India is currently facing one of its worst NPA (Non-Performing Assets) crises in history. Due in equal measure, to bad policy choices and the pandemic, NPAs are expected to be 12.5 % of all bank loans by March next year. To put the scale of the crisis into perspective, the global average NPA to total loans ratio is about 3 percent. NPA ratio in countries like Australia, UK and Republic of Korea is less than 1 percent. The situation is so adverse that just a couple of years ago, India’s 4th largest private bank, Yes Bank, almost collapsed. But while the current crisis has been heavily documented, the NPA crisis from 1997 to 2002 has not received much attention by scholars and politicians alike. It is important to dissect the causes and effects of that crisis to effectively address the current one. This article will attempt to give a general outline of what transpired during those 5 years.

What is an NPA?

In the simplest of terms, a non performing asset refers to an asset which no longer produces any income. Since loans are assets for banks, when a borrower fails to repay either the principal amount and/or the interest that is due, the loan is said to be a Non-Performing Asset. In the context of India, if a debtor fails to make a payment within 90 days after the stipulated deadline, the loan is said to be in default and is classified as an NPA. Since the banking system of a country facilitates the creation of investments from savings, piling up of NPAs is a serious obstacle in the way of capital formation and, subsequently, leads to a reduction in the growth rate.

The Crisis

From 1997 to 2002, the gross NPA to loans ratio was about 11%. While private banks were better off than public banks, they still had an NPA to loans ratio of about 8%. Most of these banks were severely undercapitalized and were barely managing to keep themselves afloat. All of this was quite unexpected in the wake of the 1991 LPG reforms because it was believed that privatization of banks would make the banking system more robust and efficient. So what exactly went wrong? This question is answered in the next paragraph.

Causes of the crisis

The banking sector was radically transformed after the 1991 LPG reforms. It was decided that more licenses would be given to private sector entities to open up banks, interest rates would be deregulated and there would be a gradual reduction in the cash reserve ratio and statutory liquidity ratio of the banks. In addition to this, Public banks were allowed to sell 49 % of their equity so as to shift some burden of to the private sector. Deregulation of entry also meant that banks now had to adopt international standards of capital adequacy to ensure stability. In this context, let us evaluate the causes of the crisis. Firstly, a lot of foreign firms entered the Indian market so the domestic firms had to ramp up their quality to compete with them. While some domestic firms thrived, others had a hard time. Their earnings took a severe hit as a result of which many of them were unable to make their loan payments. Secondly, Development Finance Institutions (DFIs) were quite effective before 1997 for advancing long term loans in the infrastructural sector. They could do this because they had access to low cost capital from RBI and faced little competition. However, after the reforms, they lost access to this low-cost capital and had to raise it from the market. In addition to this, commercial banks started advancing long term loans at lower rates compared to the DFIs. Faced with lack of capital and immense competition, the DFIs came under major financial stress and their NPAs piled up. Thirdly, 1997 was also the year when the Asian Financial Crisis rocked the continent. Many Indian firms were affected by the sudden crisis and defaulted on their loan payments. Fourthly, India’s decision to conduct nuclear bomb tests in 1998, while desirable from a national security standpoint, led to a worrisome economic situation. In the wake of these tests, many of India’s trading partners imposed strict economic sanctions on India to express their displeasure. As a result of this, a lot of domestic firms lost access to the supply of essential raw materials and foreign markets. These disruptions in their businesses meant that they were not in a position to meet their loan repayment obligations. 

Coming out of the crisis

As for how the banking system recovered from this crisis, it was an interesting combination of governmental efforts and favorable circumstances that eventually led to a reduction in NPAs. Many crumbling DFIs were rescued by merging them with commercial banks but some others became economically unviable. As far as the commercial banks are concerned, the government decided to inject capital into them until they were stable enough to raise capital from the market. The issue of whether governments should bailout private banks remains hotly contested even today but it would be fair to state that capital injections were necessary in the crisis under consideration. In addition to this, the government also restructured many commercial banks to make them more durable and resistant to market pressures. 

In the early 2000s, the IT revolution gripped the world and significantly benefitted the Indian economy. Major multi-national corporations outsourced many of their services to the subcontinent because of the benefits offered by a cheap labor in India. This was also the time when a significant number of indigenous IT firms began to develop in India. Without going into much detail, the important thing to consider here is that the IT revolution led to a direct rise in India’s growth prospects and created a highly optimistic and stable economic environment. Inflation and interest rates were low as a result of which the banks enjoyed considerable advantages. On top of this, sectors such as infrastructure and telecommunications received fresh investments which enabled their firms to secure a stable financial position and comply with their loan repayment obligations. 


This article gave an idea, in the briefest way possible, of the general causes, effects and solutions to an NPA crisis. Owing to differences in global and domestic economic contexts, many of the conclusions from the 1997-2002 crisis cannot be mechanistically applied to solve the current one. But it still serves as a valuable case study for dealing with certain specific problems arising out of an NPA crisis. For a country which has been ignorantly repeating past mistakes lately, policymakers may yet redeem themselves by learning from the past while addressing the NPA, as well as the more general economic, crisis that India is facing.



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