With the RBI regulations for the sale of bad loans, banks appear to pass on their heavy burden of NPAs and make some hot cash in the process. Market analysts say that with the slowing down of the economy, the bad loan market may gain momentum.

Ever since the financial sector reforms commenced in India, i.e., in the last decade, following the popular recommendations of the Narasimham Committee, the problem of bad loans, also known as Non-Performing Assets (NPAs), has become perennial in the banking sector. High-level of NPAs in the banking system causes financial degradation and affects the economy of the country in many ways. Despite the best efforts put in by the banks to clean up their asset portfolio, unhealthy competition, poor quality lending and inadequate monitoring probably keep allowing the performing assets to slip and become non-performing assets. The enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act 2002 had paved way for emergence of a secondary market for bad loans. In the wake of Basel II implementation, which is a pending issue for the Indian banking industry, there is a pressing need for the banks to strengthen their books. Hence, banks are making all efforts to sell bad loans to reduce their NPA levels and in the process trying to make money out of the same. Sensing the potential business opportunities emerging out of bad loan market, more and more banks, financial institutions and investment banks are ready to enter the field and the market is gaining momentum.

Banks take serious steps to sell bad loans, especially during the last quarter of a fiscal year, to strengthen their balance sheets. It is all the more important now because implementation of Basel II means putting aside more capital to guard against financial and operational risks. Basel II international accounting standards were implemented by banks with overseas operations in March 2008 and have to be implemented by other banks from March 2009. The banks are required to make higher provision for NPAs. Their risk weight will be higher and hence, they will need more capital to cover the cost of defaulted loans.

Banks do not earn any interest on NPAs but they need to make heavy provisions for them. Hence, NPAs are deadweights in the books of the banks. High-level of NPAs, thus, affects the performance and profitability of the banks. To offset this loss on interest income, banks tend to charge higher rates of interest on performing assets. With a reduction in the levels of NPAs, banks can afford to bring down their interest rates on loans.

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