SPECIAL ARTICLE
Determinants of Recovery of Stressed Assets in India
An Empirical Study
Rekha Misra, Rajmal, Radheshyam Verma
There have been signs of stress in the balance sheets of
banks in an environment of increasing uncertainties and
a fragile global economy. Weakening loan recovery rates
not only forces banks to face the burden of higher
provisions and limits their lending capacity, it also
diminishes their profitability and solvency. Examining
the determinants of recovery of defaulted loans by
banks in India, the need for a stronger and effective
insolvency regime is felt so as to improve the
debtor–creditor relationship and credit environment.
The importance of the presence of collateral, the type of
collateral used, and a conducive macroeconomic
environment towards recovery of bad loans are
highlighted. There is a need for strengthening banks’
credit appraisal system. Access to alternative resources
facilitates loan recovery, highlighting the need for
further development of capital market as a source for
adequate resources for borrowers.
The views are personal.
Rekha Misra (rekhamisra@rbi.org.in), Rajmal (rajmal@rbi.org.in) and
Radheshyam Verma (rsverma@rbi.org.in) are with the Department of
Economic and Policy Research, Reserve Bank of India, Mumbai.
62
R
ising concern about low recovery rate of defaulted
loans has attracted substantial attention and has come
to occupy centre stage in policy deliberations in an
environment of fragile global growth, heightened volatility in
financial markets and weaknesses in corporate balance sheets.
Deterioration in loan recovery not only leads to higher provisions
and diminished profitability but also constrains banks’ lending
capacity, thus affecting the economy adversely. A recent expe-
rience of global financial crisis exposed the weaknesses in the
resolution frameworks and bank supervision which severely
affected the financial systems across countries.
Recovery rate determines the extent of loans that are in
default. There can be two dimensions to recovery rate. One
measures the extent to which a creditor recovers the principal
and the accrued interest on a loan. Another dimension of the
recovery rate measures the extent to which the creditor recovers
the principal and accrued interest due on a defaulted debt. A
proper assessment of both these dimensions of loan recovery is
a crucial part of the overall risk management strategy of banks.
Studies examining the determinants of recovery rate mainly
pertain to advanced economies. Researchers using advanced
economies’ data have analysed both aspects of recovery rate.
The focus of research studies in the case of emerging economies,
however, has primarily been on analysing the first dimension
of recovery rate and the reasons why a performing loan converts
into a non-performing loan.
In the Indian context as well, researchers have primarily
focused on the first aspect of recovery rate and have analysed the
reasons for non-performing assets (NPAs) (Lokare 2014). Thus,
an in-depth empirical study on determinants of loan recovery is
yet to emerge for India. The analysis of recovery rate is particu-
larly critical in the aftermath of a cyclical downturn when banks
are saddled with huge NPAs. At this juncture, an understanding
of the enabling factors which results in greater recovery of
defaulted loans has significance from the policy angle as well.
It is increasingly recognised that loan recovery mechanism
needs to be strengthened as the rising stress on banks assets
quality and a low level of recovery could pose problem for the
financial system and disrupt the pace of growth. Accordingly,
policy initiatives are required towards strengthening effective
credit appraisal and monitoring, better balance sheet disclosures
and effective legal capacity for recovery of loans. This study
attempts to explore empirically the key determinants of the
recovery of defaulted loans of banks and is expected to fill the gap
in the literature and provide some insights for the policymakers.
OCTOBER 22, 2016 vol lI no 43 EPW Economic & Political Weekly

Review of Literature
An analysis of the factors determining the recovery rate of
stressed assets is critical to improve the recovery efforts of the
banks. However, most of the studies examining recovery rate
pertain to advanced economies. Researchers have mainly
focused on account-wise analysis while examining the deter-
minants of loan recovery. These studies have primarily
analysed the recovery rate and its distribution. There are not
many studies available for the emerging market economies
(EMEs). Several studies analysing the recovery rate in adv-
anced economies have found a recovery rate of above 70%. For
the limited studies that are available for the emerging econo-
mies, the recovery rate was found to be much lower. Literature
suggests that both macroeconomic factors as well as micro-
economic factors act as significant determinants of recovery of
defaulted loans.
Asarnow and Edwards (1995) examined 831 defaulted loans
at Citibank over the period 1970–93. They reported an average
cumulative recovery rate of 65%, based on the present value of
future cash flows received after the default date. A significant
result of their study was that the distribution of recovery rates
was bi-modal, with a concentration of recovery rates on either
the low or the high end of the distribution. Carty and Lieber-
man (1996) measured the recovery rate on a sample of 229
small- and medium-size loans in the United States (US). They
reported an average recovery rate of 79%, based on the present
value of cash flows. Again, the distribution was highly skewed
towards the high end of the scale.
Grossman et al (1998) analysed the recovery rate on 60
syndicated bank loans over the period 1991–97 and reported
an average recovery figure of 82% with a standard deviation of
24%. However, the study did not analyse the distribution of
recovery rates. Hurt and Felsovalyi (1998) analysed 1,149 bank
loan losses in Latin America over the period 1970–96. They
reported an average recovery rate of 68.2%, calculating the
present value of recovered cash flows. They showed that loan
size was a contributing factor to loss rates, with large loan
default exhibiting lower recovery rates. They attributed this to
the fact that large loans, often not secured, were made to eco-
nomic groups that were family-owned. Similar to Asarnow
and Edwards (1995), they also reported a bi-modal distribution.
La Porta et al (2003) analysed loan default and losses-given-
default in Mexico in the context of related lending, that is, lend-
ing to shareholders or directors of the bank. They reported an
average recovery rate of 46% for unrelated loans, and 27% for
related loans over the period 1995–99. Evidence of skewness
towards the high end of the distribution was also reported.
Most of the time, recovery as a percentage of exposure is either
relatively high (around 70%–80%) or low (around 20%–30%).
The recovery (or loss) distribution is said to be “bi-modal”
(two-humped). Hence thinking about an “average” recovery or
loss-given-default can be very misleading. None of the above
mentioned studies analysed the timing of the recoveries.
In addition to the analysis regarding recovery rate and
distribution of recovery, studies have also examined the
factors determining the recovery rate after a credit event. Key
Economic & Political Weekly EPW OCTOBER 22, 2016 vol lI no 43
SPECIAL ARTICLE
determinants of the recovery rate have been both micro (loan
specific) as well as macro (economy specific) in nature. The
determinants examined in the studies are the number of years
of the client’s relationship with the bank, the rate of growth of
gross domestic product (GDP), the frequency of default in the
industry/sector, the rating of the borrower and the interest
rate on the loan. The number of years of relationship could have
an effect on the effort of a distressed borrower to repay her
debt in order to protect the information-based value created by
the relationship. Borrowers with an intense client relationship
with the bank exhibit a higher recovery rate. If the exposure at
default is high, the probability that the bank can achieve a
high recovery rate increases. This may be due to the reason that
the bank intensifies inquiries regarding the creditworthiness
and monitoring of the borrower. The probability of obtaining
high recovery rates increases if the risk premium is low, the
client relationship is intense, quota of collateral is high and the
borrowers aim to continue to run their business.
The most important determinant of a defaulted claim is
whether it is backed by a security or not. Grunert and Weber
(2009) examined the recovery rates of commercial lending for
German companies and found that a higher quota of collateral
leads to a higher recovery rate, whereas the risk premium of
the borrower and the size of the company is negatively related
to the recovery rate. The place of the defaulted loan in the
capital structure of the obligor (the degree to which the claim
is subordinated) is also an important determinant. Thus bank
loans, being at the top of the capital structure, typically have
higher recovery than bonds.
Recoveries are systematically lower in recessions, and the
difference can be dramatic. Frye (2000) shows that in a reces-
sion, recovery is about a third lower than in an expansion, that
is, losses are higher in recessions, lower otherwise. Industry of
the obligor seems to matter; tangible asset-intensive indus-
tries, especially utilities, have higher recovery rates than
service sector firms, with some exceptions such as hi-tech and
telecom. Thus, industry and macroeconomic conditions are
also relevant, as are certain process factors such as pre-pack-
aged bankruptcies (Khieu et al 2012). Pre-packaged bankruptcy
reorganisation increases actual settlements. Size of exposure
seems to have no strong effect on losses.
The literature highlights that loan characteristics, such as
the presence of certain types of collateral, are significant
determinants of recovery rates, whereas many of the borrower
characteristics before default generally do not play a significant
role in determining the recovery rate of a loan.
Khieu et al (2012) using trading price data on the US loans in
default over the period 1987–2007 found that firm leverage
before default negatively affects recoveries, while firm size
and cash flows do not. Loan recoveries vary significantly with
the length of time and the relationship is non-linear. Recoveries
first decrease and then increase as the time to resolution
lengthens. Industry distress does have a negative impact on
settlement recovery rates and there is cross-sectional variation
in recoveries with respect to the type of industry the defaulting
borrowers operate in.
63
SPECIAL ARTICLE
As regards emerging market economies (EMEs), Bello et al
(2013) examined the determinants of recovery of defaulted
mortgage loans in Nigeria during 1999–2011 and found that
growth in GDP, borrower status, year of borrower, business
relationship with bank, loan supervision, age of collateral and
location of real estate collaterals are significantly positive
determinants of loan recovery. They also found that inflation
rate, interest rates, priority of collateral and collateral revalua-
tion are significantly, but inversely related to loan recovery,
while factors such as loan-to-value (LTV), loan size, and loan
duration though insignificant, exert positive influence on poss-
ibility of recovery. Similarly, Dermine and Neto de Carvalho
(2006) found that loan recovery was a function of collateral
asset, loan size, the industry factor and the age of the borrower.
According to them, when the cost associated with recovery is
high, the recovery is low. Inwon (2002) reported that to
enhance full recovery of loan there should exist a robust legal
environment that prevents multiple pledging of asset that pro-
vides an efficient process for asset realisation.
Researchers have also found evidence of concerted micro- and
macro-prudential policies acting as facilitators in distressed
loan recovery. Kick et al (2010) examined the impact of super-
visory measures on the likelihood and the timing of bank
recovery among German banks during the period 1994–2008.
They found that severe regulatory measures increase both the
likelihood of recovery and its duration while weak measures
are insignificant. They mentioned that increasing earnings
and cleaning credit portfolios are consistently important to
increase recovery likelihood, whereas earnings growth
accelerates the timing of recovery. The study emphasised that
macroeconomic conditions also matter for bank recovery.
Debt Recovery Measures and Their Effectiveness
Developing a sound recovery mechanism is crucial for facili-
tating smooth functioning of banks and achieving sustained
growth. In India, several measures have been initiated to
create enabling legal and regulatory environment to facilitate
the recovery of NPAs of banks over the years. Both the preventive
(know your customer [KYC] norms, early warning signals, etc)
and curative measures (recovery channels) assume impor-
tance to arrest the rise in NPAs. Recovery channels for bank
loans include Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest (SARFAESI) Act
2002, Debt Recovery Tribunals and Lok Adalats.
The SARFAESI Act effective from 21 June 2002 has been a
major development in the evolving institutional infrastructure
for financial regulation. This act empowers banks/financial
institutions to recover their NPAs without the intervention of
court. The Security Interest (Enforcement) Rules, 2002 enables
secured creditors to authorise their officials to enforce the
securities and recover the dues from the borrowers.
Secured creditors are given the power to take possession of
the securities in the event of default and sell such securities for
the purpose of recovery of the loan. If any borrower fails to
discharge liability in repayment of any secured debt within 60
days of notice from the date of notice by the secured creditor,
64
the secured creditor has the power to take possession of the
secured assets of the borrower, takeover of the management of
the business of the borrower and appoint any person to
manage the secured assets.
Securitisation/Reconstruction Companies
There are provisions for setting up of Securitisation Companies/
Reconstruction Companies (SCs/RCs) under the SARFAESI Act.
The act enables the banks and financial institutions to realise
long-term assets, manage problems of liquidity, asset-liability
mismatch and improve recovery by exercising powers to take
possession of security, sell them and reduce NPAs by adopting
measures for recovery or reconstruction within the framework
of the act. The SCs/RCs acquire NPAs from banks/financial
institutions by raising funds from Qualified Institutional Buyers
(QIBs) by issue of Security Receipts (SR). The act also enables
SCs/RCs to take possession of secured assets of the borrowers
including the right to transfer and realise secured assets. SCs/
RCs act as debt aggregators and are focused in the resolution of
NPAs. Thus SCs/RCs take away the distraction of banks by
isolating NPAs from the banking system. This leaves rest of the
banking system free to act in their core area of lending and
normal banking business.
Debt Recovery Tribunals (DRTs) were established consequent
to the passing of Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 to assist the banks in the speedy adjudi-
cation of matters relating to recovery of NPAs of `10 lakh and
above. The act has been applicable from 24 June 1993 to the
whole of India except Jammu and Kashmir. The recent amend-
ments to DRT Act vide the Enforcement of Security Interest and
Recovery of Debts Laws (Amendment) Act, 2012 have been
carried out to improve the functioning of the DRTs, to prescribe
time frame for filing of pleadings, adjournments, etc, and to
give recognition and validity to the settlements/compromises
entered into between banks and borrowers.
DRT grants time to the borrower/applicant to make payment,
and subject to payment, bank’s SARFAESI action is stayed.
Though Section 17(5) provides that an application under Section
17 shall be disposed of within 60 days of date of application
(extendable up to four months), the said time frame is not be-
ing strictly followed in practice. There is long delay in passing
orders by the DRTs. As per the Recovery of Debts due to Banks
and Financial Institutions (RDDBFI) Act, though the cases are
to be disposed of within six months, in some cases, the next
date itself is given after six months to one year. When an
appeal is filed before Debt Recovery Appellate Tribunal (DRAT)
against the order of DRT, though there is provision for stipulation
of deposit of 75% of the amount of debt due as a precondition
for admission of appeal, most DRATs are exercising their
discretion and do not insist for deposit of any amount despite
the specific pleas made by the banks in this regard.
Lok Adalats have been organised under the Legal Services
Authorities Act, 1987 for compromise or settlement of disputes
between parties. With high pendency of cases in the courts,
Lok Adalats can often be an efficient and alternate way of judi-
cial settlement. The Reserve Bank of India (RBI) first issued
OCTOBER 22, 2016 vol lI no 43 EPW Economic & Political Weekly
 SPECIAL ARTICLE
Figure 1: Total Amount Involved and Recovery be brought within the purview of the Lok Adalats. The mone-
10,000 40
tary ceiling of amounts regarding which civil disputes can be
35
8,000
settled under this mechanism is presently `20 lakh.
30

6,000 25 Performance of Recovery Channels

` billion

Per cent
Recovered/Total
20
Amount (%) Assessing the performance of various recovery channels in bad
4,000 15
Total Amount Recovered Amount
loans recovery assumes importance as it helps in exploring the
10
2,000 strengths and weakness of the system in place and thus provide
5
insights for further improvement and strengthening of the
0 0
2005–10 2010–11 2011–12 2012–13 2013–14 2014–15
recovery mechanism. A quick overview of recovery manage-
(Avg) ment shows that total amount referred to various recovery
Source: Report on Trend and Progress of Banking in India and Statistical Tables Relating to channels (SARFAESI, DRT and Lok Adalats) witnessed a rising
Banks in India.
trend over the period. However, the recovered amount as a
Figure 2: Recovered Amount as Percentage of Outstanding Amount under percentage of total amount involved witnessed moderation.
Various Recovery Channels
This is evident from the fact that since 2012–13, these channels
60
on an average recovered only 20% of the total referred amount.
50 The ratio of recovered amount to total amount remained in the
DRT SARFAESI
40
range of 18%–24% during these years (Figure 1).
Lok Adalats Total amount referred to all the three channels increased
Percent

30
from `0.2 trillion in the second half of the 2000s to `0.5 trillion
20 in 2010–11. The rising trend continued and the increase was
10
sharper from 2012–13 onwards. The bad loans referred to
three recovery channels rose from `1.1 trillion in 2012–13 to as
0
2005–10 2010–11 2011–12 2012–13 2013–14 2014–15
high as `9.4 trillion in 2014–15 (Figure 1). This amount may
(Avg) increase further given the weak recovery and substantial rise
Source: Report on Trend and Progress of Banking in India and Statistical Tables Relating to
in stressed assets of banks particularly public sector banks
Banks in India.
(PSBs) in the subsequent periods.
guidelines on compromise settlement of dues of banks and The SARFAESI Act has provided a significant impetus to
financial institutions through Lok Adalats in 2001. The disputes banks to ensure sustained recovery. During the period 2003–04
brought to Lok Adalats should be either a pending case before to 2014–15, the amount recovered under SARFAESI stood at `2.0
any court for which the Lok Adalat is organised or a matter trillion. This accounted for 26.4% of the outstanding amount
which is falling within the jurisdiction but not pending in any under SARFAESI. During the same period, recovered amount
court. Offences which are compoundable under any law cannot accounted for 16.5% of the outstanding amount under DRT and
Table 1: Status of Recovery under Various Channels (` billion) 5.3% under Lok Adalats. During 2014–15, the amount recov-
Period DRTs SARFAESI Lok Adalats ered was around `1.2 trillion (24% of the outstanding amount)
Amount Amount Amount Amount Amount Amount
Outstanding Recovered Outstanding Recovered Outstanding Recovered
under SARFAESI (Table 1).
2004–05 143 27 132 24 8 1 Under the DRTs, the total amount referred up to March 2015
2009–10 98 31 142 43 72 1 stood at `3.9 trillion and DRTs recovered 14% of the outstanding
2013–14 553 53 953 253 232 14 amount. In the case of Lok Adalats, the outstanding amount
2014–15 3,789 531 4,705 1,152 887 43 was `0.9 trillion and out of the total referred amount only
Source: Report on Trend and Progress of Banking in India and Statistical Tables Relating to 4.8% was recovered up to end-March 2015 (Figure 2).
Banks in India, various years.
From this evidence, it is clear that the performance of the
Table 2: Ranking in Resolving Insolvency—A Comparative Position
Country Rank Resolving Insolvency
recovery channels in India has not been very encouraging.
Ease of Resolving Recovery Rate Time Cost Strength of Consequently, when compared with its comparator countries,
Doing Insolvency (Cents on (Years) (% of Estate) Insolvency
Business the Dollar) Framework
India fares poorly in its record of resolving insolvency.
Index (0–16)
1 Brazil 116 62 22.4 4.0 12.0 13.0 Resolving Insolvency: International Comparison
2 Russian Federation 51 51 41.7 2.0 9.0 11.5 World Bank’s Doing Business Report 2016 highlights that India
3 India 130 136 25.7 4.3 9.0 6.0 is ranked 136 among 189 countries in the ease of doing business
4 China 84 55 36.2 1.7 22.0 11.5
index in the category of resolving insolvency. India’s overall
5 South Africa 73 41 35.3 2.0 18.0 14.5
ranking is 130. World Bank data show that it takes 4.3 years to
6 United Kingdom 6 13 88.6 1.0 6.0 11.0
resolve insolvency in India. In that period, the creditors in
7 United States 7 5 80.4 1.5 8.2 15.0
8 Finland 10 1 90.1 0.9 3.5 14.5
India recover about 25.7 cents on the dollar compared to 80.4
9 Japan 34 2 92.9 0.6 3.5 14.0 cents in the US in less than half the time (Table 2). The new
10 Germany 15 3 83.7 1.2 8.0 15.0 Insolvency and Bankruptcy Bill, 2016, which got assent of the
Source: Doing Business 2016, World Bank (http://www.doingbusiness.org/data). President of India in May 2016 seeks to cut down the time to
Economic & Political Weekly EPW OCTOBER 22, 2016 vol lI no 43 65
 SPECIAL ARTICLE
Figure 3: Movement of NPAs of SCBs—Bank Group
3,500
3,000
2,500
Foreign banks
` billion
2,000
PSBs excluding SBI and associates Private sector banks
1,500
PSBs All SCBs
1,000
500
0
2000 2005 2007 2008 2009 2010
Source: Statistical Tables Relating to Banks in India.
Table 3: Share of GNPAs among Bank Group (Percent to GNPAs of all SCBs)
Bank Group 2000 2005 2012
PSBs 87.9 81.6 82.5
Foreign banks (FBs) 4.4 3.8 4.4
Private sector banks (PVBs) 7.7 14.7 13.1
Source: Statistical Tables Relating to Banks in India, RBI.
less than a year. The Code prescribes a timeline of 180 days for
dealing with applications for insolvency resolution, which can
be extended for 90 days by the adjudicating authority only in
exceptional cases.
Recently, several initiatives have been taken to enhance
credit discipline, address asset quality issues, encourage
market access, enable early recognition of stress, offer appro-
priate solutions, improve corporate governance and augment
capital. Measures such as corporate debt restructuring, the
Joint Lenders’ Forum (JLF) and the Strategic Debt Restructur-
ing (SDR) scheme are out-of-court mechanisms to restructure
loan contracts with debtors. Under the SDR scheme, secured
creditors of a JLF can convert their loan dues into equity
shares at a “fair price” as per the pricing formula prescribed
by the RBI, which has been exempted from the SEBI’s ICDR
(Issue of Capital and Disclosure Requirements) Regulations,
2009 subject to certain conditions. More recently, Scheme for
Sustainable Structuring of Stressed Assets (S4A) was intro-
duced in June 2016 by the RBI as an optional framework for
the resolution of large stressed accounts. It envisages deter-
mination of the sustainable debt level for a stressed borrower
and the bifurcation of the outstanding debt into sustainable
debt and equity/quasi-equity instruments. This will help in
putting real assets back on track by another avenue for
reworking the financial structure of entities facing genuine
difficulties, while providing upside to the lenders when the
borrower turns around (RBI 2016).
The Insolvency and Bankruptcy Bill, 2016 seeks to improve
the handling of conflicts between creditors and debtors, avoid
destruction of value, distinguish malfeasance vis-à-vis business
failure and clearly allocate losses in macroeconomic down-
turns. The bill consolidates existing laws relating to insolvency
of companies, limited liability entities, unlimited liability part-
nerships and individuals which are presently scattered in a
number of legislations, into a single legislation. It seeks to
speed up the process of corporate bankruptcy by empowering
creditors so that the loss on a bad loan can be minimised. Cur-
rently, banks take several years in certain cases to recover their
money, which substantially erodes the value of the assets. It is
66
expected that new laws would bring greater
legal certainty and speed in closure of busi-
nesses which need winding up due to genuine
reasons. The objectives of new code include:
less time in resolution, lower losses in recov-
ery and higher levels of debt financing across
a wide variety of debt instruments.
Given the legal certainty and fixed time
period for recovery of bad loans, the
Insolvency and Bankruptcy Code will play a
2011 2012 2013 2014 2015
significant role in (i) development of a cor-
porate bond market, (ii) creating better
2013 2014 2015 environment for investment through attracting foreign inves-
85.0 86.3 86.1 tors, (iii) improve India’s rating in ease of doing business, and
4.1 4.4 3.3 (iv) enhance the overall banking business and economic
10.9 9.3 10.5 growth in the country.
Stylised Facts
Issues pertaining to low level of recovery rate and rising
provisions leading to diminished bank profitability have come
to occupy centre stage in policy deliberations in view of their
significant implications for financial stability. As illustrated
earlier, in recent times less than one-fifth of the total amount
referred to various recovery channels is being recovered high-
lighting the need for developing a more focused and sound
recovery system through initiating legal and regulatory reforms
by the policymakers. A strong recovery mechanism would not
only support the lenders to recover loans but also be useful to
meet the future credit requirements of the borrowers.
Bad loans—trends and magnitude: The stock of bad loans of
banks in India witnessed substantial rise since 2009. From end
of March 2009 to end of March 2011, it rose over 21% and in
the subsequent period, the growth was much faster (39.1%
during 2012–14). The gross non-performing assets (GNPAs) of
all scheduled commercial banks (SCBs) increased to `3.2 tril-
lion at the end of March 2015 from `2.6 trillion at the end of
March 2014. Rise in GNPAs was primarily led by higher deterio-
ration in the quality of assets of PSBs (Figure 3).
Bank-group GNPAs: In the Indian banking system, PSBs
accounted for about 81% of the GNPAs on an average from end
of March 2000 to 2008. Since the end of March 2012, GNPAs of
PSBs remained in the range of 83%–86% (Table 3).
Recovery Performance: Trends and Magnitude
During the period 2007–15, year-wise addition in GNPAs
witnessed substantial growth and remained relatively higher
than the reduction in GNPAs. During the period 2011–12 to
2014–15, annual growth rate in addition of GNPAs was 32.1% as
against 16.9% in case of reduction of GNPAs. In value terms,
SCBs reduced their GNPAs by `0.7 trillion, while the addition to
GNPAs was `1.5 trillion during 2011–15. In 2014–15, GNPAs to
the tune of `0.9 trillion were reduced, however addition dur-
ing the period was much higher at `2.1 trillion. In recent years,
the write-off of GNPAs by banks also witnessed a significant
OCTOBER 22, 2016 vol lI no 43 EPW Economic & Political Weekly
 SPECIAL ARTICLE
Figure 4: Trends in Recovery Performance of Loans of All SCBs Figure 6: Recovery Ratio of Bad Loans Across Bank Group
2,500 100
Private banks All SCBs
Foreign banks
2,000 80
Write-off PSBs
60
` billion

1,500

Percent
Addition in GNPA
1,000 40
Reduction in GNPA
500 20

0 0
2000–01 2005–06 2010–11 2011–12 2012–13 2013–14 2014–15
1999–2000

2000–01

2001–02

2002–03

2003–04

2004–05

2005–06

2006–07

2007–08

2008–09

2009–10

2010–11

2011–12

2012–13

2013–14

2014–15
Source: Statistical Tables Relating to Banks in India, RBI.

monitoring of fund use in the initial stage is also of critical

Source: Statistical Tables Relating to Banks in India, RBI. importance. Macroeconomic situation particularly slowdown
Figure 5: Trends in Addition and Reduction of GNPAs in economic activities could affect loan recovery significantly
(a) PSBs in an adverse manner. Reduction in GNPA s during the year as
2,000
a percentage of outstanding GNPA s at the beginning of the
1,500 year witnessed decline in recent times resulting in higher
Addition in GNPAs Reduction in GNPAs
` billion

1,000 incremental additions to the stock of defaulted loans. During

the period 2000 to 2015, recovery ratio of SCBs remained
500
about 46% on an average fluctuating in the range of 25.9%–
0 63.3%. However, since 2011–12 recovery ratio has witnessed
1999–2000 2009–10 2012–13 2013–14 2014–15
a substantial decline (33.6% in 2014–15 as against 58.3%
(b) PVBs
300 during 2011–12).
250 Bank-groupwise, the recovery ratio declined for PSBs
200 and FBs since 2011–12 while PVBs showed an improvement
` billion

Addition in GNPAs
150
Reduction in GNPAs during 2011–12 to 2013–14 before deteriorating in 2014–15
100
(Figure 6).
50
0
A graphical presentation of movement of key economic
1999–2000 2009–10 2012–13 2013–14 2014–15 variables with recovery ratio of bad loans of SCBs has been
(c) FBs attempted. As expected, it has been observed that trends of
120
Addition in GNPAs various variables including those of bank specific and macro-
100
Reduction in GNPAs economic conditions with the recovery ratio of bad loans
80
` billion

60
witnessed a mixed trend with some variables moving in same
40 direction while others in reverse direction (Figure 7, p 68).
20
0 Empirical Results and Analysis
1999–2000 2009–10 2012–13 2013–14 2014–15
A panel data regression was attempted using an unbalanced
Source: Statistical Tables Relating to Banks in India, RBI.
panel of 71 banks which include PSBs, PVBs and FBs for the
increase (`0.6 trillion during 2014–15 as against `0.4 trillion in period 2000–01 to 2014–15 to explore the determinants of re-
2013–14) (Figure 4). covery of bad loans. As pointed out earlier, most of the studies
have examined the relation using bank account level informa-
Comparative Position tion. As the account level information is not available in public
Bank groupwise comparative position of annual reduction and domain, the study relies on entirely secondary data.
addition is presented below. The gap between addition of GN-
PAs and reduction during the years has widened substantially in Data Sources and Variables Used
recent years particularly since 2012–13 onwards for both PSBs The study uses Statistical Tables Relating to Banks in India
and private sector banks (PVBs) (Figure 5). (STRBI) published by the RBI for data on banking-related
PSBs accounted for 85.4% in the total reduction of
Table 4: Trends in Reduction, Addition and Write-off of GNPA by Banks during the Period
GNPAs of all SCBs while the remaining pertained to PVBs (As a percentage of all SCBs)
(11.3%) and foreign banks (FBs) (3.3%). Of the total Year PSBs Private Banks Foreign Banks
Reduction Addition Write-off Reduction Addition Write-off Reduction Addition Write-off
write-off of GNPAs of all SCBs, PSBs’ share was nearly 85% in GNPAs in GNPAs in GNPAs in GNPAs in GNPAs in GNPAs
followed by PVBs (11.9%) and FBs (3.2%) (Table 4). 1999–2000 84.0 82.6 – 10.2 10.6 – 5.8 6.8 –
2004–05 80.4 78.5 79.1 14.6 16.4 6.5 5.0 5.1 14.4
Recovery Ratio 2009–10 62.3 64.4 29.2 23.1 21.3 41.1 14.6 14.3 29.7
2012–13 86.5 86.7 63.3 10.3 10.3 36.2 3.2 3.0 0.5
Recovery ratio1 of loans among others, indicate the 2013–14 86.2 86.2 79.6 11.5 10.2 16.9 3.5 3.6 3.5
effectiveness of a sound legal recovery system in 2014–15 85.4 85.2 84.9 11.3 12.8 11.9 3.3 2.0 3.2
place, in case the loans turn bad. Credit appraisal and Source: Statistical Tables Relating to Banks in India, RBI.

Economic & Political Weekly EPW OCTOBER 22, 2016 vol lI no 43 67

SPECIAL ARTICLE
Figure 7: Movement of Key Variables vis-à-vis Recovery Ratio of Bad Loan
(a) (b)
80 13 65
Recovery ratio Recovery ratio
Call rate (RHS) 55
60 Exchange rate
Percent

Percent

Percent
8 45
40
35

20 3 25

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
(c) (d)
70 19 80
Recovery ratio Recovery ratio
60 15
IIP growth (RHS) 60
Growth in scale of
Percent

Percent

Percent
50 11 operation
40
40 7
20
30 3

20 -1 0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

(e) unsecured bank loans at 39.9% between 1982 and 2010

80
Recovery ratio Growth in scale of operation (Ou, Chiu and Metz 2011).
60 Term loans2 are generally taken by businesses to finance
40 their medium- to long-term projects to build some fixed assets
Percent

20 which may have future income generating cash flows. Term

0 loans are generally more secured as compared to short-term
-20
loans, however, longer maturity could lead to deterioration in
value of underlying collateral and hence lower recovery. As
2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Statistical Tables Relating to Banks in India and http://dbie.rbi.org.in/.

regards short-term loans, they require request for frequent
renewal which allows banks to re-evaluate the loan terms which
variables such as loans (unsecured loans, term loans and loans in turn increases recovery prospects. Bello et al (2013) found
to real estate sector), NPAs, reduction in NPAs, write-offs that the longer the loan term, the higher the probability of
and provisioning for NPAs. Macroeconomic variables such as loan recovery. On the other hand, Khieu et al (2012) found that
rupee–dollar exchange rate, Index of Industrial Production term loans are negatively related with recovery of bank loans.
(IIP), weighted average call rate, Wholesale Price Index (WPI) Among macroeconomic environment, inflation is one of the
inflation, Bombay Stock Exchange (BSE) Sensex and External key variables impacting recovery of bad loans. Low inflation is
Commercial Borrowings (ECBs) have been sourced from the expected to reduce the uncertainty in the business environment,
Database on Indian Economy of RBI. As a proxy for regulatory which will incentivise the firms to invest and repay their dues.
environment, distance to frontier score for India for “resolving On the other hand, high inflationary conditions reduce the
insolvency” has been taken from Doing Business database of the real value of the debt which may lead to higher recovery. Bello
World Bank (Table 5). et al (2013) found that growth in inflation led to low recovery
of defaulted mortgage loans in Nigeria. Von Pischke et al (1983)
Description of Variables and Khalily and Meyer (1990) argued that controlling inflation
Economic theory suggests that secured advances should be Table 5: Variables Used in the Analysis
associated with higher recovery rates as compared to un- Variables Used Remarks
secured advances, as in the case of the former, the banks have the A Dependent variable
legal right to seize the collateral underlying the advances and 1 Recovery of loans Reduction in NPAs taken as dependent
sell the designated assets in case of default by the debtor and variable in the absence of any direct
proxy of recovery of bad loans.
recover the dues. Altman and Kishore (1996) found the aver-
B Explanatory variables
age recovery rates for senior secured and senior unsecured 1 Bank specific Unsecured loans, write-offs, term-loans,
bonds to be 58% and 48%, respectively, for bond defaults provisions for NPAs and advances to real
from 1978 to 1995 in the US. Similarly, analysing determi- sector.
2 Borrower specific ECBs taken as a proxy for alternative
nants of bank loan recovery rates in the US, Khieu et al (2012)
sources of funds
found secured loans have higher recoveries as compared to 3 Macroeconomic conditions Exchange rate, WPI inflation, call rate, IIP
unsecured loans. Based on post-default trading prices, aver- and BSE sensex
age corporate debt recovery rate for first lien bank loans at 4 Governance indicators Insolvency regime taken as an indicator
the global level was higher at 59.6% compared to senior of governance

68 OCTOBER 22, 2016 vol lI no 43 EPW Economic & Political Weekly

 SPECIAL ARTICLE

through reduction of the real interest rate may negatively revaluation of real estate collateral are significant determi-
affect recovery if borrowers have expectations about higher nants of loan recovery. Due to lack of availability of data on
inflation in the future which reduces the time value of money. real estate collateral, the current study uses advances to real
However, Grunert and Weber (2009) found increase in infla- estate sector as explanatory variable.
tion has a positive impact on bank loan recovery though only High provisions for NPAs imply that large provisions have
at 10% level of significance. been made for doubtful and loss assets. This may force the
Exchange rate depreciation is expected to lead to better banks to strengthen their recovery efforts so as to free these
recovery of bad debts as weaker domestic currency makes provisions for alternate use. Write-offs of bad loans are one of
the products of the exporters cheaper which will lead to the quickest means of removing bad assets from banks’ books.
higher receivables and higher export earnings. However, in It may be used as an indicator of how serious the bank is about
case of firms with large exposure to external commercial cleaning its balance sheet. This is expected to expedite recov-
borrowings (ECBs) with large foreign currency denominated ery through other channels as well as lead to higher recovery
loans, the repayment capacity will be affected with weaker of bad debts.
domestic currency. This will negatively impact the recovery
of bad debts. Methodology
Nominal interest rates are expected to be inversely related Most of the empirical work on recoveries focus on recoveries of
to recovery of bad loans as higher nominal interest rates increases bonds rather than bank loans and pertain to advanced eco-
the interest burden. Bello et al (2013) found that growth in in- nomies. It is expected that bank loans will do no worse, and
terest rates leads to low recovery of defaulted mortgage loan. may be better than bonds ceteris paribus3 as bank loans are
Grunert and Weber (2009) taking inter-bank interest rate as a typically more likely to be secured than bonds. Also, banks
proxy for interest rate found a negative relation with recovery more actively monitor the evolving financial health of the
of bank loans. In the present study, weighted average call rate debtor as compared to bondholders. Further, bank loans are
has been taken as a proxy for interest rate. typically senior to bonds in a company’s capital structure.
Growth rate of GDP is a good proxy for macroeconomic envi- The study has used random effects panel data model to
ronment. It is one of the most important determinants of recovery explore the variables having an impact on the recovery of bad
of bad debt. With upturn in the economy, many businesses which loans of banks. The random-effects model is applied when it is
were otherwise struggling to keep their margins at around assumed that the unobserved effect ai is uncorrelated with
break-even level turn into sound profit-making companies. each explanatory variable (Wooldridge 2009).
This improves their debt repaying capacity significantly and y it=o+1xit1+……+k xitk+ai+uit given Cov(xitj,ai)=0; t=1, 2..,
leads to improvement in recovery of bad debts. The Basel Com- T; j = 1,2,….,k
mittee on Banking Supervision (2005) suggested that banks where ai is a group-specific random element.
should use the growth of GDP and the rate of unemployment as The regression uses four groups of variables which are
factors for the recovery rate prediction. Further, Bello et al (2013) expected to have an impact on the recovery of bad loans: bank
found positive growth in GDP as an indicator of growth in the specific variables, borrower-specific variables, macroeconomic
real economy that leads to increased odds of recovery of de- conditions and governance indicators. Bank-specific variables
faulted mortgage loan. Grunert and Weber (2009) and Khieu chosen for the model are unsecured loans, write-offs, term
et al (2012) also found that GDP growth is positively related to loans, provisions for NPAs and advances to real sector. ECBs have
bank loan recovery rates. In the current study some alternative been taken as borrower-specific variable as a proxy for alterna-
variables such as IIP and BSE Sensex have been used as explan- tive sources of funds. Variables reflective of macroeconomic
atory variables in place of GDP growth as IIP and BSE Sensex environment are exchange rate, inflation, call rate, IIP growth
may be a more suitable indicator of industrial performance. and BSE Sensex growth. Insolvency regime has been taken as
A well-designed insolvency regime which is predictable, an indicator of governance. In the regression, reduction in
speedy, and transparent and is able Table 6: Correlation Matrix
to resolve the insolvencies of the 1 2 3 4 5 6 7 8 9 10 11 12 13

debtors quickly with better outcomes 1 Reduction 1

leads to better recovery of bad loans. 2 Unsecured 0.73 1
3 Exch 0.43 0.42 1.00
Weak debt enforcement and inef-
4 IIP growth -0.44 -0.53 -0.70 1.00
fective insolvency frameworks tend
5 Write-off 0.74 0.63 0.43 -0.44 1.00
to lower the recovery values of prob- 6 Term loan 0.81 0.85 0.41 -0.53 0.70 1.00
lem loans (Aiyar et al 2015). 7 Call rate 0.20 0.27 0.58 -0.64 0.22 0.29 1.00
Real estate collateral is also an 8 WPIinf -0.12 0.06 -0.47 0.02 -0.05 0.05 0.20 1.00
important determinant of bank’s 9 Provisions 0.73 0.71 0.45 -0.51 0.77 0.75 0.19 0.01 1.00
debt recovery (Davydenko and Franks 10 Advreal 0.76 0.88 0.48 -0.62 0.67 0.88 0.34 0.02 0.71 1.00
2008). Bello et al (2013) found that 11 Sensex growth -0.06 -0.26 0.08 0.56 -0.12 -0.27 -0.46 -0.60 -0.18 -0.31 1.00
location of real estate collateral, 12 Insolvency 0.35 0.35 0.81 -0.36 0.38 0.30 0.44 -0.29 0.37 0.36 0.32 1.00
age of real estate collateral and 13 ECBs 0.37 0.41 0.73 -0.60 0.35 0.39 0.76 -0.08 0.31 0.46 -0.04 0.70 1.00

Economic & Political Weekly EPW OCTOBER 22, 2016 vol lI no 43 69

SPECIAL ARTICLE
NPAs, unsecured loans, write-offs, term loans, provisions for
NPAs, advances to real sector and ECBs are used in logarithmic
form. Other variables are in the form of ratios.
To avoid multicollinearity among explanatory variables,
variables with high correlation were avoided (Table 6, p 69).
Empirical Results
Panel regression suggests that the unsecured advances and
call rate are negatively related with recovery of bad loans
(Table 7: column 2). However, call rate is found significant
only at 10% level. Regarding secured advances, it can be stated
on the basis of result that higher the proportion of secured
loans, higher will be the recovery of bad loans. The negative
sign of the call rate suggests that low interest rates will be con-
ducive for recovery of NPAs due to lower interest costs. Term
loans, advances to real estate sector and presence of good in-
solvency regime are positively associated with recovery of
NPAs (Table 7: column 2). Advances to real estate sector have
been found to be a positive determinant of recovery of NPAs as
most of the time loans to real estate sector are secured loans
which are associated with greater recovery of bad loans.
Exchange rate, IIP and provisions for NPAs are positively
associated with the recovery of bad loans (Table 7: column 3).
Positive relation with rupee–dollar exchange rate implies
depreciating domestic currency leads to higher export earn-
ings which in turn leads to higher ability to repay bad loans.
Better performance of the industrial sector is reflected in IIP
growth leading to higher recovery of loans. The move to
increase provisioning for NPAs means asset quality of banks is
worsening, thereby implying the need for concerted debt
recovery efforts by banks. Loan write-offs and BSE Sensex
growth have been found to be positively associated with bad
debt recovery (Table 7: column 4). BSE Sensex is reflective of
the corporate earnings and business sentiments. Large-scale
loan write-offs on the part of banks suggest that banks are
serious about cleaning up of their balance sheet. This implies
that banks would simultaneously be strengthening their efforts
towards recoverable bad debt. WPI inflation and ECBs are also
Table 7: Determinants of Recovery of Bad Loans
1 2 3 4
Unsecured loans -0.782*** (0.181) -0.265 (0.177)
Exchange rate 0.030*** (0.004)
IIP 0.018*** (0.006)
Write-off
Term loans 0.411*** (0.039)
Call rate -0.025* (0.014)
WPI Inflation
Provisions for NPAs 0.523*** (0.031)
Advances to real estate sector 0.101*** (0.028)
Sensex
Insolvency 0.045*** (0.008)
ECB
Constant -0.061 (0.231) 0.135 (0.236)
No of obs 736 715
R square (overall) 0.581 0.599
Model Random Effect Random Effect
Standard errors in parentheses.
Source: ***p<0.01; **p<0.05; *p<0.10.
70
positive determinants of recovery of NPAs (Table 7: column 5).
Rising inflation may improve recovery through declining real
value of debt, though it increases uncertainty in the economy.
ECBs have been taken as a proxy for alternative sources of
funds at the hands of debtors which is expected to help them
pay off their bank loans from domestic sources.
Conclusions and Policy Implications
After the passing of some stringent regulations such as the
SARFAESI Act and setting up of the DRTs, some improvement in
recovery of bad debts was witnessed. However, the momen-
tum was short-lived. More so in recent times, there has been a
significant pile-up of stressed assets in the books of Indian
banks, particularly for the PSBs. Apart from the downturn in
the business cycle, other reasons for this burgeoning of
stressed assets have been the weak creditor rights in the exist-
ing legal system along with excessive political interference in
the management of PSBs.
To overcome the problem, the enactment of the Insolvency
and Bankruptcy Code, 2016 is a welcome development towards
improving the credit environment and enhancing the creditor–
debtor relationship. Further, measures initiated towards the
reform of PSBs such as professionalising the appointments in
bank boards, separating the posts of the chairman and manag-
ing director of the PSBs, gradual reduction of the government’s
stake in PSBs and setting up of the Bank Board Bureau (which
is a step towards constitution of Bank Investment Company
that would act as a custodian of the government’s holdings in
these banks), are expected to improve the performance of PSBs
in the medium to long term.
This study suggests that in the case of secured loans, term
loans and advances to real estate sector, the recovery of bad
loans is more probable. The recovery of bad loans also had a
positive relationship with loan write-offs and provisioning for
NPAs. Similarly, the availability of alternative sources of funds
leads to higher recovery. Macroeconomic environment was
also found to play an important role in the recovery of bad
loans. Further, improving industrial performance, high busi-
ness sentiments, declining interest
5 rate environment, depreciating cur-
-0.508 (0.776) rency and increasing inflation are
conducive for bad loan recovery.
Furthermore, good insolvency reg-
0.144** (0.071) 0.054 (0.073)
ime which minimises the disputes
between creditors and debtors also
-0.045*** (0.014) leads to better recoveries.
0.319*** (0.074) Banks need to prioritise strength-
0.285*** (0.076) ening of their credit appraisal
0.439** (0.221) system, examination of the borrow-
0.038** (0.017) er’s cash flows, purpose/types and
0.681*** (0.211) maturity structure of loans, and set
-0.304 (0.466) -1.598 (1.246) a realistic repayment schedule keep-
120 103
ing in view potential uncertainties.
0.676 0.591
There is an urgent need for further
Random Effect Random Effect
deepening of the capital market as
availability of alternative resources
OCTOBER 22, 2016 vol lI no 43 EPW Economic & Political Weekly
 SPECIAL ARTICLE

facilitates bank loan recovery. Banks need to reinvent their sound resolution regime once put in place would go a long
business models and risk management practices which are in way in strengthening asset quality management efforts in a
tune with the evolving business and economic conditions. A sustainable manner.

notes
1 This is calculated as taking reduction of GNPAs
during the year as a percentage of outstanding
GNPAs at the beginning of the year.
2 Term loans have a maturity greater than one
year.
3 Other factors include industry, firm size, type
of collateral, state of the business cycle, etc.
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Review of Urban Affairs

April 23, 2016
Greenfield Development as Tabula Rasa:
Rescaling, Speculation and Governance on India’s Urban Frontier —Loraine Kennedy, Ashima Sood
Scaling Up, Scaling Down: State Rescaling along the Delhi–Mumbai Industrial Corridor —Shriya Anand, Neha Sami
Dholera: The Emperor’s New City —Preeti Sampat
Making of Amaravati: A Landscape of Speculation and Intimidation —C Ramachandraiah
Reading into the Politics of Land: Real Estate Markets in the South-west Peri-urban Area of Chennai —Bhuvaneswari Raman
The Politics of Urban Mega-projects in India: Income Employment Linkages in Chennai’s IT Corridor —M Vijayabaskar, M Suresh Babu
Making Sense of Place in Rajarhat New Town: The Village in the Urban and the Urban in the Village —Ratoola Kundu
New Regimes of Private Governance: The Case of Electronics City in Peri-urban Bengaluru —Mathew Idiculla

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