Corporate Defaults and Bank Exposure: What are NPAs

Corporate Defaults and Bank Exposure: What are NPAs

In this sophisticated world of finance, corporate defaults are a stark reminder of the risks that come with lending and investments. A corporate default occurs when a company is unable to meet its debt commitments. This can be due to financial mismanagement, economic downturn, or any unanticipated crisis. These defaults not only shake investor confidence but also pose a serious threat to banks, which often carry the financial burden of outstanding debts.
When companies default on their loans, banks' Non-Performing Assets (NPAs) rise. NPAs are loans that no longer generate income for banks because of missed payments by borrowers. This is one of the biggest problems caused by corporate defaults, as it weakens banks financially, draining their ability to lend, and slows down economic growth. In the economy, this acts as a ripple effect and affects everyone, like companies will face challenges in securing fresh loans, banks will not be able to allocate funds, and this leads to a reduction in credit flow in the economy, impacting industries, employment, and overall economic momentum. Let’s catch corporate defaults and Non-Performing Assets more-

Understanding NPAs

Non-performing assets are a major concern for banks worldwide. In simple terms, an NPA is a loan that has stopped generating income for banks due to non-payment by the borrower for a specific duration, typically 90 days. ⁽¹⁾ What qualifies as an NPA?
1. The borrower has not paid interest or principal for more than 90 days.
2. A cash credit or overdraft remains ‘out of order’ beyond the 90-day mark.
3. A bill purchased or discounted remains overdue for more than 90 days.

Classification of NPAs
The Reserve Bank of India categorizes NPAs based on the severity of default ⁽²⁾:
1. Sub-Standard Assets - These assets display signs of risk but still have recovery potential and have remained non-performing assets (NPAs) for less than 12 months.
2. Doubtful Assets- These are the loans that have remained classified as Non- Performing Assets (NPAs) for a period exceeding 12 months. Banks are insecure about a full recovery.
3. Loss Assets- These are declared by the RBI or by auditors as futile and are written off as losses.

Regulatory Perspective on NPAs

Globally, NPAs are defined similarly, but different countries have varying criteria for classification. Like India, the RBI has set strict rules for NPAs, ensuring that banks maintain financial discipline. Provisioning Requirements mandates that banks set aside funds to cover probable losses from NPAs. RBI also mandates restructuring options like the Insolvency and Bankruptcy Code (IBC) to recover unpaid debt. ⁽³⁾
While if we talk about the Securities and Exchange Commission (SEC), it doesn’t directly administer NPAs but has sanctioned strict financial disclosure norms, corporate governance norms, and fraud avoidance measures to maintain economic stability.

Causes of Corporate Defaults and NPAs
Now we know that corporate defaults and NPAs are a result of various incidents, but what causes them? Understanding these causes is crucial for banks, corporations, and governments to reduce risks and maintain financial stability.

1.     Poor Financial management within companies
Many corporations’ default because of poor internal management, like enormous borrowing or improper business strategies. Companies that fail to maintain a healthy financial position or engage in reckless expansion often find themselves unable to meet their financial burden. Weak internal controls lead to exaggerated problems, leading to NPAs. ⁽⁴⁾

2.     Economic downturns and industry-specific crises
The aviation and hospitality industry faced severe financial hardships during the COVID-19 pandemic. Similarly, industries like the real estate sector have historically seen an increase in NPAs due to market fluctuations. Thus, recession or sector-specific slowdown can impact businesses, reduce their revenue streams, and make loan repayments difficult. ⁽⁵⁾

3.     Fraudulent Activities and Misreporting of Financial Health
High-profile cases like Yes Bank have showed how financial misreporting can lead to NPAs, reducing investors' morale and affecting the broader economy. Such corporate defaults are often deliberate, caused by fraudulent activities like window dressing financial statements. ⁽⁶⁾

4.     Government regulations
Changes in regulation or taxation policies, or sudden shifts in government decisions, can impact corporate income. For example, demonetization in India affected banks' liquidity. Similarly, poor lending practices by banks have also added to rising NPAs. ⁽⁷⁾

Government & Regulatory Interventions
Different countries adopt different approaches to mitigate financial risks. In India, the Reserve Bank of India (RBI) has introduced several frameworks to manage NPAs, like the SARFAESI Act in 2002. SARFAESI, short for Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest, empowers banks to recover loans without court intervention and permits them to seize and auction assets of defaulting borrowers. ⁽⁹⁾ Similarly, the Insolvency and Bankruptcy Code (IBC, 2016) streamlines the resolution process for distressed companies, ensuring the fast recovery of bad loans. (9) The government also infuses capital into struggling banks to strengthen their balance sheets and absorb NPA-related losses as much as it can.

Similarly, the United States introduced the Troubled Asset Relief Program (TARP) in 2008 after the financial crisis to strengthen the banking sector by purchasing troubled assets.  According to the U.S. Department of the Treasury, “Although Congress initially authorized $700 billion for TARP in October 2008, that authority was reduced to $475 billion by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).” ⁽¹⁰⁾

While regulatory frameworks have improved NPA management, continuous reforms and stronger oversight are needed to ensure financial stability.

Strategies to Prevent NPAs

Proactive strategies can significantly reduce the occurrence of Non-Performing Assets (NPAs). By implementing stronger credit assessment procedures, corporate governance reforms, loan structuring mechanisms, and AI-driven risk analysis, financial institutions can at least safeguard themselves from bad loans.

·       Stronger Credit Assessment Procedures
Banks must conduct thorough due diligence before approving loans and use credit scoring techniques to assess borrower risks. With the enhancement in technology, they can adopt early warning systems to detect financial distress before it happens. A robust credit evaluation process is the first line of defense against NPAs.⁽¹¹⁾  

·       Corporate Governance and Transparent Financial Practices
Ensuring accurate financial disclosures and promoting ethical lending, to prevent fraudulent practices. Poor governance and financial misreporting often lead to defaults, so ensuring strict regulatory compliance to maintain financial integrity will strengthen corporate governance. ⁽¹²⁾

·       Restructuring Loans
Early measures can prevent loans from becoming NPAs. Banks need to restructure their policies time and again to get their money back, like implementing flexible repayment plans to ease financial pressures or using debt resolution frameworks like the Insolvency and Bankruptcy Code (IBC) to recover funds efficiently. ⁽¹¹⁾

·       Adoption of AI and Fintech
Technology is revolutionizing NPA; AI and Fintech can help by predicting credit risk using data provided, detecting fraudulent activities before they escalate, and automating loan monitoring to identify potential defaults before they occur. ⁽¹³⁾

Preventing NPAs requires combining various financial approaches. As banks embrace AI-driven risk assessment and strengthen governance, the financial system will become more resilient against defaults.  

Case Studies: Yes Bank’s Crisis & Recovery

Corporate defaults shake the financial market, but some can bounce back. Yes Bank was one of India’s fastest-growing private banks in 2020, but due to reckless lending and poor financial management led it to the brink of collapse. The bank's financial health deteriorated to a level that the Reserve Bank of India (RBI) had to intervene and restrict withdrawals to Rs. 50,000 per withdrawal. ⁽¹⁴⁾ But what went wrong?

Yes Bank gave loans to high-risk borrowers, like DHFL, IL&FS, and many others, who later defaulted, resulting in a pool of non-performing assets. Adding on to this, Yes Bank under-reported these bad loans, which eroded investors' and depositors' confidence. Governance failures also played a key role in the crisis. Despite attempts, the bank later failed to raise sufficient capital.

According to an article from The Economic Times, the Finance Minister of India, Ms. Nirmala Sitharaman, stated that, “I wouldn’t even mind taking their names as they are in the public domain and I am not violating any customer’s privacy. Anil Ambani Group, Essel Group, DHFL, IL&FS, and Vodafone are some of those very stressed corporates to whom Yes Bank has been exposed. This is from before 2014.” ⁽¹⁵⁾ Aggressive lending to stressed companies and underreporting NPAs lead to a sudden surge in bad loans. When anything like this happens, depositors start withdrawing money in panic, a similar thing happened, and Yes Bank faced a liquidity crisis. Corporate governance issues like mismanagement and regulatory violations added to this.

At the end, the lender of the Last Resort, the Reserve Bank of India (RBI), intervened with a reconstruction scheme, bringing in the State Bank of India (SBI) and other major banks to infuse fresh capital. A whole new leadership team was appointed, and government reforms were implemented. Over the period, Yes Bank stabilized, regained investor confidence, and returned to profitability. ⁽¹⁵⁾

The lessons learnt were very crucial as this crisis taught us that corporate governance and transparency are crucial in preventing financial crises. Timely intervention by regulators can save institutions from collapsing, and innovation and being flexible help businesses to recover and thrive.

Future Trends
The future of Non-Performing Assets is shaped by economic conditions, technological advancements, and evolving financial regulations.

Will NPA Rise or Decline?

According to S&P Global, “Defaults of investment-grade issuers (where an issuer was investment grade at the start of the year it defaulted) are becoming more infrequent. There was one investment-grade default in 2024, and the investment-grade defaults that occurred in 2023 were the first ones in four years. In addition, there have been only seven investment-grade defaults since 2010--an average of 0.5 per year.” ⁽¹⁶⁾

Stronger banking regulations and debt resolution frameworks can curb NPAs. Banks are increasingly leveraging AI-driven models to analyze and predict defaults, while fintech solutions enable better tracking of diverse borrower repayment patterns. As a result, the next decade is likely see a decline in NPAs, provided banks continue to embrace technology and responsible lending practices.

Conclusion

Corporate defaults and non-performing assets (NPAs) pose a persistent challenge, but with evolving regulations, technological innovations, and responsible lending practices, financial institutions can mitigate risks effectively. The integration of AI-driven risk analysis, ESG-focused lending, and proactive policy interventions is reshaping the way banks manage credit. While NPAs will never fully disappear, a smarter, more resilient banking system will ensure financial stability and sustained economic growth. The key lies in adaptability, transparency, and innovation, essential pillars for a stronger financial future.

Sources:

1.        IJCRT, NON-PERFORMING ASSETS: A STUDY ON NPA IN INDIAN BANKS AND ISSUES AND CHALLENGES, May 5, 2023

2.        Unacademy, New NPA Norms of RBI

3.        RBI, Discussion Paper on Securitisation of Stressed Assets Framework (SSAF), Jan 25, 2023

4.        Research Gate, Non-Performing Assets (NPA) in Indian Banking: Causes, consequences, and remedial measures

5.        Testbook, NPA: Meaning, Examples, Causes, Impacts, Measures & More

6.        Business Today, Why did Yes Bank collapse? Here are 6 main reasons, Mar 6, 2020

7.        CFI Education Inc., Corporate Fraud

8.        AngelOne, NPA: Impact on Banking & Economy

9.        JETIR.ORG, Impact and Challenges of the SARFAESI Act on Asset Recovery and Financial Stability in India, December 2024

10.    U.S. Department of the Treasury, Troubled Asset Relief Program (TARP)

11.    BCT Digital, Reducing non-performing assets and credit risk through early warning systems

12.    Inspira Journals, Artificial Intelligence: A Way Forward for NPA Management in Indian Banking Sector (Special Reference to Global Trends)

13.    Gnani.ai, Technology in Banking: How AI Can Help Prevent NPAs, March 26, 2021

14.    IOSR Journals, A Study on Yes Bank Crisis, July 21, 2020

15.    Economic Times, How five corporates led to the downfall of Yes Bank?, March 10, 2020

16.   S&P Global, Default, Transition, and Recovery: 2024 Annual Global Corporate Default And Rating Transition Study, March 27, 2025

Disclaimer: This article is for educational purposes only and is based on publicly available sources. While efforts have been made to ensure accuracy, the content should not be considered professional advice