NPAs and Insolvency for UPSC

NPAs and Insolvency for UPSC

NPAs and Classification

Non-performing assets refer to loans or advances where interest or instalments remain overdue for more than 90 days. When a bank's asset stops generating income, it strains profitability, capital adequacy and credit growth. To improve transparency and ensure early identification of stress, the Reserve Bank of India (RBI) stipulates detailed norms for categorising loan accounts.

Standard Asset versus Stressed Asset

A standard asset is a performing loan on which payments are made on schedule and there is no sign of distress. Once a borrower fails to pay interest or principal beyond 90 days, the account is marked as a non-performing asset. Between these two extremes are Special Mention Accounts (SMAs) that indicate early stress even though the account has not yet become an NPA. The SMA framework has three buckets based on the number of days past due (1-30 days, 31-60 days and 61-90 days) and applies to term loans as well as working-capital facilities like overdrafts.

NPA Categories

Once a loan is classified as an NPA, banks must further classify it based on how long it remains non-performing. The main categories are:

• Sub-standard asset: The loan has been an NPA for up to 12 months. This category is considered to have some credit weakness, and banks are required to make a minimum provisioning of 10 % of the outstanding amount.
• Doubtful asset: The loan has remained in the sub-standard category for more than 12 months. Doubtful assets are further subdivided depending on how long they have been doubtful (up to 1 year, 1-3 years and more than 3 years). Provisioning is higher, ranging from 20 % to 100 % on the secured portion and 100 % on the unsecured portion.
• Loss asset: The asset is considered uncollectible or of little value even though there may be some residual recovery. Such assets should be written off or fully provided for at 100 %.

Banks also track Gross NPA (GNPA) and Net NPA (NNPA). GNPA is the total value of non-performing loans, while NNPA subtracts provisions made by the bank, giving a clearer picture of the real stress.

Table - Classification of Stressed Assets

The table below summarises the key classification norms for term loans and working-capital accounts based on RBI guidelines. It helps aspirants quickly recall the overdue days and provisioning requirements.

*Provisioning requirements are minimum percentages; actual provisioning may be higher based on bank policy and regulator instructions.

Current Trends in Asset Quality

The asset quality of Indian banks improved markedly during 2024-25. According to the Reserve Bank of India's Financial Stability Report released in June 2025, the gross NPA ratio of scheduled commercial banks fell to a multi-decadal low of 2.3 % as of 31 March 2025. The net NPA ratio stood at an even lower 0.5 %. Public-sector banks reported gross NPAs of around 2.8 %, down from 3.7 % a year earlier, while private-sector banks maintained a stable ratio of around 2.8 %. Stress tests conducted by the RBI indicate that under a baseline scenario the gross NPA ratio could edge up slightly to 2.5 % by 2027, but under adverse shocks it may rise above 5 %. Nevertheless, the sharp decline from double-digit NPA ratios observed during 2016-2018 underscores the success of reforms, improved credit appraisal and the deterrent effect of the IBC.

Causes of NPAs

Understanding why loans become non-performing is essential for designing preventive policies. NPAs arise from a mixture of borrower-specific factors, macroeconomic shocks and institutional weaknesses. The major causes include:

• Economic slowdown and sectoral downturns: Slumps in sectors like infrastructure, steel, power and telecom during the early 2010s led to defaults. Unexpected events such as the COVID-19 pandemic reduced demand, cut cash flows and impaired repayment capacity.
• Poor credit appraisal and monitoring: Banks sometimes extended large loans without proper due diligence, overestimating cash flows or collateral value. Weak monitoring allowed borrowers to divert funds or delay projects without timely intervention.
• Wilful default and fraud: Certain borrowers deliberately avoided repayment despite having the ability to pay. Cases of siphoning off funds, multiple borrowing against the same collateral and promoter guarantees being invoked led to protracted litigation.
• Policy and regulatory issues: Delays in land acquisition, environmental clearances, litigation and stalled government contracts hampered project execution and increased interest burdens. A lack of bankruptcy framework prior to 2016 meant recoveries were slow.
• External shocks: High global commodity prices, currency depreciation, natural calamities and trade disruptions can erode margins and push borrowers into default. For example, the energy price spike after the Russia-Ukraine conflict in 2022 increased input costs for many firms.
• Borrower mismanagement: Inefficient operations, poor corporate governance, and diversion of funds to unrelated businesses reduce profitability and repayment capacity.

These factors often interact. For instance, a project that is poorly appraised and heavily leveraged may collapse if a macro shock occurs. That is why preventive measures such as robust credit evaluation, post-disbursement monitoring and diversification of loan portfolios are crucial.

To visualise the interplay of causes, imagine a simple diagram showing three concentric circles labelled macro factors (economic slowdown, global shocks), institutional factors (regulatory delays, weak legal framework), and borrower factors (mismanagement, wilful default). The overlapping area in the centre represents the loans most likely to become NPAs. This conceptual diagram underscores that NPAs cannot be attributed to a single cause and require holistic solutions. (Diagram description: three overlapping circles labelled macro factors, institutional factors and borrower factors, with the overlap labelled "potential NPAs".)

Resolution Mechanisms Before the IBC

Before the Insolvency and Bankruptcy Code came into force in 2016, Indian banks used several mechanisms to recover bad loans or restructure them. These tools often operated in silos, were time-consuming and delivered modest recovery. The main mechanisms were:

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002

The SARFAESI Act allows secured creditors to seize and sell collateral without court intervention if the borrower defaults. After serving a 60-day notice, banks can take possession of assets and recover dues through auction. The Act also provides for asset reconstruction companies (ARCs) that purchase NPAs and manage recovery. SARFAESI is useful for secured loans backed by tangible assets such as property, vehicles or plant and machinery.

Debt Recovery Tribunals (DRTs)

DRTs were established under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 to adjudicate claims of banks and financial institutions for recovery of debts above a threshold (now Rs 20 lakh). DRTs have the powers of a civil court and can issue recovery certificates to attach property and bank accounts. However, limited bench strength and a rising caseload have led to delays.

Lok Adalats

Lok Adalats are alternative dispute resolution forums, usually organised at district level, where parties voluntarily settle disputes through conciliation. They are particularly useful for small loans (below Rs 20 lakh) and rural advances. Once a case is settled in Lok Adalat, the decision is binding and enforceable like a decree of a civil court. Recovery rates through Lok Adalats, however, are low because parties often lack incentive to settle.

Corporate Debt Restructuring (CDR) and Other Schemes

To tackle stress in large corporate loans, the RBI introduced several restructuring frameworks:

• Corporate Debt Restructuring (CDR): Launched in 2001, CDR allowed multiple lenders to rework terms (tenor, interest rate, conversion of debt into equity) of loans exceeding Rs 100 crore with the consent of 75 % of creditors by value. It lacked legal backing and depended on borrower cooperation, which limited its success.
• Joint Lenders Forum (JLF): Introduced in 2014, JLF required all lenders to a stressed borrower to jointly decide on corrective action within 45 days of stress recognition. Options included rectification, restructuring or recovery. JLF reduced coordination failures but suffered from delays and lack of enforceability.
• Strategic Debt Restructuring (SDR): This 2015 scheme allowed lenders to convert part of the debt into equity and assume management control if the borrower defaulted. The idea was to bring in new promoters or sell the company. In practice, legal challenges and the absence of prospective buyers limited its use.
• Scheme for Sustainable Structuring of Stressed Assets (S4A): Launched in 2016, S4A split the debt into sustainable and unsustainable portions. Sustainable debt was serviced normally, while unsustainable debt was converted into equity or preference shares. S4A required an external expert opinion and was used selectively.
• 5/25 Refinancing: This allowed infrastructure and core industry projects with long gestation periods to refinance loans with longer repayment periods (up to 25 years) while maintaining 5-year repricing. It provided temporary relief but sometimes only postponed the problem.

Comparative Table of Recovery Channels

The following table compares the key features of major recovery channels used before and after the advent of the IBC. It highlights why the IBC became the dominant tool.

Figures for recovery rate and time are indicative averages and vary across cases and years.

IBC Process: Step-by-Step

The Insolvency and Bankruptcy Code, 2016 was a watershed reform. It consolidated several scattered laws into a single framework with the objective of time-bound resolution, maximising asset value, and balancing interests of creditors and debtors. The Code covers corporate persons, partnership firms and individuals (with separate processes for each). The following subsections focus on the Corporate Insolvency Resolution Process (CIRP), which applies to companies and limited liability partnerships.

Initiation of Insolvency

A creditor (financial or operational) or the corporate debtor itself may initiate insolvency if a default of at least Rs 1 crore has occurred. The applicant files a petition before the National Company Law Tribunal (NCLT), the adjudicating authority for corporate persons. The NCLT must admit or reject the application within 14 days of filing. Once admitted, a moratorium kicks in, staying all suits, enforcement actions, and recovery proceedings against the debtor, and prohibiting transfers of its assets.

Appointment of Interim Resolution Professional (IRP)

Within 14 days of admission, the NCLT appoints an Interim Resolution Professional. The IRP takes over management of the debtor, collects information, and publicises the commencement of CIRP to invite claims. The IRP verifies claims, constitutes the Committee of Creditors (CoC) composed of financial creditors, and convenes the first meeting within 30 days.

Committee of Creditors and Resolution Professional (RP)

The CoC decides whether to continue with the IRP or replace them with another Resolution Professional. Decisions of the CoC require a 66 % voting share. The RP manages the debtor as a going concern, prepares an information memorandum, and invites expressions of interest from prospective resolution applicants. Operational creditors above a threshold and workmen's representatives may attend meetings but cannot vote.

Submission and Approval of Resolution Plan

Prospective resolution applicants submit their plans, which must provide for payment of insolvency costs, repayment to operational creditors at least equal to liquidation value, and management of the debtor in the future. The RP presents all plans to the CoC. If the CoC approves a plan by a 66 % vote, the plan is submitted to the NCLT for approval. Once approved by the tribunal, the plan is binding on all stakeholders, including government authorities.

Timeframe and Liquidation

The IBC originally prescribed 180 days for completion of CIRP, extendable by 90 days. Amendments later capped the total period, including litigation, at 330 days. However, in practice many cases have overshot the deadline. If no resolution plan is approved within the prescribed time or if the plan is rejected, the debtor proceeds to liquidation. During liquidation, a liquidator sells the assets and distributes proceeds in a waterfall manner prioritising insolvency costs, workmen's dues, secured creditors, unsecured creditors, government dues, and shareholders last.

Pre-Packaged Insolvency for MSMEs

Recognising the need for quicker resolution for small businesses, the government introduced the Pre-Packaged Insolvency Resolution Process (PPIRP) in 2021 for micro, small and medium enterprises (MSMEs) with default up to Rs 1 crore. Under PPIRP, the debtor and creditors negotiate a base resolution plan before approaching the NCLT. Once admitted, the process must conclude within 120 days, with only 90 days for the CoC to approve the plan. During the pre-pack, the existing management continues to run the company (debtor-in-possession), but control shifts to creditors if the plan fails.

Upcoming Reforms: IBC (Amendment) Bill, 2025

To address delays and broaden the Code's scope, the government introduced the IBC (Amendment) Bill, 2025. The key proposals include:

• Creditor-initiated insolvency resolution (CIIRP): A simplified, out-of-court process that allows creditors to resolve defaults quickly with only post-facto approval from the NCLT.
• Group insolvency framework: Joint proceedings for related companies to avoid value destruction, inspired by cases like the Videocon group where assets were spread across multiple entities.
• Cross-border insolvency: Adoption of the UNCITRAL Model Law to enable recognition of foreign proceedings and cooperation across jurisdictions.
• Expanded pre-pack mechanism: Extending PPIRP to larger companies and introducing sector-specific provisions.
• Other reforms: Increasing NCLT benches, allowing part-wise resolution of debt, expanding the time period for submitting claims and empowering the adjudicating authority to approve sale of assets separately to maximise value.

These reforms aim to reduce delays, enhance flexibility and align the Code with global best practices.

Outcomes and Impact of the IBC

The IBC has profoundly altered the credit culture in India. Its emphasis on creditor control and time-bound resolution has created a credible threat for errant borrowers, leading many to settle dues without entering formal insolvency proceedings. Major outcomes include:

• Dominant recovery channel: The RBI's Trend and Progress of Banking in India 2023-24 report shows that the IBC accounted for 48 % of all recoveries in FY 2023-24, far ahead of SARFAESI (32 %), DRTs (17 %) and Lok Adalats (3 %). This underscores its effectiveness compared to earlier mechanisms.
• Large volumes resolved: According to the Ministry of Corporate Affairs, by 31 December 2024, banks initiated 8,175 corporate insolvency resolution processes. Of these, 3,485 companies were rescued (1,119 through resolution plans, 1,236 via appeal or settlement and 1,130 through withdrawal), while 2,707 were liquidated. The realisable value for creditors in the 1,119 cases where resolution plans were approved was around Rs 3.58 lakh crore, which is 162.79 % of the liquidation value and 87.58 % of the fair value of assets.
• Improved credit culture: An estimated Rs 9 lakh crore of debt has been settled before admission into the CIRP, as promoters prefer to avoid losing control to resolution professionals. This deterrent effect reduces strategic defaults.
• Enhanced recovery rates: On average, creditors have recovered about 30-35 % of admitted claims under the IBC, significantly higher than the 22 % recovery rate under SARFAESI, 17 % under DRTs and 3 % in Lok Adalats.
• Restoration of viability: Successful cases like Bhushan Steel (acquired by Tata Steel), Essar Steel (acquired by ArcelorMittal-Nippon Steel), and Jaypee Infratech illustrate how the IBC can preserve jobs and keep factories running by bringing in new investors.
• Challenges remain: Despite these successes, the average resolution time has grown to about 713 days-double the statutory limit-due to litigation and capacity constraints at NCLTs. Haircuts (losses to lenders) are high in many cases. Small and medium enterprises find the process expensive. The proposed 2025 amendments seek to address these issues.

Overall, the IBC has transformed the resolution landscape. It is not a panacea-improving debt appraisal, strengthening governance and developing a deeper market for stressed assets remain essential-but it has created a culture of accountability and provided a credible exit mechanism.

For UPSC Prelims vs Mains

Prelims Pointers

• Remember that a loan becomes an NPA when interest or principal remains overdue for more than 90 days. SMA categories (SMA-0, 1 and 2) track delays of 1-30 days, 31-60 days and 61-90 days respectively.
• Identify the NPA sub-categories: sub-standard (up to 12 months), doubtful (beyond 12 months, further classified as D1, D2, D3) and loss asset (uncollectible).
• Know the key features of the SARFAESI Act, Debt Recovery Tribunals and Lok Adalats. SARFAESI allows banks to seize collateral without court; DRTs adjudicate higher-value cases; Lok Adalats use conciliation.
• The Insolvency and Bankruptcy Code is a creditor-in-control, time-bound resolution framework. The moratorium, Committee of Creditors and the role of the Resolution Professional are core elements.
• Recall that the gross NPA ratio of Indian banks fell to around 2.3 % by March 2025, the lowest in over a decade.
• Be aware of the average recovery rate: ~30-35 % under the IBC, compared to lower rates under SARFAESI, DRTs and Lok Adalats.
• Remember the statutory CIRP timeline of 330 days, though actual resolution often takes longer.

Mains Notes

• Analyse the structural causes of NPAs-economic, institutional and borrower-specific-and suggest preventive measures such as better project appraisal, diversification, and strengthening of governance and legal frameworks.
• Discuss how the IBC has transformed the debtor-creditor relationship, shifting control to creditors and creating deterrence against wilful default. Examine its impact on bank balance sheets and the broader economy.
• Evaluate the effectiveness of pre-IBC mechanisms like SARFAESI, DRTs and various restructuring schemes. Why did they fail to stem the NPA crisis? How does the IBC overcome their shortcomings?
• Critically assess the challenges facing the IBC: delays, high haircuts, limited NCLT capacity, and concerns over the fate of small creditors. Examine proposals in the IBC Amendment Bill, 2025 (creditor-initiated process, group insolvency, cross-border insolvency) and discuss how they address these issues.
• Suggest policy steps to reduce future NPAs: strengthen credit risk management, promote stressed asset markets, improve insolvency infrastructure, and foster financial literacy among borrowers.
• Use examples of resolved cases to illustrate how timely resolution can preserve value, jobs and economic activity. Contrast these with cases where delayed resolution led to value destruction.

Quick Facts

• The gross NPA ratio of scheduled commercial banks fell to 2.3 % and the net NPA ratio to 0.5 % as of March 2025.
• NPAs of public-sector banks declined from 9.11 % in March 2021 to 2.58 % in March 2025, reflecting a concerted clean-up.
• Special Mention Account categories SMA-0, SMA-1 and SMA-2 flag loans overdue by 1-30, 31-60 and 61-90 days respectively.
• Under the IBC, 8,175 corporate insolvency cases were admitted by December 2024; 3,485 companies were rescued and 2,707 were liquidated.
• Creditors recovered around Rs 3.58 lakh crore from 1,119 resolved cases-about 162.79 % of liquidation value.
• The average resolution period under the IBC has lengthened to about 713 days, well above the 330-day statutory limit.
• The IBC accounted for 48 % of bank recoveries in FY 2023-24, ahead of SARFAESI (32 %), DRTs (17 %) and Lok Adalats (3 %).
• The proposed IBC Amendment Bill, 2025 introduces creditor-initiated insolvency, group insolvency and cross-border insolvency frameworks.

UPSC Previous Year Questions (Selected)

The following paraphrased questions illustrate how UPSC has tested candidates on NPAs and insolvency:

1. 2017 Prelims: Consider the following statements about the Insolvency and Bankruptcy Code (IBC): (1) It applies only to corporate debtors, not to individuals. (2) The Code aims to conclude insolvency resolution within 90 days. Which statements are correct? Answer: Both statements are incorrect. The IBC covers companies, limited liability partnerships, partnership firms and individuals. The initial resolution period for corporate insolvency is 180 days, extendable up to 330 days.
2. 2018 Mains (GS III): "The rising burden of NPAs is symptomatic of deeper problems in India's banking system." Analyse the structural causes of NPAs and examine the role of the Insolvency and Bankruptcy Code in addressing them. Answer: Candidates should discuss economic slowdowns, poor credit appraisal, policy delays and wilful default as causes. They should highlight how the IBC created a unified, time-bound framework that empowered creditors, improved recovery rates and deterred defaults, while noting challenges like delays and high haircuts.
3. 2021 Prelims: With reference to non-performing assets (NPAs), which of the following statements is/are correct? (1) A loan becomes an NPA when interest is overdue for more than 90 days. (2) All NPAs are treated alike in provisioning. (3) Special Mention Accounts are a type of NPA. Select the correct answer using the codes given below. Answer: Only statement 1 is correct. NPAs are further classified as sub-standard, doubtful and loss assets with differing provisioning. SMAs are accounts showing early signs of stress and are not yet NPAs.
4. 2023 Mains (GS III): Evaluate the performance of the Insolvency and Bankruptcy Code in improving the recovery of stressed assets. What reforms would you suggest to enhance its efficiency? Answer: Candidates should cite data on recovered amounts, rescued companies and improved NPA ratios. They should also mention delays, high haircuts and capacity constraints. Suggested reforms include more NCLT benches, streamlined procedures, adoption of cross-border insolvency, group insolvency and improved coordination among regulators.

Practice MCQs

1. Which of the following correctly describes a doubtful asset (D2) according to RBI guidelines?
   1. An asset that has been NPA for up to 12 months
   2. An asset that has been in the sub-standard category for more than 48 months
   3. An asset that has remained NPA for more than 24 months but up to 48 months
   4. An asset that is uncollectible and should be written off
2. Under the SARFAESI Act, secured creditors can seize and sell collateral after serving notice of:
   1. 30 days
   2. 60 days
   3. 90 days
   4. 180 days
3. Which of the following is not a feature of the Insolvency and Bankruptcy Code?
   1. Moratorium on suits and enforcement actions once a case is admitted
   2. Committee of Creditors controls the resolution process
   3. Resolution plans must be approved by a simple majority of creditors
   4. Resolution Professional manages the debtor as a going concern
4. Pre-Packaged Insolvency Resolution Process (PPIRP) is presently available for:
   1. Any corporate debtor irrespective of size
   2. Only micro, small and medium enterprises (MSMEs)
   3. Only large listed companies
   4. Only partnerships and individuals
5. As per recent data, the IBC accounted for what share of total bank recoveries in FY 2023-24?
   1. 12 %
   2. 32 %
   3. 48 %
   4. 60 %

Answer key: 1-C, 2-B, 3-C, 4-B, 5-C.

Frequently Asked Questions

What is a non-performing asset (NPA)?

An NPA is a loan or advance where the borrower has not paid interest or principal for more than 90 days. It stops generating income for the lender and signals financial distress.

How does the IBC differ from SARFAESI?

The IBC is a comprehensive insolvency law that provides for time-bound resolution of stressed companies through a tribunal-supervised process, whereas SARFAESI allows secured creditors to enforce collateral without court intervention. The IBC covers all kinds of creditors and emphasises restructuring over mere asset seizure.

What happens during the moratorium under the IBC?

Once the NCLT admits a CIRP application, a moratorium is declared. It stays all suits, proceedings, foreclosure and enforcement actions against the corporate debtor. The moratorium protects the debtor's assets while a resolution plan is explored.

Why do banks need to provision for NPAs?

Provisioning means setting aside a portion of profits to cover potential losses from bad loans. It cushions banks against future defaults and ensures that financial statements reflect the real health of the loan book. Provisioning requirements increase as the asset ages (sub-standard, doubtful, loss).

Can individuals be resolved under the IBC?

Yes. While the corporate insolvency process receives most attention, the IBC also contains provisions for insolvency resolution of individuals and partnership firms, adjudicated by Debt Recovery Tribunals. However, these provisions have been notified in phases and are yet to be fully operationalised.

What are the proposed reforms in the IBC Amendment Bill, 2025?

The Bill proposes creditor-initiated insolvency (CIIRP) for quicker out-of-court resolution, group insolvency for related companies, adoption of cross-border insolvency norms, expansion of pre-packaged insolvency beyond MSMEs, more NCLT benches and flexibility to sell assets separately to maximise value.

Why are resolution timelines under the IBC often exceeded?

Although the Code sets a 330-day limit, delays arise due to legal challenges, appeals to appellate bodies, shortage of NCLT benches and complex cases involving multiple claimants. Efforts are underway to improve tribunal capacity and streamline procedures.

Does the IBC impact small borrowers?

Yes. While large corporate cases dominate headlines, the Code also covers individuals and small businesses. The pre-packaged insolvency mechanism is designed for MSMEs. However, costs, complexity and fear of losing control may deter small borrowers from using the process.