Bad loans, NPAs and the Insolvency and Bankruptcy Code

In the mid-2010s, India faced what the Economic Survey of 2016–17 called the twin balance sheet problem: over-leveraged companies that could not repay their debts, and banks weighed down by the resulting bad loans. The banks stopped lending; the companies stopped investing. Untangling that knot took several years and one of the biggest legal reforms of the decade — the Insolvency and Bankruptcy Code.

What is an NPA?

A loan becomes a non-performing asset (NPA) when interest or principal remains overdue for more than 90 days.

NPAs are further classified by how long they have been non-performing:

Banks must set aside provisions against NPAs — a share of the loan's value — which eats into their profits and capital.

Gross NPA is the total value of bad loans; net NPA is gross NPA minus provisions.

How the problem built up

• The investment boom (roughly 2004–2011) — companies borrowed heavily for infrastructure, power, steel and telecom projects, often on optimistic assumptions.
• Things went wrong — delays in land acquisition and clearances, cancellation of coal block and spectrum allocations, falling commodity prices, and a slowing economy left projects stalled and companies unable to pay.
• Evergreening — banks sometimes restructured or rolled over loans instead of recognising them as bad, hiding the true extent of stress.
• Public sector banks were hit hardest.

The response: the 4R strategy

The government and RBI's approach is often summarised as the 4Rs:

1. Recognition — the RBI's Asset Quality Review (from 2015) forced banks to recognise hidden bad loans. Reported NPAs rose sharply — painful, but necessary.
2. Resolution — new legal mechanisms to resolve stressed assets, above all the IBC.
3. Recapitalisation — the government injected capital into public sector banks, including through recapitalisation bonds.
4. Reforms — governance changes in public sector banks, consolidation through mergers, and tighter monitoring (including the RBI's Prompt Corrective Action framework for weak banks).

Gross NPAs of scheduled commercial banks peaked above 11 per cent of advances around 2018 and fell steadily afterwards, reaching multi-year lows in recent years.

Tools before the IBC

These helped, but recovery was slow and outcomes were weak. The system favoured debtors who could delay.

The Insolvency and Bankruptcy Code, 2016

The IBC created a single, time-bound framework for resolving insolvency of companies, partnerships and individuals.

Key institutions:

• Insolvency and Bankruptcy Board of India (IBBI) — the regulator.
• National Company Law Tribunal (NCLT) — the adjudicating authority for companies; appeals go to the NCLAT and then the Supreme Court.
• Insolvency professionals — manage the process.
• Information utilities — store financial information.

How the corporate process works:

1. A creditor (financial or operational) or the company itself applies to the NCLT once a default occurs.
2. If admitted, a Corporate Insolvency Resolution Process (CIRP) begins. A moratorium halts all legal actions against the company.
3. An insolvency professional takes over management from the promoters — the key shift from "debtor in possession" to "creditor in control".
4. A Committee of Creditors (CoC), made up of financial creditors, considers resolution plans from bidders.
5. The process is meant to be completed within 180 days, extendable by 90 days, with an outer limit of 330 days including litigation (after a 2019 amendment).
6. If no plan is approved, the company goes into liquidation.

Section 29A, added in 2017, bars defaulting promoters and certain connected persons from bidding for their own companies.

A pre-packaged insolvency process for MSMEs was introduced in 2021.

Assessment

Achievements:

• A credible threat to defaulting promoters; improved credit culture.
• Resolution of several large stressed accounts.
• A clear hierarchy of claims and a market for distressed assets.

Concerns:

• Delays — many cases take far longer than the statutory limits, largely because of the NCLT's capacity and prolonged litigation.
• Low recovery rates in many cases, with large "haircuts" for creditors.
• High share of liquidations among concluded cases, many of them companies that were already defunct.
• Operational creditors, including small suppliers, often recover little.

The "bad bank"

The National Asset Reconstruction Company Limited (NARCL), set up in 2021, acquires large stressed loans from banks, with a government guarantee on part of the payment. It works alongside the India Debt Resolution Company Limited (IDRCL), which manages the resolution. The idea is to aggregate bad loans in one place and speed up their resolution.

Practice questions

1. Prelims-type: After how many days overdue does a loan become an NPA? Which body is the adjudicating authority for corporate insolvency under the IBC?
2. Mains-type (150 words): What was the twin balance sheet problem? How did it affect investment in India?
3. Mains-type (250 words): "The Insolvency and Bankruptcy Code has changed the credit culture in India, but its implementation has fallen short of its promise." Discuss.