Securities are taken by bank

Available for only current Available for all account holders

account
holders

8
 4. Bills discounted and purchased: banks grant advances to their customers by discounting
bills of exchange. The amount after deducting the interest from the instrument is
credited in the account of the customer. In this form of lending the interest is received by
the banker in advance.
5. Letter of credit
A letter from a bank guaranteeing that buyer's payment to a seller if the buyer is unable to make
payment on the purchase,
There are 4 important parties: Applicant (importer)
Issuing Bank (importers bank)
Beneficiary (exporter)
Advisory Bank (exporters country)
It is a written commitment to pay, by a buyer's or importer's bank (called the issuing bank) to the
seller's or exporter's bank (called the accepting bank, negotiating bank, or paying bank).
In banking, charges are created over securities to secure loans through various methods like
pledge, hypothecation, and mortgage, which involve the physical transfer of assets, the creation
of an equitable charge over movable property, and the transfer of interest in immovable property,
respectively. Other common methods include liens (right to retain assets), assignments (transfer
of rights to an asset), and set-off (using one asset to cover another). These can be further
categorized as fixed charges on specific assets or floating charges on fluctuating assets, and may
also be established on a pari passu (shared) or exclusive basis.
KINDS OF LOANS
Loans can be utilized for various things in today's world. It can be used for funding a start-up to
buying appliances for your newly purchased house. The different types of loans available in the
market and their specific characteristics that make these loans useful to the customers:
1. Personal Loans
Most banks offer personal loans to their customers and the money can be used for any expense
like paying a bill or purchasing a new television. Generally, these loans are unsecured loans. The
lender or the bank needs certain documents like proof of assets, proof on income, etc. before
approving the personal loan amount. The borrower must have enough assets or income to repay
the loan. In case of personal loans, the application is 1 or 2 pages in length. The borrower gets to
know about the denial or approval of the loan within a couple of days.
2. Credit Card Loans

9
When you are using a credit card, you must understand that you will have to repay for all the
purchases you make at the end of the billing cycle. Credit cards are accepted almost everywhere,
even when you are traveling abroad. As it is one of the most convenient ways to pay for the
things you buy, it has become a popular loan type.
3. Home Loans
When you wish to purchase a house, applying for a home loan can help you to a great extent. It
provides you with financial support and helps you buy the house for yourself and your loved
ones. These loans generally come with longer tenures (20 years to 30 years). The rates offered by
some of the top banks in India with their home loans start at 8.30% Your credit score is checked
before the loan request is approved by the lender. If you have a good credit score, there is a fair
chance that you will be able to enjoy lower rates of interest with your home loan.

4. Car Loans
Buying a car can definitely instill a great sense of joy and happiness in you. A car will remain as
your asset and it is going to be one of the biggest investments that you make. A car loan helps
you to pave the path between your dream of owning a car and actually buying your car. Since
credit reports are crucial for judging your eligibility towards any loan, it is good to have a high
credit score when you apply for a car loan. The loan application will get approved easily and you
might get a lower rate of interest associated with the loan.
5. Two-Wheeler Loans
A two-wheeler is pretty essential in today's world. May it be going for a long ride or busy road in
a city-bikes and scooters help you to commute conveniently. A two-wheeler loan is easy to apply
for. This amount you borrow under this loan type helps you purchase a two-wheeler. But if you
do not pay the installments on time and clear your debt, the insurer will take your two-wheeler to
recover the loan amount.
6. Small Business Loans
Small Business Loans are loans that are provided to small scale and medium scale businesses to
meet various business requirements. These loans can be used for a variety of purposes that help
in growing the business. Some of these could include purchase of equipment, buying inventory,
paying the salaries of employees, marketing expenses, paying off business debts, meeting
administrative expenses, or even to open a new branch or take up a franchise,
7. Payday Loans
Payday loans are also called salary loans. These are unsecured short-term loans that require the
customer to be employed with a steady income. They usually have high interest rates. This is

10
based on the applicant's credit profile, age, and income. Documents required would be salary
statements and other proof of income.
8. Cash Advances
These loans are offered by credit card issuers and allow credit card users to withdraw cash from
an ATM machine using the credit card. The amount of cash that can be withdrawn from a credit
card in this way will depend on the credit limit available. The cash has to be paid back with
interest, which is usually calculated from the day the cash has been withdrawn. There are also
other fees associated with a cash advance, such as cash advance fees and ATM or bank fees.
9. Home Renovation Loan
Home innovation loans are offered by most lenders. These can be availed to meet the expenses
related to renovation, repairs, or improvement of an existing residential property. Depending on
the lender, there is a lot of flexibility with what you can do with a home. renovation loan. You
can use it to buy products or pay for services. For example, you can use it to pay for the services
of a contractor, architect, or interior decorator. You can also use it to buy furniture, furnishings,
or household appliances such as a refrigerator, washing machine, air conditioner, etc. It can be
used for painting, carpentry, or masonry work as well.
10. Agriculture Loan

Agriculture loans are loans that are provided to farmers to meet the expenses of their day-to-day
or general agricultural requirements. These loans can be short term or long-term .They can be
used for raising working capital for crop cultivation or to buy agricultural equipment.
11. Gold Loan
A gold loan can be used to raise cash to meet emergency or planned financial requirements, such
as business expansion, education, medical emergencies, agricultural expenses, ete. The loan
against gold is a secured loan where gold is placed as security or collateral in return for a loan
amount that corresponds to the per gram market value of gold on the day that the gold has been
pledged. Any other metals, gema, or stones that are in the jewelry will not be calculated when
determining the value of the gold loan.
12. Loan against Credit Card
Loan against credit card is like a personal loan that is taken against your credit card. These are
usually pre-approved loans that do not require any additional documentation. Depending on the
lender, this can be converted into a personal loan that is interest free within a certain period of
time. After that, it will attract a certain percentage of interest. There is a processing fee associated
with converting the credit limit that is pre-assigned into a loan.

11
13. Education Loan
An education loan is availed specifically to finance educational requirements towards school or
college. Depending on the lender, it will cover the basic fees of the course, the exam fees,
accommodation fees, and other miscellaneous charges. The student is the borrower with any
other close relative being the co-applicant, such as a parent, grandparent, spouse, or sibling. It
can be availed for courses in India or abroad. It can be taken for a wide variety of recognized
courses which are either part time or full time. They cover vocational courses as well as
undergraduate and postgraduate courses.
14. Consumer Durable Loan
Consumer durable loans are loans that are available to finance the purchase of consumer durable
such as electronic gadgets and household appliances. Depending on the lender, they can be used
to buy anything from mobile phones to television sets. Loan amounts range from Rs. 5,000 to
Rs.5 lakh. There is no security deposit required usually. Some lenders offer 0% interest on
consumer durable loans with instant approvals and minimal documentation required as well.
SHORT-TERM LOANS
A short term loan is a type of loan that is obtained to support a temporary personal or business
Capital is anything that increases one's ability to generate value. It can be used to increase value
across a wide range of categories, such as financial need. As it is a type of credit, it involves
repaying the principal amount with interest by a given due date, which is usually within a year
from getting the loan.
There are many advantages for the borrower in taking out a loan for a period of time, including
the following
1. Shorter time for incurring interest
Short term loans need to be paid off within about a year, there are lower tinal interest payments.
Compared to long term loans, the amount of interest. Interest expe arises out of a company that
finances through debt or capital leases. Interest is fed in the income statement, but can also paid
in significantly less o Brief
2. Quick funding time
These loans are considered less risky compared to long term loans because of a shorter maturity
date. The borrower's ability to repay a loan is less likely to change significantly over a short
frame of time. Thus, the time it takes for a lender underwriting to process the loan is shorter.
Thus, the borrower can obtain the needed funds more quickly.
3. Easier to acquire

12
Short term loans are the lifesavers of smaller businesses or individuals who suffer from less than
stellar credit scores. The requirements for such loans are generally easier to meet, in part because
such loans are usually for relatively small amounts, as compared to the amount of money usually
borrowed on a long term basis.
DISADVANTAGE OF SHORT TERM LOANS
The main disadvantage of short term loans is that they provide only smaller loan amounts. As the
loans are returned or paid off sooner, they usually involve small amounts so that the borrower
won't be burdened with large monthly payments.
CASH CREDIT
Cash credit is a short-term cash loan to a company. A bank provides this type of funding, but
only after the required security is given to secure the loan. Once a security for repayment has
been given, the business that receives the loan can continuously draw from the bank up to a
certain specified amount. This type of financing is similar to a line of credit.
Cash Credit is also known as Working Capital Cash Credit is a facility to withdraw the amount
from the business account even though the account may not have enough credit balance.
OVERDRAFT
Overdraft is the amount by which withdrawals exceed deposits or the extension credit by a
lending institution to allow for such a situation. A bank overdraft is a limit on borrowing on a
bank current account.
1. Overdraft against Pledge of Securities

A customer offers a kind of collateral security in terms of shares or mutual fund units or bonds to
the bank or lending institute to obtain an overdraft facility. The bank can liquidate these
securities to cover up the overdrawn amount and the interest thereon if the customer fails to settle
the obligation.
2. Overdraft against Insurance Policy

Insurance Policy is another type of security against which Overdraft facility can be obtained. The
bank or lending institute determines the actual amount of premium paid and the amount on
maturity to set the Overdraft limit. In case of the death of a customer the overdrawn amount is
recovered from the claim settlement from the Insurance Company.
3. Overdraft against Property

Property can also be mortgaged with the bank or lending institute to get an overdraft facility.
Properties generally have appreciating value in the market and hence are preferred as securities.
On defaulting on the settlement of overdrawn amount the bank or lending institute may well the

13
property to recover the overdrawn amount with interest thereon and balance, if any, is returned to
the customer.
4. Overdraft against Receivables

Any kind of authenticated receivables like Bills Receivable, Rent Receivables can be taken as
security for the overdrafts. The proceeds of all receivables are routed through the overdraft
account and immediately settled against the overdrawn amount. However drawings can be
allowed against fresh receivables. Thus the amount of receivables remains as a continuing
security for all drawings. The bank or lending institute ensures that no other loan or obligation is
availed by the customer using the same receivables. The amount of receivables and the time
required to honor or materialize the receivables are the key factors to determine the limit of
overdraft.
5. Overdraft against Stock

Traders and manufacturers prefer availing the cash credit facility against the stock. The value of
the stock of goods is assessed by the bank or lending institute and against; the cash credit limit is
sanctioned. The amount is gradually settled against the amount of sale of the stock. The value of
stock is assessed by physical verification and from the purchase invoices and is ensured that it is
fully paid for. The bank will fix a margin amount that has to be brought by the borrower.
MEANING OF BILLS DISCOUNTING
Bill discounting refers to the trading or selling a bill of exchange prior to the maturity date at a
value less than the par value of the bill. The amount of the discount will depend on the amount of
time left before the bill matures and on the perceived risk attached to the bill.
Meaning of Letters of Credit
Letter of Credit refers to a letter from a bank guaranteeing that a buyer's payment to the seller
will be received on time and for the correct amount. In the event that the buyer is unable to make
payment on the purchase, the bank will be required to cover the full or remaining amount of the
purchase. It is a payment term generally used for international sales transactions.

Types of securities and Methods of creation of charge

1. PLEDGE
The Pledge refers to the mode of creating a charge over movable security to avail the secured
debt from any banks or financial institutions/companies. In other words, Pledge is the process of

14
creating a charge over movable assets/ property of the borrower against the availed loan by the
banks or financial institutions/ companies/ lenders.
2. HYPOTHECATION
Hypothecation refers to the practices of creating a charge on movable assets/properties of the
borrower, however, the possession of property retains with borrower itself. without
Hypothecation is the practice where you pledge an asset (in this case, a car) to a bank when
applying for a loan. The bank keeps the car as collateral or security until you pay it M off. Your
bank technically "holds" your car during your loan's tenure, though you physically have
possession of it.
EXAMPLE OF HYPOTHECATION
Vehicle loans (Auto/bike Loans) are the best example to understand the hypothecation. If an
individual wishes to purchase a car and doesn't have sufficient funds to buy hard cash. He will
surely approach the bank to get the vehicle loan. The bank will hypothecate the vehicle which is
to be purchased and approve the loan.
That means the bank will create a charge (hypothecation) over the car till the repayment of the
loan. In this case, both possession, as well as the ownership, retain with the borrower. The
borrower enjoys the benefits of property and gradually repay the loan to the bank or finance
company.
Some other examples of hypothecation are CC loan (Cash Credit) against stocks or inventory.

FEATURES OF HYPOTHECATION
a) The concept of hypothecation is defined in Section 2 of SARFAESI ACT 2002.
b) Hypothecation is also created on movable properties only like pledge.
c) Neither ownership nor possession of the movable properties/goods is transferred to the banks
or financial institutions.
d) In the case of hypothecation, the charge created is the equitable charge.
e) When any business firms/owner hypothecate its stocks/inventory to obtain a loan/debt (CC
loan), then such hypothecation is a floating charge.
f) If the borrower defaults the loan, the lender will first seize and take possession of assets then
he can go for auction to recover the debt.
g) The borrowers don't have the rights to sell the hypothecated assets until the debt obligation is
fulfilled

15
 3. Mortgage:
A mortgage is a loan used to buy a property, where the property itself serves as collateral for the
loan. If the borrower fails to make payments, the lender can seize and sell the property to recover
the debt. The borrower repays the loan over a set period through regular payments that include
the principal and interest.
 Loan agreement:
You enter into an agreement with a lender (like a bank) for a specific amount of money to
purchase a property, such as a house or land. The agreement outlines the interest rate, repayment
schedule, and other terms.
 Collateral:
The property you are buying becomes the collateral for the loan. This means you pledge the
property to the lender as security.
 Repayment:
You make regular monthly payments over a fixed period (often 10-30 years) to repay the
loan. These payments are made up of two main parts:
 Principal: The original amount of money you borrowed.
 Interest: The fee the lender charges for lending you the money.
Key components
 Mortgagor: The borrower who takes out the mortgage.
 Mortgagee: The lender who provides the mortgage.
 Mortgage-money: The principal amount of the loan and any accrued interest.
 Mortgage-deed: The legal document that secures the loan with the property.
4. LIEN
"Lien" is not an acronym, but a word from Old French that means "bond" or "restraint". In legal
and financial contexts, a lien is a legal claim or right that a creditor has over a debtor's property
to secure the payment of a debt. The word comes from the Latin "ligamen," meaning "to bind".
In banking, a lien is a legal claim or hold that a bank places on a customer's funds or assets to
secure a debt. This claim prevents the customer from accessing the specified amount until the
debt or obligation is settled. For example, a bank might place a lien on a portion of your account
balance to cover an unpaid loan installment or on an asset like a Fixed Deposit (FD) when it's
used as collateral for a loan.

16
  Meaning:
A lien gives the creditor a legal right to the property until the debt is paid off.
 Purpose:
It ensures that the creditor will be repaid. If the borrower defaults, the creditor can seize and sell
the property to recover the money owed.
 Examples:
Liens are common in mortgages (a lien is placed on the house) and car loans (a lien is placed on
the vehicle).
 Origin:
 The term is derived from the Latin word "ligare" ("to bind"), which is also the root of
"ligament". Security for the bank:
A lien provides the bank with a secure right to the asset or funds if the borrower defaults on their
loan.
 Restricted access:
The amount of money or the specific asset under lien cannot be accessed or withdrawn until the
lien is removed.
 Removal of lien:
The lien is lifted once the borrower has fully repaid the debt, resolved the issue, or met the
obligation for which the lien was placed.
Common reasons for a bank lien
 Unpaid loan installments:
This is one of the most common reasons, especially if there are insufficient funds in the account
on the due date for an auto-debit.
 Loan collateral:
A bank places a lien on an asset, such as a Fixed Deposit, when that asset is used as security for a
loan.
 Legal judgments:
A government authority, like the IRS or a tax department, can place a lien on a bank account to
collect delinquent taxes.
 Account disputes:

17
In some cases, a lien might be placed due to a system error or another dispute that needs to be
resolved with the bank.
5. Assignment
An assignment in banking as security is a legal transfer of a borrower's rights to an asset or
future income to a bank as collateral for a loan. This provides the bank with a way to recover the
loan amount if the borrower defaults, as it gives the bank the right to seize and sell the asset or
collect the income. Common examples include assignments of future income, receivables, or
even a buyer's rights to a property under a sale agreement before the final title is issued.
How it works
 Transfer of rights: The borrower (assignor) transfers their rights to an asset to the bank
(assignee).
 Security for the loan: This transfer acts as a security interest for the bank, making it a
secured loan.
 Conditional reassignment: The bank holds these rights subject to a condition to reassign
them back to the borrower once the loan is fully repaid.
 Protection for the bank: In case of default, the bank can exercise its right to the
assigned asset or income to recover the outstanding loan amount.
 Borrower's benefit: The borrower is facilitated in obtaining the loan, as they can use the
asset or income as collateral without having to sell it or grant a mortgage on a different
property.
Common examples
 Property assignment: A borrower assigns their rights under a property purchase
agreement to the bank as security for a mortgage loan. Once the title is issued, this is
typically replaced by a legal charge.
 Assignment of receivables: A borrower assigns their right to receive future payments
from a customer or a contract to the bank as security.
 Assignment of security interest: A lender transfers their security interest in an
obligation to another party, often a special purpose vehicle in securitization transactions.
6. SET OFF
In banking, "set off" as a security refers to the lender's legal right to combine a borrower's
accounts to offset a debt, such as using a customer's deposit (credit) to cover a loan (debit) that is
in default. This right acts as a form of security for the bank, as it allows the bank to use the

18
borrower's funds to satisfy the debt without having to sell other assets, provided the debts are
mutual and liquidated.

 Pari Passu Charge:

A charge where multiple lenders share the security in proportion to their loan amounts.
 Exclusive Charge:
A charge created in favor of a single lender.
 Further Charge:
A second charge created over an asset that is already subject to a first charge, but with the
consent of the first charge holder.
NON-PERFORMING ASSET
NPA stands for Non-Performing Asset, which is a loan or advance that is no longer generating
income for a bank. A loan becomes an NPA when the borrower fails to make interest or principal
payments for a period of 90 days or more. This status is significant because it indicates a
potential default, which negatively impacts the bank's profitability and financial stability.
An NPA, or Non-Performing Asset, is a loan that is considered "bad" because the borrower has
failed to make payments on the principal or interest for 90 days or more. When a loan becomes
an NPA, it stops generating income for the bank and can negatively affect its financial health,
profitability, and stability.
 Definition:
An asset (like a loan) is classified as non-performing when it ceases to generate income for the
bank. For a loan to be classified as an NPA, payments of principal or interest must be overdue for
90 days or more.
NPA stands for Non-Performing Asset, which is a loan or advance that is no longer generating
income for a bank or financial institution because the borrower has failed to make payments for
90 days or more. When a loan becomes an NPA, it negatively impacts the bank's profitability and
stability, and it can severely damage the borrower. A loan is classified as a Non-Performing Asset
(NPA) when the borrower has failed to make payments for 90 days or more. This means the
lender can no longer expect to receive the loan's interest and principal, and the account is moved
to a non-performing status, often triggering intensified collection efforts or legal actions credit
score.
How Nonperforming Assets Affect Borrowers and Lenders
Nonperforming assets can adversely impact the lender and borrower.

19
Impact on the Borrower
A nonperforming asset for a borrower indicates an inability to repay a loan. The default on
your credit report can remain in your credit history for years, showing that you didn't repay a
debt. A nonperforming asset for a consumer can also lower your credit score. Your credit score is
a three-digit number that measures your creditworthiness based on your credit history.
As a result, you may get denied when applying for new credit or loans, including a car loan or
credit card. Also, the interest rates you pay on your debts will likely be higher due to the damage
to your credit.
 Damaged credit score:
The default will be reported to credit bureaus, leading to a sharp drop in your credit score,
making it difficult to get new loans or credit cards.
 Increased penalties:
Lenders may charge additional penal interest, increasing the outstanding loan amount.
 Recovery proceedings:
The lender will start taking steps to recover the debt, which can include sending recovery
notices, making follow-up calls, and engaging recovery agents.
 Legal action:
If other methods fail, the lender may file a lawsuit to recover the money.
 Seizure of collateral:
If the loan was secured by an asset (like a car or property), the lender can seize and sell it to
recover the dues.
 Negative impact on co-borrowers/guarantors:
Anyone who co-signed or guaranteed the loan will also have their credit negatively impacted and
may become liable for the debt.
Impact on the Lender
Carrying nonperforming assets, also referred to as nonperforming loans, on the balance sheet
places distinct burdens on lenders. The nonpayment of interest or principal reduces cash flow for
the lender, which can disrupt budgets and decrease earnings.
 Loss of income: The loan no longer generates interest income.
 Need for provisions: The bank must set aside funds to cover the potential loss from the
NPA.

20
  Impact on profitability: High NPAs reduce a bank's profitability and can weaken its
financial position.
 Reduced lending capacity: A higher NPA ratio can lead to lower liquidity and the ability
to issue new loans.
Types of Non Performing Assets (NPA)
The three types of non-performing assets (NPAs) are substandard assets, doubtful assets, and loss
assets. Substandard assets are those that have remained an NPA for up to 12 months, while
doubtful assets are those that have been NPAs for more than 12 months. Loss assets are
considered uncollectible with very little value.
 Substandard assets: An asset that has been non-performing for up to 12 months.
 Doubtful assets: An asset that has remained an NPA for more than 12 months, making
recovery increasingly uncertain.
 Loss assets: An asset that has been identified as uncollectible, with very little or no
recovery value, and is typically written off.
NPA Classification:
The loan account is officially flagged as an NPA, marking a default on the loan.
 Intensified Collection:
The lender will likely increase efforts to recover the money, such as sending legal notices or
taking legal action.
 Collateral Seizure:
If the loan is secured by collateral, the lender may begin the process of seizing it.
 Credit Bureau Reporting:
The default will be reported to credit bureaus, which can negatively impact the borrower's credit
score and make it difficult to get future loans.
 Write-off or Recovery:
The bank has two options: continue trying to recover the amount or, if they deem it a loss, write
it off from their books.
Other considerations
 Agricultural Loans:
For agricultural loans, the 90-day rule may be based on crop seasons, not just calendar days.

21
  Overdrafts and Cash Credits:
For accounts like overdrafts and cash credits, the criteria for being "out of order" can also lead to
an NPA classification after 90 days.
 MSME Loans:
There are sometimes government-mandated extensions for certain borrower groups. For
example, the standard 90-day period was extended to 180 days for MSMEs during the COVID-
19 pandemic, and a proposal to make this a permanent change was under consideration in August
2025.
Reasons for Increasing Non Performing Assets
Over-optimism of Banking Sector: Bank did not show much accountability and diligence when
the economy was growing and infrastructure improved during 2006-08.
Slow Growth: The financial crisis of 2008 led to slower economic growth which in turn affected
the profits of the companies and reduced their ability to pay back the loans on time.
External Factors: To counter the aftermath of the financial crisis and declining growth, major
central banks globally adopted the easy money policy which also resulted in easy liquidity in
emerging markets such as India.
This phenomenon pushed up asset prices and led to inflation and also posed threat of stagflation.
Regulatory and Policy Risks: A volatile regulatory framework in the country in the past few
years has led to stress in certain industries.
For example, Mining ban in certain southern Indian states caused significant financial and
operating stress in companies engaged therein, which had a cascading effect on overall
investments in the Indian economy.
Industry Specific Risks: There are industry-specific reasons that cause a rise in the level of Non
Performing Assets in India.
For example, higher Non Performing Assets in aviation sector could be attributed to high cost of
aviation turbine fuel. For Indian airlines, turbine fuels constitute 45% of total operating costs, as
compared to the global average of 30%.
Poor Credit Appraisal System: The credit appraisal by the banks before giving loans remains of
low quality.
Diversion of Loans: The poor end-use monitoring system of the Banks has led to diversion of
funds by the companies for other wasteful purposes.
Willful Defaulters: A lack of proper mechanisms to deal with them means that there has been an
increase in the number of willful defaulters.

22
Willful Defaulters refer to those loanees who fail to repay back the loans despite of being capable
of doing so.
Red-Tapism: Delays in government approvals led to increase in the number of stalled projects.
Lack of Policy Foresight: Legal provisions to deal with Non Performing Assets such as
Insolvency and Bankruptcy Code (IBC) and SARFAESI Act have been formulated only recently.
Frauds: The system has failed to bring any high-profile fraudsters to justice. It was only after the
NPA crisis that the RBI established a fraud monitoring cell to facilitate the early reporting of
fraud cases to investigative agencies.
Ineffective Recovery Tribunal: There has been undue delay in the resolution of cases before the
debt recovery tribunals leading to higher Non Performing Assets.
Political Interference in working of PSBs: The Non Performing Assets are mainly concentrated
in the Public Sector Banks which could be linked to their poor governance, political interference
and lack of independent decision making body.
Priority Sector Lending: The lending by the Banks to priority sectors such as Agriculture and
MSMEs has also contributed to Non Performing Assets.
Credit Culture: The frequent announcement of farm loan waivers by the Central has affected the
credit culture in India.
Absence of Integrated Database on Credit Information: Presently, the credit related information
is captured by multiple agencies without proper coordination.
The RBI’s proposal of creating Public Credit Registry faces legal challenges.
Impact of Rising Non Performing Assets
Rising Non Performing Assets has negative impact the overall growth of the economy as can be
seen below.

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Profitability: On an average, banks are providing around 25% to 30% additional provision on
incremental Non Performing Assets which has direct bearing on the banks’ profitability.
Asset (Credit) Contraction: The increased Non Performing Assets has reduced the banks’ ability
to lend more and thus lesser interest income.

24
It contracts the money stock which may lead to economic slowdown.
Liability Management: High Non Performing Assets may make Banks lower the interest rates on
deposits on one hand and levy higher interest rates on advances.
This may become hurdle in smooth financial intermediation process and hampers banks’
business as well as economic growth.
Capital Adequacy: According to Basel norms, banks must maintain sufficient capital for their
risk-weighted assets.
An increase in the level of Non Performing Assets adds to risk weighted assets which requires
the banks to shore up their capital base further.
In case of PSBs, it may put additional burden on the Government for recapitalisation of PSBs.
Shareholders’ Confidence: The rise in Non Performing Assets is likely to negatively affect the
bank’s business and profitability. As a result, shareholders may not receive a market return on
their capital, and their investment value could erode.
Public Confidence: The credibility of the banking system is significantly impacted by high levels
of NPAs, as it undermines the general public’s confidence in the system’s stability and reliability.
Steps Taken to Curb NPAs
Debt Recovery Tribunal (DRT): It was set up in 2013 to reduce the time required for settling
cases.
It is governed by Recovery of Debt due to Banks and Financial Institutions Act, 1993.
Credit Information Bureau: It was set up in 2000 to prevent NPAs by sharing of information on
wilful defaulters.
Asset Reconstruction Companies (ARCs): ARCs have been set up to fasten the recovery of value
from stressed loans, bypassing courts.
Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act,
2002: This act provides the legal framework for securitization activities in India.
It grants banks and financial institutions the authority to seize immovable property that has been
pledged to recover debts, without needing to go through the Debt Recovery Tribunal (DRT).
Corporate Debt Restructuring: It was implemented in 2005 to alleviate the debt burden on
companies by extending the repayment period as well as reducing interest rates.
5:25 Rule: Introduced in 2014, it is also known as Flexible Restructuring of Long-Term Project
Loans for Infrastructure and Core Industries.

25
Joint Lenders Forum (JLF): Established in 2014, it was designed to prevent scenarios where a
loan from one bank is used to repay loans from other banks.
Mission Indradhanush: It was launched in 2015 as a comprehensive 7-pronged reforms to
improve the functioning of the Public Sector Banks.
The reforms under Mission Indradhanush include: Appointments, Bank Board Bureau,
Capitalisation, De-stressing, Empowerment, Framework for Accountability, and Governance
Reforms.
Strategic Debt Restructuring (SDR): This scheme was launched in 2015 under which if the
corporates, who have taken loans from banks, are unable to repay, the banks can convert part or
complete loans into equity shares.
Asset Quality Review (AQR): Initiated in 2015 as a preventive measure, it involves the early
identification of assets that might become stressed in the future.
Insolvency and Bankruptcy Code (IBC): It was enacted in 2016 and lays down clear-cut and
faster insolvency proceedings to help creditors, including banks, recover dues and prevent bad
loans.

Priority Sector Lending (PSL)

Priority Sector Lending (PSL) is a requirement for banks in countries like India to lend a portion
of their loans to certain sectors of the economy that are considered crucial for inclusive growth.
These sectors are often labor-intensive and include areas like agriculture, micro and small
enterprises (MSMEs), housing, education, and renewable energy. The goal of PSL is to ensure
adequate credit flow to these important but sometimes underfinanced sectors to support
economic and social development.
Key aspects of Priority Sector Lending:
 Mandatory allocation: Banks must lend a specific percentage of their total advances to
priority sectors, as set by the central bank (e.g., the Reserve Bank of India).
 Sectors covered: Common priority sectors include:
o Agriculture: Loans to farmers for various agricultural activities, equipment, and
allied activities.
o MSMEs: Lending to Micro, Small, and Medium Enterprises, including small
businesses and artisans.
o Housing: Providing housing loans, often with a focus on affordable housing and
weaker sections of society.

26
 o Education: Loans to students for education, with limits that have been increased
in recent guidelines.
o Renewable Energy: Financing for projects like windmills, solar power, and
biomass plants.
 Purpose: The main purpose is to provide credit to sectors that may not have regular
access to finance and to promote balanced economic and social development.
 Benefit to borrowers: PSL schemes can make it easier for individuals and businesses in
these sectors to get loans, sometimes with more favorable terms or relaxed collateral
requirements.

ADDITIONAL INFORMATION
Insolvency and bankruptcy code 2016 (IBC 2016)
The Insolvency and Bankruptcy Code 2016 (IBC 2016) is a landmark reform aimed at
addressing multiple challenges in the Indian economy. By addressing the inefficiencies in India’s
insolvency and bankruptcy processes, it has improved the resolution of stressed assets along with
promoting entrepreneurship. This article aims to study in detail the Insolvency and Bankruptcy
Code 2016 (IBC 2016), its needs, provisions, achievements, concerns and other related concepts.
What is Insolvency and Bankruptcy Code 2016 (IBC 2016)?

27
  Insolvency and Bankruptcy Code is a legislation enacted in 2016 based on the ‘T.K
Vishwanathan Committee Report’.
 It consolidates various laws pertaining to the resolution of insolvency of businesses and
firms.
 It establishes streamlined and expedited insolvency procedures to assist creditors, such as
banks, in recovering dues and mitigating bad loans, which are a significant burden on the
economy.
 It is also known as the exit law of India.
What is Insolvency?
 Insolvency refers to a situation where individuals or companies cannot repay back their
outstanding debt obligations.
What is Bankruptcy?
 Bankruptcy refers to a legal status declared by a court of competent jurisdiction for a
person or entity that is insolvent i.e. unable to pay off debts.
 The court issues appropriate orders to resolve the insolvency and protect the rights of
creditors.
Objectives of Insolvency and Bankruptcy Code
Major objectives of the Insolvency and Bankruptcy Code are as follows:
 To consolidate and amend all insolvency laws that are existing in India.
 To simplify and expedite the process of resolution of Insolvency and Bankruptcy in India.
 To protect the interest of creditors, including stakeholders in a company.
 To revive the company in a time-bound manner.
 To promote entrepreneurship.
 To get the necessary relief to the creditors and consequently increase the credit supply in
the economy.
 To work out a new and timely recovery procedure to be adopted by the banks, financial
institutions or individuals.
 To set up an Insolvency and Bankruptcy Board of India.
 Maximization of the value of assets of corporate persons.
Need for Insolvency and Bankruptcy Code (IBC)

28
The need for a new Insolvency and Bankruptcy Code can be seen as follows:
 Previously, India had several overlapping laws and adjudicating forums aimed to address
financial failure and insolvency of companies and individuals.
o This led to undue delays in the recovery of the NPAs by the Banks.

 The Insolvency and Bankruptcy Code (IBC Code) was needed to consolidate all the laws
related to Insolvency and Bankruptcy resolution and to simplify the process of insolvency
resolution.
Institutional Mechanism of IBC
The institutional mechanism of the Insolvency and Bankruptcy Code includes the following:
Insolvency Professionals (IPs)
Insolvency Professions (IPs) are a specialized cadre of licensed professionals who administer the
process of insolvency resolution, manage the debtors’ assets, and provide information for
creditors to assist them in decision-making.
Insolvency Professional Agencies
Insolvency Professional Agencies are tasked with conducting examinations to certify the
Insolvency Professionals (IPs) and enforcing a code of conduct for their performance.
Information Utilities
The creditors would report financial information of the debt owed to them by the debtor.
Adjudicating Authorities
 The proceedings of the resolution process are to be adjudicated by
o National Companies Law Tribunal (NCLT) in case of companies; and

o Debt Recovery Tribunal (DRT) in case of individuals.

 The duties of the authorities includes the approval to initiate the process of resolution,
appointing the insolvency professional, and approving the final decision of creditors.
Committee of Creditors (CoC)
 During the insolvency resolution process, a committee of lenders is formed to make
decisions on the resolution process through voting.
 The CoC may either decide to restructure the debts of the debtors by preparing a
resolution plan or liquidate the assets of the debtors.

29
  However, such a decision must be approved by at least 66% of the total votes in the
Committee of Creditors (CoC).
Insolvency and Bankruptcy Board
 The Insolvency and Bankruptcy Board is mandated with regulating the Insolvency
Professionals (IPs), Insolvency Professional Agencies (IPAs), and Information Utilities
(IUs).
 The Board would comprise of representatives of the Reserve Bank of India (RBI), along
with the Union Ministries of Finance, Corporate Affairs and Law.
Insolvency Resolution Process under IBC
The chronological order of resolution process under the Insolvency and Bankruptcy Code (IBC
Code) is as follows:
 When a default occurs, either the debtor or creditor may initiate the resolution process
before the adjudicating authority.
 The NCLT appoints an Insolvency Professional (IP) to administer the Insolvency
Resolution Process (IRP).
 The Insolvency Professional (IP) identifies the financial creditors and then constitutes a
Committee of Creditors (CoC).
 The CoC prepares the plan of resolution for the restructuring the loans of the defaulted
borrower which may be in the form of extending the maturity period of the loan, reducing
the rate of interest on loans etc.
 Such a resolution plan must be approved by at least 66% of the total votes in the
Committee of Creditors (CoC).

30
Priority of Claims under IBC
The Insolvency and Bankruptcy Code significantly changes the priority waterfall for the
distribution of liquidation proceeds.
 Insolvency resolution process costs and the liquidation costs to be paid in full.
 Claims of secured creditors and workmen are due up to 24 months.
 Employees’ salaries upto 12 months.
 Financial debt owed to unsecured creditors.
 Government dues (2 years) and unpaid dues to secured creditors.
 Any remaining debt and dues.
 Equity.
Achievements of Insolvency and Bankruptcy Code 2016 (IBC 2016)
 Improved Legal Provision: Insolvency and Bankruptcy Code (IBC Code) is a vast
improvement on the two earlier laws for recovering bad loans:
o Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), and

o Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDB).

 Addressing Chakravyuha Challenge: It addresses the Chakravyuha challenge of Indian

Economy

31
 o 1991 LPG Reforms has enabled easier entry of private sector but made the exit
difficult.
o Old Inefficient firms continue to operate with highly efficient firms leading to
misallocation of factors of production.
 Speedier Resolution: Introduction of Insolvency and Bankruptcy Code has brought down
the average time for resolution processes from earlier 4-6 years to just around 317 days at
present.
 Higher Recoveries: Recoveries are also higher: 45% after its introduction, against 26%
before it.
 Ease of Doing Business (EoDB): Post introduction of the Insolvency and Bankruptcy
Code (IBC Code), many business entities can be seen paying up front before being
declared insolvent. Moreover, many cases have been resolved even before it was referred
to NCLT.
 Behavioural Change: The Fear of losing control of the company forces the promoters to
operate at highest level of efficiency. This encourages the borrowers to settle dues at the
earliest.
 Overall Improved Performance: India’s Ranking in resolving insolvency has improved
significantly from 136 in 2017 to 52 in 2020, as reported by World Bank.
Challenges for Insolvency and Bankruptcy Code
 Lack of operational NCLT benches: Most of the single and division benches of NCLT
remain non-operational or partly operational on account of a lack of adequate support
staff and proper infrastructure.
 Low approval rate of resolution plans: As per the Insolvency and Bankruptcy Board of
India’s data, only 60% of the cases have been closed, and the majority of the cases have
been closed through liquidation, only a few cases have been closed due to resolution.
o High number of liquidations is a cause for major worry as it violates IBC’s
principal objective of resolving bankruptcy.
 Delay in Process: Delay in admission of Applications and Approval of Resolution plans
and slow judicial process in India allows the resolution processes to drag on.
 Low Recovery Rate: Recovery rates have, on average, been low.
o Moreover, when a few large recovery cases are excluded from accounting, a
recovery rate of around 35-36% is observed.
Conclusion

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The Insolvency and Bankruptcy Code (IBC) has led to significance improvements in India’s
insolvency landscape, providing a robust framework for the resolution of distressed assets. By
fostering a culture of credit discipline, promoting entrepreneurial ventures, and ensuring the
efficient use of resources, it has set the stage for a more resilient and dynamic economy. Ongoing
efforts to refine and strengthen the code will be crucial for managing the complexities of
insolvency and bankruptcy in the future.
Insolvency and Bankruptcy (Amendment) Act, 2021
The Insolvency and Bankruptcy (Amendment) Act, 2021 introduced an alternate insolvency
resolution process for Micro, Small and Medium Enterprises (MSMEs) with defaults up to ₹1
crore called the Pre-packaged Insolvency Resolution Process (PIRP).

Bad Bank: Meaning, Needs, Framework & More

Bad Bank has emerged as a potential solution to India’s persistent problem of Non-Performing
Assets (NPAs). As a dedicated entity to manage and resolve bad loans, it has made important
efforts towards the resolution of stressed assets. This article aims to study in detail the concept of
Bad Bank, its meaning, needs, evolution, framework, achievements, concerns, and other related
concepts.
What is Bad Bank?
 The Bad Bank is a specialised Asset Reconstruction Company that purchases NPAs from
Banks and restructures them.
 It is not involved in lending and taking deposits but helps commercial banks clean up
their balance sheets and resolve bad loans.
 The takeover of bad loans is normally below the book value of the loan and the bank tries
to recover as much as possible subsequently.
 It has often been touted as a magic bullet for reducing NPAs, improving Banks’ Balance
sheets, unlocking banks’ capital, increasing the Credit creation and consequently, a way
out of the vicious economic cycle created due to the Twin Balance Sheet (TBS) problem.
Evolution of Bad Bank in India
 The Economic Survey 2016-17 had recommended setting up Centralised Public Sector
Asset Rehabilitation Agency (PARA) as Bad Bank to address the growing problem of
NPAs.
 The budget 2021 proposed an Asset Reconstruction Company (ARC)-Asset Management
Company (AMC) structure, wherein the ARC will aggregate the debt, while the AMC
will act as a resolution manager.

33
Need for Bad Bank in India
 Economic Recovery: With the pandemic hitting the banking sector, the RBI fears a spike
in bad loans in the wake of a six-month moratorium it has announced to tackle the
economic slowdown.
 Government Support: Professionally-run, funded by the private lenders and supported by
the government, can be an effective mechanism to deal with Non-Performing Assets
(NPAs).
o The presence of the government is seen as a means to speed up the clean-up
process.
 Rising NPAs: The K.V. Kamath Committee noted that corporate sector debt worth ₹15.52
lakh crore has come under stress after COVID-19 hit India, while another ₹22.20 lakh
crore was already under stress before the pandemic.
o This staggering number of NPAs has led to the Twin Balance Sheet Problem in
India.
 International Precedents: Many other countries had set up institutional mechanisms to
deal with a problem of stress in the financial system.
Framework for Bad Bank in India
For resolution of huge NPAs (Non-Performing Assets) in the Indian Banking sector, the
Government of India has set up the following two new entities to acquire stressed assets from
banks and then sell them in the market.
National Asset Reconstruction Company Limited (NARCL)
 NARCL has been incorporated under the Companies Act and has applied to the Reserve
Bank of India for a license as an (ARC).
 NARCL will acquire stressed assets worth about `2 lakh crore from various commercial
banks in different phases.
 Public Sector Banks (PSBs) will maintain 51% ownership in NARCL.
Read our detailed article on:
 Merger of Public Sector Banks (PSBs) in India
 Privatisation of Public Sector Banks (PSBs) in India
India Debt Resolution Company Ltd (IDRCL)
 Another entity, India Debt Resolution Company Ltd (IDRCL), will then try to sell the
stressed assets in the market.

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  PSBs and Public Financial Institutes (FIs) will hold a maximum of 49% stake in IDRCL.
The remaining 51% stake will be with private-sector lenders.
 The NARCL-IDRCL structure is the new bad bank structure.
Arguments in Favor of Bad Bank
 Improvement in the balance Sheet of the Banks due to a decrease in the NPAs.
 Unlocking of the capital that was earlier locked up as provisioning requirements. This
would lead to increase in the credit creation.
 Enable the Bank to focus on their core areas of accepting deposits and lending loans. The
function of recovery of bad loans gets transferred to the bank, specialised in this work.
 Address the problem of coordination and delays in the recovery of NPAs by multiple
Banks. Setting up of such a Bank would enable multiple Banks to transfer their NPAs
simultaneously to them and improve their balance sheets.
Arguments Against Bad Bank
 Moral Hazard: Taxpayer’s money would be used to bail out inefficient Banks.
Guaranteed takeover of NPAs by such banks may prevent Banks from exercising due
caution before giving loans.
 Pricing of NPAs: If the NPAs are sold at higher prices to bad banks, such Banks
themselves would fail. If NPAs are sold at lower prices, the Banks would be required to
take higher haircuts.
 No Substantial Impact: Merely leads to transfer of Bad Assets from one entity to another.
 No long-term Impact: Does not address the core underlying problems which led to
increase in NPAs in first place Without governance reforms, the Public sector banks
(accounted for 86%, of the total NPAs) may go on doing business the way they have been
doing in the past and may end up piling-up of bad debts again.
 International Experience: As seen in Sweden, such Banks works best in case of NPAs in
small value housing loans. However, in case of India, the NPAs are present across
multiple sectors.
 Financing: Difficult to mobilise finances for setting up such Banks. Finding buyers for
bad assets in a pandemic hit economy will be a challenge, especially when governments
are facing the issue of containing the fiscal deficit. Thus, setting up of such Banks would
only be a superficial and band-aid solution to long-term problems.

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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 (RoA) 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.

Conclusion
Non Performing Assets pose a significant challenge to the banking sector and the economy.
While various measures have been taken to address the issue, it requires continuous efforts to
prevent a recurrence and maintain financial stability. A robust credit culture, effective risk
management, and strong governance are essential for mitigating NPA risks.
Special Mention Account (SMA)
It is an account showing early signs of stress that may lead to the borrower defaulting on timely
debt servicing, even though it has not yet been classified as an Non Performing Asset according
to current RBI guidelines.
SMAs show symptoms of bad asset quality and have potential to become an NPA/Stressed Asset.

SMA Sub-categories Basis for classification – Principal or interest payment overdue between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

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.
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:
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Loan loss provisions, which are set aside to cover potential losses, reduce the capital available to
provide subsequent loans. Once the actual losses from defaulted loans are determined, they are
written off against earnings.
What Is the Foreclosure Process?
The foreclosure process can vary by state, but typically, the lender will contact the borrower to
inform them of the foreclosure. The loan is considered nonperforming at 90 days. During
foreclosure, the lender will take possession of the property to resell it and recoup losses from the
outstanding loan.
What Is Debt Restructuring?
Debt restructuring for consumers involves a loan modification by the lender to help the borrower
repay the debt. The loan amount, interest rate, or term may be adjusted to give the borrower more
time to pay. However, loan restructuring can harm your credit and hinder future credit
opportunities.

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