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CHAPTER 4
CONCEPTUAL FRAMEWROK FOR NON
PERFORMING ASSETS
4.1 The Non-Performing Assets
A core set of financial stability indicators for banks are: (a) capital adequacy;
(b) asset quality; (c) earnings and profitability: (d) liquidity; and (e) sensitivity
to market, credit and operational risks. Asset quality indications are a
combination of non-performing loans to total loans, non-performing loans net of
provisions to capital, sectoral distribution of loans to total loans and large
exposures of capital to single parties.
NPAs typically are the advances from banks to borrowers who are unable to
repay. The urgency for resolution of NPAs is well understood. It is generally
felt that NPAs reduce the profitability of a bank, weaken its financial health and
erode its solvency. Resolving NPLs enables banks to free-up capital and
resources and put it to productive use, leading to the effective recycling of
capital. Further, resolution of NPLs brings the underlying assets back to
productive use with attendant gains. Thus, recycling of capital in the economy
in a timely manner is the overarching objective of an NPA resolution
framework.
NPAs create problems for the banking sector's balance sheet on the asset side.
And they have a negative impact on the income statement as a result of
provisioning for loan losses. In the worst case scenario, a high level of NPLs in
a banking system poses a systemic risk, inviting a panic run on deposits and
sharply limiting financial intermediation, and subsequently investment and
growth in the economy. In fact, a high ratio of non-performing loans to total
outstanding loans is itself an indication of a banking crisis. In this way, NPAs
can be at once the consequence and cause of a banking crisis.157
157
Dash M.K. and Kabra G., “The Determinants of Non-Performing Assets in Indian
Commercial Banks: an Econometric Study”, Middle Eastern Finance and Economics, Issue 7,
2010
124
4.2 Life Cycle of NPAs in Bank
Understanding of asset cycle will help in effective management of NPA. The
asset cycle shows how an asset moves to different positions depending upon the
recovery, security and risk associated with it. However, the recoveries the main
criterion for determination of its status in the asset cycle. The Bank gets cash,
fund by way of deposits from the depositors. On sanction of a loan the bank
converts its cash into a loan asset. At the beginning, every loan asset is
(supposed to be) a performing one; which generates income to the Bank. This
performing asset is known as Standard Asset, which does not carry any problem
other than normal business risk. When it shows symptoms of delay in recovery
of due amount and it will become NPA as on the coming balance sheet date
unless the symptom is rectified, it becomes a Potential NPA. The period of
remaining in Potential NPA may vary from one quarter to 4 quarters depending
upon the nature of the account. If the due amount is recovered before the next
balance sheet date, it remains in the performing zone; otherwise it crosses the
Laxman Rekha of NPA & slips into the non-performing zone as on the balance
sheet date. Then it is known as Substandard Asset. Unless the critical overdue
amount is recovered, it remains as Substandard Asset up to for a period of less
than or equal to twelve months with effect from March 31, 2005 and then it
becomes Doubtful Asset. It remains as Doubtful Asset so long it is not declared
as Loss Asset by the auditors, RBI inspectors. The Standard Asset, Potential
NPA and Substandard Asset may slip into Doubtful, Loss Asset when there is
substantial loss of security or it carries more than normal business risk. A Loss
Asset can be converted to Doubtful Asset, Substandard Asset, Potential NPA,
Standard Asset depending upon its age of NPA by addition of substantial
security, bringing under normal business risk and recovery of critical overdue
amount, A Doubtful Asset cannot be converted to Substandard Asset but to
Potential NPA, Standard Asset by recovery of critical past due, overdue
amount. Similarly, a Substandard Asset can be converted to Potential NPA,
Standard Asset by recovery of critical overdue amount.
In the normal process, the Standard Asset converts to Cash in an asset cycle by
recovery of due amounts as per the sanction. But Substandard Asset as well as
Doubtful Asset can convert into Cash by cash recovery, legal process, and
125
compromise. Similarly a Loss Asset can be converted into Cash or liquidated by
write-off, compromise, legal process, cash recovery. In case of write-off and
compromise the bank pays cash from its profit.
There are three main stages in the life cycle of NPA in a bank Identification of
stressed assets and NPAs, investigation by measurement and obtaining insight
and lastly, resolution through crisis management and revitalization of stressed
assets.158
4.3 Development of NPA in Indian Banking Sector
The origination of the NPAs in the Indian Banking can be classified into two
stages:
a) Pre-liberalization era; and
b) Post-liberalizing era
4.3.1 Pre-liberalization era: In the context of accretion to NPAs in the banking
system, the contributory factors during this period were mainly the following:
i. Down-swings in agricultural sectors triggered by monsoon vagaries, bringing
about all-round economic and demand recessions.
ii. Industrial Licensing: The scale of the economy in relation to international
standards was compromised, leading to high capital costs per unit of production.
This was often said to be offset by lower labour costs. However, in reality
labour productivity, coupled with application of automation, outweighed the
benefit from lower labour costs in the Indian context.
iii. Sector-wise reservation
Reservation of major sectors for investment by the Government of India in the
public sector structure in post-independence days became a necessity owing to
various reasons, among others, non-availability of private capital. In later years
many of these Public Sector Units (PSUs) (though they might have served their
socio- economic objectives) became commercially unviable in the absence of a
proper growth plan. When faced with burgeoning employee costs during their
lifecycle.
158
Siraj K.K., “A Study on the Performance of Non-Performing Assets (NPAs) of Indian
Banking During Post Millennium Period”, IJBTM,Vol.2, No.3, March, 2012
126
As a result, down-stream integration of SMEs with these PSUs led them to a
sticky situation with their bankers owing to a longer receivable cycle/non-
realization of receivables. In addition, reservation in some of these sectors led to
setting up of uneconomical facilities, and improper quality and product pricing
(price-quality matrix issues) despite subsidization by the Government of India.
iv. Controlled interest rate: In the controlled interest rate regime, banks were
not in a position to price the risk premium. This led to cross-subsidization
across the risk profile of the loan assets. Although additional collaterals were
taken for risky loan assets, in the absence of a conducive Legal system, the
banks were not in a position to realize value from these collaterals.
v. Tariff protection: In the absence of a long-term tariff policy, it was difficult
for the banking system to appraise project viability with any degree of certainty
during the loan pay-back period.
vi. Role of Developmental Financial Institutions (DFIs): The DFIs played a
predominant role in the growth financing during the pre-liberalization era. This
model became unsustainable as they started facing difficulties in raising funds.
In a way, the DFIs in India played the role of Venture Capital (VC) funding
without capturing the possible upside of the model. The success of DFIs can,
therefore, be compared only with VC funding. However, because of non-
availability of a favourable legal environment, coupled with various extraneous
factors, they are often discredited with the failures.
4.3.2 Post-liberalizing era
Indian macroeconomic policies were conservative till the early eighties. There
were efforts for liberalization in the form of de licensing of selected industries,
permitted changes in the form of de-licensing of selected industries, relaxation
of import duties among eighties. There was a mini-industrial boom in the early
part of the seventh five-year plan (1985-88). However, a growing fiscal deficit
triggered a macroeconomic crisis in 1991. With the commencement of reform
of the economy in 1991, banks were to follow the Basel Capital Accord.
Consequently, the Reserve Bank of India (RBI) issued the first set of
comprehensive guidelines for Income Recognition and Assets Classification
(IRAC) in April 1992. The central bank, with a cautious move, adopted a time-
127
based provisioning method and averted a near crisis situation by not imposing a
write-off of the entire loan asset impairment amount based on present value of
realizable cash flow upon recognition of NPA.159
During post-commencement of reforms, and against the back-drop of hyped-up
demand projections endorsed by several leading strategists, the Indian economy
once again experienced a quick capacity build-up during the mid-nineties. On
the face of a liquidity crisis, many of these projects had to borrow at abnormally
high rates of interest. However, towards the end of the decade, the mistake was
realized as those loan assets started showing signs of impairment. The volume
of NPAs in the system reached a peak level, requiring focused attention. Many
banks set up taskforces, special asset management groups, etc. to deal with the
situation in a focused manner by creating a type of bad bank within the bank.
By that time there was economic crisis triggered by the high level of NPAs in
the banking system.160
By the mid-nineties the banking industry became risk-averse towards corporate
lending activity. Many banks took a strong position in government securities.
Propelled by the growth in the retail sector, the banking sector registered a
decent credit growth during the subsequent period. In the late-nineties, during a
declining interest rate regime, the banking sector was sitting on a sizeable
capital gain. As such, in order to tackle the NPA stock problem, the banking
sector generally adopted a ‘provide and hold’ strategy. 161
As a result, net NPAs
in the system declined as a result of the setting up of a self-help mechanism,
namely Corporate Debt Restructuring (CDR).
As a result, two committees were set up in quick succession and reports were
submitted: one in April 1998 (Committee on Banking Sector Reform –
Narasimham Committee) and another in October 1999 (Restructuring of Weak
Public Sector Banks – Verma Committee. the SARFAESI Act, 2002 was
passed.
159
G.V.Bhavani Prasad, NPAs Reduction Strategies for Commercial Banks in India IJMBS Vol.
1, Issue 3, September 2011 160
Indira Rajaramanan, GairamVasishtha – Non Performing Loans of PSU Banks some panel
results – Economic and Political Weekly – February 2002 161
Sardar N.S. Gujaral (2003), “Asset Quality and Management of NPA’s”, The Journal of
Indian Institute of Bankers”, Vol. -72, April-June, P-20.
128
4.4 Development of the NPA classification in Indian Banking Sector
Tandon Committee in 1975 recommended for classification of borrower’s
accounts into four categories as: Excellent, Good, Average and Satisfactory /bad
and doubtful accounts.
Pendharkar Committee was set up in 1981 which recommended the
classification of advances in different categories, to index the overall quality of
assets portfolio. It is the starting point for the introduction of the health coding
system of categorizing bank loan portfolio by the Reserve Bank of India in
1985.
Until mid-eighties, management of NPAs was left to the banks and auditors. In
1985, the first ever classification of assets for the Indian banking industry was
introduced on the recommendation of A.Gosh Committee on Final Accounts.
The mechanism was ‘Health Code System’ (HCS) involved classification of
bank advances into eight categories ranging from 1 (satisfactory) to 8 bad and
doubtful debts. 162
RBI introduced ‘Health Code’ system in 1980 for credit administration. Under
health code system, the bank loan assets were classified under eight categories
such as-
H C – 1 Satisfactory
H C – 2 Irregular
H C – 3Sick but Viable
H C – 4 Sick but Non – Viable
H C – 5 Recalled
H C – 6 Suit –filed
H C – 7 Decreed
HC-8 Bad and doubtful
The mechanism was introduced for classification of the accounts as per the
health code in the following manner.
162
Two decades of Credit Management in Indian Banks: looking back and moving ahead Dr. K.
C. Chakraborty Nov, 2013.
129
(a) Satisfactory: The account in which all terms and conditions are complying
with and safety of advances are not in doubt.
(b) Irregular: The account where safety of advances is not suspected, though
there may be occasional irregularities.
(c) Sick – viable: Advances to units which are sick but viable under nursing or
revival programs are under taken.
(d) Sick – non – viable / sticky: Advances where irregularities continue to
persist and there are no immediate prospects of regularization.
(e) Advances – recalled: Advances where the recalled repayment is highly
doubtful and nursing is not considered worthwhile, includes accounts where
decision has been taken to recall the advances.
(f) Suit – file – accounts: Accounts where legal action or recovery proceedings
have been initiated.
(g) Decreed debts: Accounts for which decrees have been obtained.
(h) Bad and doubtful accounts: The accounts in which the recoverability is in
doubtful due to shortfall in the value of the securities and inability /
unwillingness of the borrower to repay the bank’s dues partly or wholly.163
With reference to the loans which were categorized under health code 5 to 8,
interest on accrual basis should not be charged and booked to profit and loss
account. However charging of interest and provisioning were left to be decided
by the bank management. The banks continued to book income by charging
interest on accrual basis even on those loan assets, which has shown symptoms
of loss. This was not a prudential business practice; as the banks paid tax and
dividend on these incomes, which were never realized.
These guidelines were subjective and did not reflect the true picture of the
banks health. The Reserve Bank, as an authority for bank supervision in India,
felt the need to introduce more objectivity in the assessment of the bad debts of
the banks and to standardize the relative accounting norms as per the
international standards for maintaining sound banking system in this country.
163
S.C.Mitra and R.P.Kataria An Exhaustive Commentary on The Securitisation and
Reconstruction of Financial Assets and Enforcements of Security Interest Act, 2002 P242.
130
Further, if a balance sheet is to reflect a bank’s actual financial health, a proper
system for recognition of income, classification of assets and provisioning for
bad debts on a prudential basis is necessary. The Committee on financial
system, popularly known as Narasimham committee, examined the above issue
in 1991 and made various recommendations.
The Reserve Bank of India accepted these recommendations with certain
modifications and laid down norms to be implemented in a phased manner over
a three year period commencing from 1st April, 1992.the introduction of the
Prudential Accounting Norms, which are essentially based on the concept of
Nonperforming Assets (NPA). In 1998 the Narasimham committee has
submitted its 2nd report for further tightening of the prudential accounting
norms. A retrospect of the events clearly indicates that the Indian banking sector
has come far away from the days of nationalization. The Narasimham
Committee and the Verma Committee laid the foundation for the reformation
and improvement of the Indian banking. At a macro level the reforms brought
structural changes in the financial sector and succeeded in easing external
constraints on its operation i.e. reduction in CRR and SLR reserves, capital
adequacy norms, restructuring and recapitulating banks and enhancing the
competitive element in the market through the entry of new banks. The reforms
also include increase in the number of banks due to the entry of new private and
foreign banks, increase in the transparency of the banks’ balance sheets through
the introduction of prudential norms and increase in the role of the market
forces due to the deregulated interest rates these have significantly affected the
operational environment of the Indian banking sector.
To encourage speedy recovery of Non-performing assets, the Narasimham
committee laid directions to introduce special tribunals which lead to the
creation of an Asset Reconstruction Fund for revival of weak banks and to
maintain macroeconomic stability and also RBI has introduced the Asset
Liability Management System.
The Verma Committee (1999)
The committee was given the mandate for the identification of Banks as weak
strong and potential weak based upon the parameters of financial performance.
131
These parameters include capital adequacy ratio, coverage ratio, return to assets,
net interest margin, operating profits to average working funds, cost to income,
and staff cost to net interest income plus other income. Accordingly, UCO
Bank, United Bank of India and Indian Bank were identified as weak banks in
whose case none of the seven parameters were met. As against this, Oriented
Bank of commerce and State Bank of Patiala were identified as strong banks
because they satisfied all the parameters. But in respect of six banks, viz.
Allahabad Bank, Central Bank of India, Indian Overseas Bank, Punjab and Sind
Bank, Union Bank of India and Vijaya Bank, most of the parameters i.e. five or
six of the total seven parameters were not fulfilled. Hence, they were described
as potential weak banks.
4.5 Major Policy Initiatives pertaining to Non-Performing Assets
PERIOD DEVELOPMENTS
1992-93
(i) In order to reflect actual financial health of banks, the RBI
instructed the commercial banks to treat an amount in respect of term
loans, overdrafts and cash credit accounts. Bills purchased and
discounted and other accounts as 'past due' when not paid on the due
date (since revised to 30 days beyond the due date),
(ii) Banks were instructed not to charge and take into income
account, interest on all NPAs. An NPA is defined as a credit facility
in respect of which interest has remained' past due' for a period of
four quarters ending March 31, 1993, three quarters ending March
31, 1994, two quarters ending March 31, 1995 and onwards.
(iii) Banks were required for classification of assets as per the
prudential guidelines as were introduced based on the global
practices.
(iv) From a practical viewpoint, aggregate provisioning in respect of
amounts less than Rs 25,(00 to the extent of 2.5 per cent of the total
outstanding was to be made rather than a case by case evaluation of a
very large number of small accounts.
(v) Provisioning of NPAs was stipulated at 3() per cent of the total
provisions on substandard assets, doubtful assets and advances with
132
balance less than Rs 25000 for loss assets, the entire amount as to be
provided for by March 1993.
1993-94
(i) Banks were requested to Make full stipulated provision against
NPAs identified during 1993-94 besides the carried forward
provisioning for 1992-93.
(ii) In respect of advances with balances less than Rs 25.000, the
required provision for the year end March 3. 1 I 994 was enhanced
from 2.5 per cent to 5 per cent without reckoning the DICGC/ELGC
cover.
1994-95
(i) The provisioning requirement of NPAs with balances of less than
Rs 25,000 was increased from 5 per cent of the aggregate amount
outstanding to 7.5 per cent for the year ending March 31, 1995 and
further to 10 per cent for the year ending March 31, 1996
1995-96
(i) Banks were advised on April 31. 1995 that interest accrued and
credited to income account during the year ended March 1994 in
respect of accounts identified as NPAs for the first time during the
year ended March 31. 1995 should be reversed or pro\vided for as on
that date.
(ii) Banks were advised that provision need not be made for a period,
of one year from the date of disbursement in respect of additional
facilities sanctioned under the rehabilitation' package as approved by
BIFR term lending institutions.
1996-97
(i) On December 24, 1996 banks were granted an extension of one
year. i e, up to March 31, 1998 to complete the excercise of
classifying accounts with outstanding of less than Rs 25.000 into the
four asset categories. Pending such classification, a provision of 15
per cent of the aggregate amount outstanding was stipulated for such
advances for the year 1996-97 from 10 per cent for the year ended
March 31. 1996.
(ii) On January 29. 1997, regarding classification of NPA, it was
clarified as under:
(a) An advance account should not be classified as NPA based
133
merely on temporary deficiencies such as non-availability of
adequate drawing power, balance outstanding exceeding the limit,
non-submission of stock statement, the non-renewal of the banks on
the due date. etc.;
(b) If accounts of the borrowers have been regularised before the
balance sheet date by repayments of overdue amounts from genuine
sources, such accounts need not be treated as NPA even if the
interest/installments of principal remainedpast due for any two
quarters of the year. Accounts with potential threats of recovery
should.be straightaway classified as doubtful asset or loss asset, as
appropriate, irrespective of the period for which they remained as
NPA; and
(c) In respect of consortium advances, each bank was allowed to
classify the borrowal accounts according to its record of recovery and
factors having a bearing on the recoverability of the advances, as in
the case of multiple banking arrangements.
1997-98
(i) On April 9, 1997 banks were advised that advances granted for
agricultural purposes where interest/installment remained in arrear of
or more than two quarters (as against two seasons of harvest or two
half-years earlier) it should be treated as NPA from the accounting
year 1'997-98.
(ii) Banks were advised to make the following additional disclosures
in the 'Notes on Account' to the balance sheet for the year ended
March 31, 1997
(a) Percentage of net NPAs to net advances.
(b) the amounts of provisions made towards NPAs was reversed in
April 1997 when RBI advised the banks to reduce the interest
overdue period of two half-years in the case of agricultural advances,
to two quarters, i e, fi-om 12 months to six months, from 1997-98
onwards.
134
4. 6 Meaning and Concept of Non-Performing Assets
Regulators in different countries define NPAs differently. However, the broad
definitions include advances that show signs of weakness and impairment.
NPAs are those loans given by a bank or financial institution where the
borrower defaults or delays on interest or principal repayment.
An asset, which ceases to generate income for the bank, is called an NPA. The
factor used to determine whether an asset is an NPA or not is the record of
recovery and not the availability of security.' Securitization of non-performing
assets is used as a tool by banks and financial institutions to convert their
liabilities to investments, as once the assets are transferred they go off the
balance sheet of the banks and the security receipts issued for such transfers are
considered an investment.
Statutory Definition of NPAs
A non-performing asset is an asset or account of a borrower, which has been
classified by a bank or financial institution as substandard, doubtful or loss
asset.164
An NPA is an asset for which:
Interest or principal (or installment) is overdue for a period of 180 days or more
from the date of acquisition or the due date as per contract between the
borrower and the originator, whichever is later;
Interest or principal (or installment) is overdue for a period of 180 days or more
from the date fixed for receipt thereof in the plan formulated for realization of
the assets;
• Interest or principal (or installment) is overdue on expiry of the planning
period, where no plan is formulated for realization of the assets; and
• Any other receivable, if it is overdue for a period of 180 days or more on the
books of the Securitization Company or ARC.
164
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 ("SARFAESI Act") in Section 2(1) (o)
135
However, the board of directors of an SC or ARC may, on default by the
borrower, classify an asset as an NPA even earlier than the period mentioned
above.165
Gross and Net NPAs
There are two concepts related to NPAs: gross and net. Gross NPA refers to all
NPAs on a bank's balance sheet irrespective of the provisions made. It consists
of all the non-standard assets, viz. substandard, doubtful, and loss assets. Net
NPAs are gross NPAs less provisions. In India, because bank balance sheets
contain a huge number of NPAs and the process of recovery and write-off of
loans is very time consuming, the provisions the banks have to make against the
NPAs, according to the Reserve Bank guidelines, are quite significant. That is
why the difference between gross and net NPAs is quite high. While gross
NPAs reflect the quality of the loans made by banks, net NPAs show the actual
burden to banks. The requirements for provisions are: 100 percent for loss
assets; 100 percent of the unsecured portion plus 20 percent to 50 percent of the
secured portion, depending on the period for which the account has remained in
the doubtful category; and 10 percent general provision on the outstanding
balance under the substandard category.
Gross NPA is an advance which is considered irrecoverable, for bank has made
provisions, and which is still held in banks' books of account. Net NPAs are
those type of NPAs in which the bank has deducted the provision regarding
NPAs. Net NPA shows the actual burden of banks. Since in India, bank balance
sheets contain a huge amount of NPAs and the process of recovery and write off
of loans is very time consuming, the banks have to make certain provisions
against the NPAs according to the Central Bank guidelines.
165
The Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines
and Directions, 2003
136
The NPAs movement of private sector bank shows a positive trend as they are
able to better manage compared to Public Sector banks. The above graphs show
that the Private Sector banks are better able to manage the NPAs as compared to
Public Sector bank. The data stated that nationalized banks accounted 64.05%
in total – and witnessed gross NPAs at Rs 5.07 lakh crore from Rs 4.18 lakh
crore in Financial Year 2016. Last fiscal, it accounted for 68.30% of total gross
NPAs.
0
1000
2000
3000
4000
5000
6000
7000
NP
As
Am
ou
nt
(in
'0
00
s C
rore
s)
Financial Year
Figure 4.1 Gross and Net NPAs Amount of Scheduled Commercial
Banks
Gross NPAs Amount Net NPAs Amount
Source : Department of Banking Supervision, RBI
0
1000
2000
3000
4000
5000
6000
NP
As
Am
ou
nt
(in
'0
00
s C
rore
s)
Financial Year
Figure 4.2 Gross and Net NPAs Amount of Public Sector Banks
Gross NPAs Amount
Net NPAs Amount
Source : Department of Banking Supervision, RBI
137
Nationalised banks saw decline mainly because private banks have seen rise in
their share of total gross NPA. Private Banks gross NPAs stand at Rs 93,209.2
crore in Financial Year 2017 (having share of 11.78%) versus gross NPAs of Rs
56,185.70 crore (with share of 9.18% share) in Financial Year 2016. the
combined gross NPAs of State Bank of India group stood 1.6 Lakhs ores on
December 31, 2016 which is equivalents to 8.6% of the total assets , while the
net NPAs were at 5.33%. 166
The gross NPAs of public sector banks have risen
to Rs 6.06 Lakhs Cr. in December 2016, from Rs 5.02 Lakhs Cr. at the end of
March 2016.The Gross NPA (GNPA) ratio of the banking system stood at 9.6%
and the stressed advances ratio stood at 12% as of March 31, 201
Reserve Bank of India is empowered to prescribe the guidelines on
Classification of NPA.167
As the concept of the NPA is dynamic- as it changes
with the change in the financial regime and thus requires continuous monitoring
and updating.
NPA is defined as ‘an account of a borrower which has classified’ by a Creditor
either ‘as a sub-standard asset or a doubtful asset or a loss asset’ of the Creditor
and such a classification is required to be made in accordance with the
directions or guidelines relating to assets classification issued by the Reserve
Bank. RBI guidelines governing the ‘classification of accounts’ and related
treatment are mandatory. 168
Following table displays the classification of
NPAs.
166
http://economictimes.indiatimes.com/industry/banking/finance/banking/sbi-bad-loans-
balloon-.cms 167
KeshavLalKhem Chand and Sons Pvt. Ltd. Versus Union of India and others AIR2015 SC
1168 168
M/s. Signal Apparels Pvt. Ltd. & Another Vs. Canara Bank P.N. Road Branch, Tirupur &
Another, 2010 (5) CTC 337, 2010 (8) MLJ 967
LOAN
ASSETS
PERFORMING ASSETS (PA)
STANDARD ASSETS
NON PERRFORMING ASSETS (NPA)
SUB STANDARD
ASSETS
DOUBTFUL ASSETS
LOSS ASSETS
138
70%
75%
80%
85%
90%
95%
100%%
of
To
tal
Lo
an
Ass
ets
Financial Year
Figure 4.3 Classification of Loan Assets (Private Sector Banks)
Loss Advances Doubtful Advances Sub-Standard Advances Standard Advances
Source : Department of Banking Supervision, RBI
139
The above table depicts the Loan Assets of Private Sector Banks which have
turned into Non-Performing Assets. From the table above it is inferred that the
Gross NPAs in the year 2005 is 88 Billion, which is 3.9% of the total advance
of the year. The amount in the year 2006 is as 78 Billion which was 2.5% of the
total advances. The amount of NPAs in the year 2007 is 92 Billion which is
2.2% of the total advances. The amount of the NPAs in the year 2008 was 130
Billion which was 2.5% of the total advances. The amount of the NPAs in the
year 2009 was 170 Billion which was 2.9% of the total advances. The amount
of the NPAs in the year 2010 was 176 Billion which 2.7% of the total advances
were. The amount of the NPAs in the year 2011 was 182 Billion which was
2.2% of the total advances. Amount of the NPAs in the year 2012 was 185
Billion which 1.9% of the total advances were. The amount of the NPAs in the
year 2013 was 208 Billion which was 1.8% of the total advances. The amount
of the NPAs in the year 2014 was 242 Billion which was 1.8% of the total
advances. The amount of the NPAs in the year 2015 was 337 Billion which was
2.1% of the total advances. The amount of the NPAs in the year 2016 was 559
Billion which was 2.8 % of the total advances. In 2016 there has been rise in the
accumulation of the NPAs even in the private sector banks.
When we look into the data of the classification of loan assets of private sector
banks in 2017 it displays a high rise in the level of the amount. There is slight
improvement in the level of standard advances but the level of amount in
substandard, doubtful advances the level is at alarming point. Almost 516
billion of amount was classified as doubtful assets. While 90 billion of the
amount was classified as loss advances and the amount of NPAs was 919
billion. The gross NPAs of private sector banks has become almost as compared
to the last financial year. At the end of financial year on March 2016 the
amount of NPAs was 559 billion which has now mounted up to 919 billion in
the year 2017. It clearly gives an indication that the private sector banks are
also struggling to minimize the level of the NPAs. Froom the year 2012-20017
there is consistent rise in the level of the NPAs in private sector banks.
140
70%
75%
80%
85%
90%
95%
100%
2004-052005-062006-072007-082008-092009-102010-112011-122012-132013-142014-152015-16
% o
f L
oa
n A
sset
s
Financial Year
Figure 4.4 Classification of Loan Assets (Public Sector Banks)
Loss Advances Doubtful Advances Sub-Standard Advances Standard Advances
Source : Department of Banking Supervision, RBI
141
The figure 4.4 displays the trends in the classification of the assets by the Public
Sector Banks. From the table above it is inferred that the Gross NPAs in the
year 2005 is 476 Billion, which is 5.4% of the total advance of the year. The
amount in the year 2006 is as 414 Billion which was 3.7% of the total advances.
The amount of NPAs in the year 2007 is 389 Billion which is 2.7% of the total
advances. The amount of the NPAs in the year 2008 was 405 Billion which was
2.2% of the total advances. The amount of the NPAs in the year 2009 was 450
Billion which was 2% of the total advances. The amount of the NPAs in the
year 2010 was 599 Billion which was 2.2% of the total advances. The amount
of the NPAs in the year 2011 was 747 Billion which was 2.25% of the total
advances. amount of the NPAs in the year 2012 was 1173 Billion which was
3% of the total advances. The amount of the NPAs in the year 2013 was 1645
Billion which was 3.6% of the total advances. The amount of the NPAs in the
year 2014 was 2273 Billion which was 4.4% of the total advances. The amount
of the NPAs in the year 2015 was 2785 Billion which was 5% of the total
advances. The amount of the NPAs in the year 2016 was 5400 Billion which
was 9.3 % of the total advances. The above data provides that the percentage of
the advances as compared to gross advances has been rising in the public sector
banks, which represents a picture that there is consistent rise in the NPAs as of
advances.
142
4.7 Prudential Norms on Income Recognition, Asset Classification and
Provisioning Pertaining to advances
India during the phase of liberalization by bringing the globally accepted
practices. In India also ther globally followed standards with regard to Income
Recognition, asset classification were introduced by the Regulator. 169
Non performing Assets
An asset, including a leased asset, becomes non performing when it ceases to
generate income for the bank.
1) A non-performing asset (NPA) is a loan or an advance where;
i. interest and/ or installment of principal remain overdue for a period of
more than 90 days in respect of a term loan,
ii. the account remains 'out of order', 170
in respect of an Overdraft/ Cash
Credit (OD/CC),
iii. the bill remains overdue for a period of more than 90 days in the case of
bills purchased and discounted,
iv. the installment of principal or interest thereon remains overdue for two
crop seasons for short duration crops,
v. the installment of principal or interest thereon remains overdue for one
crop season for long duration crops the amount of liquidity facility
remains outstanding for more than 90 days, in respect of a securitization
transaction undertaken in terms of guidelines on securitization dated
February 1, 2006.
vi. in respect of derivative transactions, the overdue receivables
representing positive mark-to-market value of a derivative contract, if
169
The Reserve Bank of India introduced in the year 1992 the prudential norms of “income
recognition, asset classification, provisioning and other related matters” and such norms were
revised periodically keeping in mind various developments in the banking system, both
nationally and internationally. Reserve Bank of India in exercise of the statutory authority under
Section 21 and Section 35A of the Banking Regulation Act, 1949 prescribes norms for the
various aspects of banking specified under the Act 170
An account should be treated as 'out of order' if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding
balance in the principal operating account is less than the sanctioned limit/drawing power, but
there are no credits continuously for 90 days as on the date of Balance Sheet or credits are not
enough to cover the interest debited during the same period, these accounts should be treated as
'out of order'.
143
these remain unpaid for a period of 90 days from the specified due date
for payment.
In case of interest payments, banks should, classify an account as NPA only if
the interest due and charged during any quarter is not serviced fully within 90
days from the end of the quarter.171
Prior to the financial sector reform in the year 1992-93, banks used to debit
interest to the loan account on accrual basis and recognized the same as income
even in accounts with poor recovery. Recognizing income on accrual basis in
accounts where the realization is in doubt is not a prudential norm. As per the
recommendation of the Narsimhan Committee the regulator introduced
prudential accounting norms applicable from the financial year 1992- 93. The
prudential accounting norms are based on the NPA concept, N for No income, P
for provisioning and A for asset classification. The prudential accounting norm
consists of the following:
1. Income recognition
II. Asset classification
III. Provisioning
For the purpose of income recognition, banks are required to classify their loan
account into two categories:
a. Performing Assets (PA)
b. Non-performing Assets (NPA)
Categories of NPAs
Nonperforming Asset does not bring substantial income to its owner or it is just
dormant. Basically, it is having something that should perform but actually it
does not perform. The RBI has issued guidelines to banks for classification of
assets into four categories:
Under the guidelines financial assets are sub-divided into 4 categories i.e. (i)
standard assets (ii) substandard assets (iii) doubtful assets and (iv) loss
assets.While loss assets will include overdue loans in cases
171
DBOD. No. BP.BC. 1/21.04.048/2013-14 July 1, 2013
144
red or documents are
lost which are legal proof to claim the debt,
leaving no tangible assets,
property and their sureties have also no means to pay the dues
4.8 Factors Contributing for Rise in NPAs
There are various reasons why a debt becomes bad debt. In India the Banking
Sector has been facing the serious problem of the rising NPAs. The mounting of
NPAs in Public Sector Banks is more serious as compared to private sector
banks and foreign banks. There are various reasons like a business fails to take
off, pushing loans even unsecured ones, lending of loans by banks without
verifying financial position etc. The factors responsible for rise in NPAs may be
classified as Internal Factors as well as External Factors.172
4.8.1. External Factors
Ineffective Recovery Tribunals: There has been establishment of number of
Recovery tribunals, which were established with the aims of recovery of loans
and advances. Due to the negligence and ineffective in the functioning of the
tribunals has led to the severe consequences with the banks like reducing their
profitability and liquidity.
Willful Default: there are certain borrowers who are capable of repaying back
but they are making default intentionally. Such kinds of group should be
identified and proper measures must be taken in order to get back the money.
Natural Calamities: country like India is hit by natural calamities which
effecting the borrowers in such a way that they are unable to pay back their
loans. Activities like agriculture are dependent upon the mercy of Nature in
India which ultimately affects the capacity of farmers to repay back.
172
Madan Mohan Jana and Manas KumarThakur, “An Overview of Non-Performing Assets
Management and Banking Performance - An Empirical Analysis”, The Management
Accountant, Vol. 50, No. 1, pp. 42-48, 2015.
145
Industrial Sickness : Industrial sickness which may arise due to various
reasons like inefficient management, lack of adequate resources, lack of
technology, change in Government Policies etc. give rise to the industrial
sickness. Industrial sickness reduces the profitability and liquidity of an
organization.
Lack of Demand: some time the Entrepreneurs could not foresee their product
demand and starts production which ultimately piles up their product thus
making then unable to pay back the money. The Bank will recover the amount
by reselling the assets which covers minimum label.
Change in Government Policies: with the change in Government their change in
the Government Policies. As a result with the changing policies the organization
is not able to cope up with the situation.
4.8.2. Internal Factors
Defective Lending Process: there are various cardinal principles of bank
lending which have been followed by the commercial banks:
Principle of safety states that the borrower is in a position to repay the loan both
principal and interest.
The repayment of loan depends upon the borrower’s capacity to pay and
willingness to pay. Capacity of pay depends upon: Tangible Assets and Success
in business. Willingness to pay depends on: Character, Honesty and Reputation
of borrower.
The banker should, therefore take utmost care in ensuring that the enterprise of
business for which loan is sought is a sound one and the borrower is capable of
carrying it out successfully.
Inappropriate Technology: Due to inappropriate technology and Management
Information System there is lack of market driven decisions on real time basis.
Lack of Proper Management System and financial accounting system leads to
the poor credit collection which further leads to rise in NPAs. All the branches
should be computerized.
146
Improper SWOT Analysis:
There should proper analysis of Strength, Weakness, Opportunity and the
Threat. There should analysis of borrower’s capital investment. The lending
institutions should collect the information about the borrower analyzing his
credit worthiness
Analysis of Financial Statement: there should be proper analysis of
Profit and Loss Account and Balance Sheet to reveal the true picture of
business.
Purpose of Loan: While giving loan Bank there should be efforts for
analyzing that the loan which has been sanctioned for the purpose is
utilized for the same. this is one of the serious concern in countries like
India that the borrower will borrow huge sum and the fund will be
diverted for purposes other than for which it was sanctioned.
Poor Credit Appraisal System: There is also a room for the improvement
of the mechanism for the appraising the credit.
Managerial Deficiencies: The Banker should always select the borrower
carefully and should take tangible asset as security to safeguard its interest.
While accepting securities banks should keep in mind following points like
marketability, Acceptability, Safety, Transferability. The banker should follow
the principle of diversification of risk based on the maxim “ don not keep all the
eggs in one basket” ; it means that banker should not grant advances to a few
big firms only.173
Absence of Regular Industrial Visit: There should be regular visit of Bank
official to the customer for revealing the exact situation of the borrower. The
NPAs due to the willful defaulter can be collected through regular visit.
4.9 Impact of NPAs
Profitability is a bench mark for any business enterprise including the banking
industry. Rising of NPAs have a direct impact on the bank’s profitability and
the earning capacity. The recovery of Loan has always been problem for banks
and Financial Institution. The primary function of bank is to lend fund as loans
173
Banambar Sahoo, “Non-Performing Assets in Indian Banks: Its Causes, Consequences &
Cure”, The Management Accountant, Vol. 50, No. 1, pp. 30-32, 2015.
147
to various sectors such as agriculture, trade , personal loans, housing loans etc.
it has been seen that major defaulters are big borrower from the non- priority
sector. The Banks and Financial Institutions have to take various strategic
moves to reduce NPAs in a time bound approach.174
For recovery of NPAs an
elaborative mechanism has been evolved for management of NPAs under which
several options are available for debt recovery and restructuring. Banks and
Financial Institutions are free to design and implement their own policies for
recovery for recovery and write off incorporating compromise and negotiated
settlements. The impact of NPAs on the banks is in following aspects:
Profitability: Due to NPA money is booked in terms of bad debt. As the money
is getting blocked the prodigality of bank decreases. Mounting of non-
performing assets have multifold effects in the economy. A large amount of
money of lending institutions is blocked and it is a serious threat for their
survival.
Liquidity: As the money is blocked there is decline in profit which further leads
to lack of enough cash. Due to lack of money there are various difficulties in
operating the functions of bank such as routine payment and dues.
Involvement of Management: to handle the NPAs the most of the time and
efforts of management goes, which they could invest in certain fruitful
activities. There are various employees in the banks to handle NPA which also
raises additional cost to the Banks.
Credit Loss: Problem of NPA also affect the value of bank in terms of market
credit.
4.9.1 Consequences of NPA
Institution does not get return on their capital and it continues further
Bank may lose their assets. It may further affect various stakeholders.
Depositor to the bank do not receive a market return on saving. In some
cases depositor may also lose their asset.
174
Krishnamohan, V. and Rao, Suryachandran, D. (2007), “Management of Non- Performing
Assets in Scheduled Commercial Banks: A Study of Incidence, Causes, Impact and Strategies”,
Gitam Journal of Management, Vishakhapatnam, Vol. -05, No-02, April- June, PP- 111-129.
148
The lending institutions including the banks has due to NPAs has to
divert the impact. These institutions will raise the lending rates and in
future a burden over the customers.
Non-performing asset may spill over the banking system and contract the
money stock which may lead to economic contraction. When any
borrower fails to pay interest, bank may experience liquidity shortage.
Illiquidity constraints bank in paying depositors.
4.9.2 Impact of NPAs on performance of Bank
Interest income is reduced due to non – performance of assets.
Desirable yield is not achieved.
The total net worth of the bank stands reduced.
The bank has to incur additional cost in supervision and follow – up.
The bank has to face the problem of demoralized staff.
The bank has to provide for the provisioning, thus effecting the net profit of
the bank.
The bank faces difficulty to get license for new branches.
NPAs have a very negative effect on CRAR (Capital Risk Adequacy
Ratio).
NPAs restrict the recycling of funds
4.10 Strategy for Management of NPAs
4.10.1 Models for Resolution OF NPAs
Around the globe, the countries which are facing the menace of a plethora of
NPLs, primarily use one of several models for addressing the crisis."
(a)Bank-based Model
In the bank-based model, the NPLs effectively remain on the books of banks or
are transferred to a specialized workout unit or to a separate organization such
as a subsidiary of the bank. The focus is typically on workouts as opposed to
rapid disposal. While this model does offer certain advantages, such as focus on
resolution and operational flexibility, it suffers from slow resolution progress on
account of lack of debt aggregation in a multi-lender situation, and the
149
requirement of certain skill-sets to drive the complex resolution process.
Moreover, the risks and reward of NPLs remain with the concerned bank
itself.175
(b)Non-Governmental Market-based Model
The non-governmental or market-based model is adopted essentially where
there is an absence of crisis but the nature and size of NPLs could undermine
the efficiency of intermediation by the banks. Governments typically provide an
enabling legal and regulatory environment for market-based exits at values
determined through market forces between sellers (banks) and buyers
(investors). Governments also provide selective capitalization support to banks
for their cleanup programs. Governments may also provide for specialized
intermediation in the form of ARCs for acquiring and resolving NPLs that
might be set up by the banks or the investors. This model relies upon successful
participation by willing sellers and buyers, and strong regulatory inducements in
the absence of direct financial support. The strategies followed by banks,
investors, and ARCs could be both (workout and rapid sell) and suited to meet
buyer/seller requirements.
(c) Government Owned and Supported Model
The government owned/sponsored approach is employed as a response to an
economic crisis. The governments typically set up nodal ARCs to transfer the
stock of NPLs from the system as a measure of system wide one-time cleanup.
The governments bear the cost of such cleanups. ARCs raise money from third
party investors (typically foreign) for the acquisition of NPLs. The investors
implement the resolution and carry the risk and rewards arising therefrom.
Several Southeast Asian countries extensively used this model in the aftermath
of the economic crisis more as a knee-jerk reaction to address the situation at
hand.
India has adopted a mix of bank-based and non-governmental market based
models with the objective of creating a sound platform for market led resolution
and exit from NPLs for the banking system.
175
Nachane D.M. (1999), “Capital Adequacy Ratios – An agnostic View Point”, Economic and
Political Weekly, January, PP-16-23.
150
Various steps have been taken by the Government and RBI to recover and
reduce NPAs. The strategies can be divided into heads: Preventive
Management and Curative Management
4.10.2 Preventive Management
Preventive management are the strategies which precautionary measures to
prevent an asset becoming Non-Performing Asset. Under this head the Banks
concentrate on the following mechanism to minimize the level of NPAs.
(i) Early Warning Signals (EWS)
Banks should have adequate preventing measures, fixing pre sanctioning
appraisal responsibility and having an effective post-disbursement supervision.
Banks should continuously monitor loans to identify accounts that have
potential to become non –performing. In early warning system there should be
sensitivity towards the signals of credit deterioration. These early warning
signals are used for identification of potential NPA. Most of banks in India have
laid down a series of indicators like operational, financial; transactional that
could serve to identify emerging problems in credit exposure at an early
stage.176
Early warning signals can be classified under following broad categories:
Financial, Operational, Banking, Management and External factors.
(a) Financial Warning Signals: financial related warnings generally emanate
from the borrowers’ balance sheet, income expenditure statement, statement of
cash flows, and statement of receivables etc. Financial Warning Signals can be
like as: Consistent irregularity in the account, Default in repayment obligation,
Decline in the liquidity/ working capital position, Substantial increase in long
term debts in relation to equity, Decline in sales.
(b) Operational Signals: operating losses, falling profits, disproportionate
increase in overheads relative to sales, rising level of bad debts, low activity
level in plant, frequent change in plan, loss of customers , frequent labour
problems, large level of inventory.
176
Sahoo, Banambar (2015) – ‘Non- Performing Assets in Indian Banks: its causes,
consequence and cures’. The Management Accountant.Vol.50. no.1.Jan.2015
151
(c ) Banking related signals:
Decline in bank balance/ operation in the account.
Maintaining new account with other bank.
Return of outwards bills / dishonoured cheques.
Sales transactions not routed through the account.
Frequent application for loan
Regular delay in submitting stock statement, financial data etc.
(d) Management related warning signals
Lack of cooperation among key personnel
Change in management ,ownership
Suffering undue risks
Family dispute
Poor financial control
Fudging of financial controls
Diversion of funds
(e) Signals relating to external factors
Recession in the economy
Enhancement of competition
Change in technology
Change in Government policies
Natural calamities
Role of Early Warning System in mitigating credit risks
Over the years, the credit monitoring function has assumed criticality for banks,
as it has direct impact on the profitability and liquidity of their credit portfolios.
The significance of Credit monitoring can be understood from the following
reasons:
Dynamic portfolio mix: With changing market conditions, a robust
credit monitoring system allows the bank to align its exposure in line
with its risk strategy.
152
Slippages and NPAs: Increase in slippages and NPAs indicate low asset
quality on the loan book leading to credit and reputational risks for the
banks.
Better capital management: Provisions have a draining effect on the
profitability of the bank and hence the equity, which has an impact on
the capital structure.
Efficient cost management: Recovery of NPAs could lead to
incremental operational and legal cost for the bank.
Early warning systems can be an important tool to mitigate credit risks through
proactive monitoring. 177
A good early warning system can include key
parameters indicative of ’hidden’ problems:
The building blocks of an early warning system
Analysis of trends in NPAs of the bank including factors leading to NPAs:
Internal factors include diversion of funds, time and cost overruns during
project implementation, business failure, inefficiency in management, slackness
in credit management and monitoring, inappropriate technology and lack of
coordination between lenders.
External factors include recession, price escalation and currency fluctuations,
changes in government policies, environment concerns and accident and natural
calamities to name a few.
• Analysis of trends in credit portfolio diversification
• Studying the relationship between diversified portfolio and NPAs of the bank
• Profiling and analysis of concentration risk in the bank
• Evaluating the credit risk management practices in banks
Key elements of EWS
Key element of Early warning system can be studied under the following heads
Financial, operational, Attitude of borrowers and other.
177
http://articles.economictimes.indiatimes.com/2014-03-20/news/48402053_1_npas-
nationalized-banks-early-warning-system
153
Financial
Irregularity in installment and insufficient payments
Irregularity of operations in the accounts
Bouncing of cheque due to insufficient balance in the accounts
Unpaid overdue bills
Declining current ratio
Diversion of funds
Operational
Information about borrower initiating the mode of liquidation of the
assets of the borrowing institutions.
Turning to the receivable as overdue
External non-controllable factor like natural calamities in the city where
borrower conduct his business
Frequent changes in plan and nonpayment of wages
(ii) Know your client (KYC)
Most of Banks have a system of preparing a report of their clients. In this report
they keep a track over the client’s business.
(iii) Assessment of Credit and Risk Management System
Assessment of credit and management of risk system is one of the mechanism
to control NPA. Management of credit risk is a long term approach which aims
for managing the quality of credit portfolio before the default takes place.
(iv) Organizational restructuring
Whenever there is rise in NPA in the organization the onus lies over the banks
only. In order to improve the managerial efficiency it is necessary to have
restructuring in the organization.
(v) Less dependence on Interest
154
The banks in are largely dependent upon lending and investment. Main income
of banks in India comes from the interest. This further paves the way for the
NPA.
(vi) Watch List
The grading of bank’s risk asset is an important internal tool control. The
grading serves the need of the management to identify and monitor potential
risks of loan assets. The identification of potential NPA ensures that preventive
/ corrective steps could be taken by the bank to protect against the loan asset
becoming non –performing. The categorization of such account in watch list or
special mention category provides early warning signals credit officer to
anticipate credit deterioration and the necessary preventive steps to avoid their
conversion into Non Performing Asset.
(vii) Willful Defaulter
There are certain borrowers who have the capacity to honor the obligation to the
lender despite of this they make willful default. The fund has been utilized by
them for purposes other than for which the finance was granted. The list of
willful defaulter is to be sent to the SEBI and RBI to prevent their access from
market. Sharing of information of such nature will help banks in their due
diligence exercise? There were more than 9,100 willful defaulters who together
owed Rs 91,155 Cr. to public sector banks at December-end. Banks declare
willful defaulters as per the norms stipulated by the Reserve Bank of India.
There were 9,130 willful defaulters who owe Rs 91,155 Cr. to public sector
banks.178
4.10.3 Curative Management
This is also one of the mechanisms which is for management of the non-
performing assets. The options available under this head are entirety different
from the preventive management. In curative management the strategy is to cure
the menace which has been due to various factors. Curative Management are
One Time Settlement Scheme, LokAdalat, Debt Recovery Tribunals (DRTs)
(iv) Securitisation and SARFAESI Act,2002
178
http://economictimes.indiatimes.com/industry/banking/ finance/banking/wilful-defaulters-
owe-rs-91155-Cr.-to-psbs/articleshow accessed on April 2017.
155
The term “Asset Reconstruction” implies the acquisition of any right or any
interest in the financial assistance of the bank or financial institution for the
purpose of the realisation of the same by the securitisation or reconstruction
company. 179
The term financial assistance connotes any loan or advance given
or letters of credit established or any other credit facility extended by any bank
or financial institution. 180
The acquisition of any right or interest in the
financial assistance by the securitisation or the reconstruction company for the
realisation of such financial assistance would amount to the asset
reconstruction. When all the ingredients are present in the transaction the same
would amount to the asset reconstruction otherwise it would not amount to asset
reconstruction. The reconstruction can be carried out by either the securitisation
company or by the reconstruction company as the case may be.181
Both of these
companies have been separately defined in the provisions.182
The reconstruction
provides the acquisition of the rights or interest in the financial assistance of the
bank or the financial institution for the purpose of realisation of the same.
The SARFAESI Act was enacted for certain objectives-
Speedy disposal and redressal of pending cases through non judicial methods.
To regulate securitization & reconstruction of financial assets and enforcement
of security interest.
To help realize long term assets, manage liquidity problems, asset-liability
mismatch etc.
Setting up of asset Reconstruction Company by taking possession of secured
assets.
Taking over management of Company which is liable to pay.
To assign debts to securitisation companies (which is absent in DRT Act) for
liquidation in time.
(v) Corporate Debt Restructuring
179
Section 2 (1) (b) of the SARFAESI Act 2002. 180
Section 2(1)(k) of the SARFAESI Act 2002. 181
An Asset Reconstruction Company (ARC) is meant for the reconstruction of the assets by
repackaging the financial assets Banks/FI to make them marketable as per the provisions of the
SARFAESI Act 2002. 182
Justice Banerjee, B.P.; “Guide to Securitization Reconstruction of Financial Assets &
Enforcement of Security Interest Act, 2002”; 1st Ed.; Wadhwa and Company, Nagpur; 2014; p
140
156
In today’s competitive world it is very obvious for organization to find
themselves in financial difficulties because of factors beyond their control. In
such cases, keeping in mind the interest of workers, suppliers and creditors etc.
timely support through restructuring of the business in a manner acceptable to
all interested parties is required. This acceptable manner is only possible if there
exists an institutional mechanism for restructuring of corporate debt.
One of the features of resolution strategies used in India that has been noted on
internationally is the Corporate Debt Restructuring scheme. What makes it more
interesting is that the CDR scheme runs parallel with several far reaching legal
powers available to the banks.
The objective of the CDR framework is to ensure timely and transparent
mechanism for restructuring of the corporate debts of viable entities facing
problems for the benefit of all concerned.
CDR process consists of four steps
The consultation process
The negotiation process
The liquidation of assets
The restructuring process starts
Structure of CDR System: CDR system has a three tier structure
CDR Standing Forum
CDR Empowerment Group
CDR Cell
The restructuring is to be carried out in accordance with detailed guidelines
issued by the Reserve Bank of India on restructuring like Joint Lenders’ Forum
(JLF), Strategic Debt Restructuring (SDR) and Scheme for Sustainable
Structuring of Stressed Assets. For agricultural accounts that became impaired
on account of reasons other than natural calamities, restructuring is allowed in
terms of RBI guidelines on Income Recognition and Asset Classification.183
183
https://www.assocham.org/userfiles/Banking-bulletin
157
Credit Information Bureau
The enactment of the Credit Information Companies (Regulation) Act,2005
provides for the setting up of Credit Information companies for collection ,
sharing and dissemination of credit information, which will help in arresting
fresh accretion of NPAs and framing of the rules under the Credit Information
Companies (Regulation) Act,2005 which would ensure that Credit Information
Companies collect, process and collate accurate and complete data relating to
borrowers, that fresh loans and advances given to the borrowers do not become
sticky. 184
Credit rating agency
In the case of sanctioning of loans, banks use the ratings as filter and sometimes
performs an additional check through an independent due diligence review on
credit matrix. Banks may use the credit rating issued by CRAs to the debtor as
important information during the credit appraisal. The
RBI’s regulatory framework requires banks to have their own credit risk
assessment framework for lending and investment decisions and not rely only
on ratings assigned by credit rating agencies. The Indian banking system’s
mandated reliance on external credit ratings is limited to capital adequacy
computation for credit risk and general market risk under standardized approach
of Basel II.185
As banks develop their internal ratings model as mandated by the Advanced
Basel framework, they can validate the credit rating for a particular borrower
generated from that model with that of the publicly available ratings by CRAs.
Banks can also seek information from CRAs if there is wide variation in its
credit assessment vis-a-vis the rating agencies. Banks and CRAs should be able
to contribute to developing an ecosystem where credit assessments become
more effective.RBI guidelines also stipulate that as a general rule, banks need to
use only solicited ratings from chosen credit rating agencies and cannot
184
Smt. Ranjana Kumar, Chairperson & Managing Director, Indian Bank, Chennai –
Restructuring of Debts: The best bet for bankers and the borrowers – IBA Bulleting Special
Issue – March 2003 – p.no:40 – 47 185
Sood Rajesh Kumar (2004), “Operational Risk under New Basel Accord”, IBA Bulletin,
Vol. XXVI, No-6
158
consider any ratings given on an unsolicited basis by CRAs for risk weight
calculation as per the standardized approach.
Borrowers can benefit from the rating exercise as it can help them tone up their
management systems and business models. CRAs play a vital role in the
assessment of various risks.
4.11 Corrective Action initiatives for minimizing NPAs
Before a loan account turns into an NPA,banks are required to identify incipient
stress in the account by creating a sub – asset category viz Special Mention
Accounts.186
Banks would be required to have three sub- categories under the
SMA category
4.12 Analysis of various NPA Resolution Mechanisms
After analyzing the various mechanism discussed above it can be concluded that
there is no single optimum solution, but rather a combination of solutions that
may vary over time for each country and by bank. In there are basically three
forums, apart from recourse of the courts, which are available for handling the
bad loans or NPAs. The performance of these forums is highlighted in the given
table.
The data presented in the figure 4.5 below displays the same trend from 2002 -
2017 as there is consistent rise in the Non-Performing Assets of the Banks in
India. Non-performing assets (NPAs) soared to Rs 7 Lakhs Crore by end of
March 2017. There has been change in the framework with regard to managing
it but the framework is not able to cope with the challenges posed by the
accumulation of the Nonperforming Assets.
186
RBI Circular No. DBS.CO.OSMOS/B.C./4/33.04.006/2002-2003 dated September 12, 200
presribes the mode for categorizing the account under the SMA Category.
159
The above table number 4.6 displays the reduction of NPAs during the year for
a period from 2004 to 2016. The above data displays that there are not positive
trends with regard to the reduction in the level of NPAs in Indian Banking
sector raising a serious question over the legislative and policy framework.
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
Gro
ss N
PA
s (i
Am
ou
nt
in
Bil
lio
n
Source: Report on Trend and progress of Banking in India, RBI
Figure 4.5 Growth of Gross NPA in Scheduled Commercial
Banks (%)
Gross NPAs
0
100000
200000
300000
400000
Am
ou
nt
in M
illi
on
s
Source: Report on Trend and progress of Banking in
India, RBI
Figure 4.6 NPAs Reduction during the Year
Reduction during the Year
160
Table 4.1 NPAs of SCBs recovered through various channels
Percentage of Amount Recovered to Amount Involved
Year Lok adalat DRTs SARFAESI Act,2002
2002-03 16 7 4.1
2003-04 14 17.2 14.7
2004-05 14.1 18.8 18.1
2005-06 14 37.8 34.81
2006-07 8.2 51.9 41.40
2007-08 2.4 81.1 61
2008-09 1.5 32 33
2009-10 3.7 27.6 30
2010-11 11.8 17 37.78
2011-12 6.1 14.1 28.60
2012-13 6.2 9.5 27.10
2013-14 6 9.6 25.80
2014-15 3.2 7 16.30
2015-16 4.4 9.2 16.50
2016-17 3.6 24.4 6.89
Source: Report on Trend and progress of Banking in India,
RBI Various issues
In the figure and table displays the percentage of Non-Performing Assets of
Scheduled Commercial Banks recovered through the several channels of
recovery available to banks, the DRTs and SARFASESI Act. But even the
recovery under SARFASI Act, 2002 has not been as ambitious for this law was
introduced.
Among the various channels, the amount of NPAs recovered under the
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002, formed over half of the total amount of NPAs
recovered in 2009-10. The SARFAESI Act has, thus, been the most important
means of recovery of NPAs. However, there has been a steady fall in the
amount of NPAs recovered under the SARFAESI Act as a percent of the total
161
amount of NPAs involved under this channel in recent years, a trend which
could also be seen between 2008-09 and 2009-10
The main inferences from the data presented above pertaining to
advances which have accumulated in NPAs given to priority sector non-priority
sector and public sector. When the comparisons are made regard to the lending
in the priority and nonpriority sector the data shows that as compared to 2002-
03 now in 2015-16 till 2016-17 the percentage of NPAs accumulation in the
priority sector has almost reduced to half. But with respect to amount there is
almost five times higher of Non-Performing Assets in Public sector. While in
non-priority sector the accumulation of non-performing assets is in normal rate
as compared to 2002-03. From 2002-03 to 2004-05 there has been the figure of
fifty percent of the Non-Performing Assets in Non-Priority Sector. The
accumulation of Nonperforming assets for lending in public sector has been
declining as compared to 2005. When the data is analysed as percentage wise it
is found that in 2002-03 the percentage of NPAs ( out of total) was fifty percent
Table 4.2 COMPOSITION OF NPAs OF PUBLIC SECTOR
BANKS
(Amount in ` Billion)
Years PRIORITY
SECTOR
NON PRIORITY
SECTOR
PUBLIC SECTOR
2016-17 1257.29 3811.92 147.19
2015-16 969.03 3210.85 17.63
2014-15 709.34 1337.67 2.59
2013-14 537.5 935.67 1.3
2012-13 408.34 599.01 9.48
2011-12 324.24 355.55 10.68
2010-11 246.2 194.1 2.42
2009-10 195.67 165.23 3.05
2008-09 157.54 106.68 1.21
2007-08 159.72 85.63 4.38
2006-07 153.44 103.4 4.87
2005-06 149.22 132.27 6.68
2004-05 153.36 170.62 4.06
2003-04 238.41 256.98 6.1
2002-03 249.39 267.81 10.87
Source: Department of Banking Supervision, RBI
162
and it has accumulated in 2015-16 up to seventy six percent. While percentage
of Non-Performing Assets in Public sector has reduced from 2.06% in 2002-03
to 0.42% in 2015-16.
The above table displays the Movement of Non-Performing Assets in Indian
Commercial Banks from a period of 2005-2017. It also analyses the percentage
growth of Non-Performing Assets year wise. From the year 2008-09 there has
been consistent rise in the percentage growth of the Non-Performing Assets.
From year 2005-2008 the level of Non-Preforming Assets was lowest. While
during the year 2016-17 the percentage growth has reached up to the level of
eighty nine percent which is not a health sign for the Indian Banking Sector.
MOVEMENT OF NON-PERFORMING ASSETS (NPAs) OF SCHEDULED COMMERCIAL
BANKS (Amount in Millions)
Year NPA in the
previous year
Addition
during the
Year
Reduction
during the
Year
Write-off
during the
Year
Growth of
Gross NPA
(%)
2005-06 6,43,101.14 2,04,056.04 2,28,790.62 24,631.71 0.00%
2006-07 5,83,631.58 2,13,799.04 2,85,951.56 510.75 -13.94%
2007-08 5,05,198.31 2,62,114.39 2,61,597.54 849.5 -1.19%
2008-09 5,01,914.40 3,49,812.00 2,79,467.70 9,167.20 11.53%
2009-10 5,48,368.47 5,23,458.69 3,38,706.97 49,838.20 21.34%
2010-11 6,82,843.20 6,95,796.97 2,84,213.22 2,47,418.72 23.96%
2011-12 8,39,088.53 7,04,398.54 3,31,630.09 2,32,606.97 15.61%
2012-13 9,79,711.31 10,71,765.60 4,27,590.26 2,00,622.36 45.34%
2013-14 14,23,264.18 13,80,076.72 5,41,479.32 3,26,771.44 35.96%
2014-15 19,34,968.33 18,97,219.07 7,91,387.14 4,07,082.79 36.10%
2015-16 26,33,618.78 20,86,381.40 8,84,682.35 6,01,966.29 22.77%
2016-17 32,25,899.17 44,21,924.69 8,03,339.19 7,25,011.83 89.26%
163
Table 4.3 Trends in Net NPAs before the SARFAESI
Act, 2002
Year
Net NPAs (Rs.) Net NPAs to Total
Advances Ratio (%)
1995-96 19985 8.90
1996-97 20285 9.18
1997-98 21232 8.15
1998-99 24211 8.13
1999-00 26187 7.42
2000-01 27969 6.74
2001-02 27958 5.80
The above table displays the trend in Net Non-Performing Assets before the
enactment of SARFAEASI Act, 2002. There is analysis with regard to the Net
NPAs and total advances ratio. Table shows that the amount of Net NPAs was
Rs. 19985 in the year 1995-96 and then in the year 2001-02 increased up to Rs.
27958 crore. The table also reveals that the percentage of Net NPAs to total
Advances ratio shows reduction from 8.9% in the year in the year 1995-96 to
5.8% in the year 2001-02.While in the year 2000-01 Net NPAs to Total
Advances Ratio is 5.80 percent. While in the year 1999-2000 Net NPAs to Total
Advances Ratio is 7.42 percent. In the year 1998-99 Net NPAs to Total
Advances Ratio is 8.13 percent. In the year 1997-98 Net NPAs to Total
Advances Ratio is 8.15 percent.
While in the table below an attempt has been made to study the position of Non-
Performing Assets globally. The aim to analyse that whether this problem also
subsist in the Banks and Financial Institutions globally.
164
Ratio of NPLs to Gross Loans - An International Comparison
Country 2004
-
2005
2005
-
2005
2006
-
2007
2007
-
2008
2008
-
2009
2009
-
2010
2010
-
2011
2011
-
2012
2012
-
2013
2013
-
2014
2014
-
2015
2015
-
2016
Australi
a
0.5 0.6 0.6 0.6 1.3 2 2.1 2 1.8 1.5 1.1 1
Belgium 2.8 2 1.3 1.2 1.7 3.1 2.8 3.3 3.8 4.3 4.1 4
Canada 1.3 0.5 0.4 0.4 0.8 1.3 1.2 0.8 0.7 0.6 0.5 0.5
France 5 3.5 3 2.7 2.9 4 3.8 4.3 4.3 4.5 4.2 -
German
y
4.7 4.1 3.4 2.7 2.9 3.3 3.2 3 2.9 2.7 2.3 -
Greece 12.3 6.3 5.4 4.6 5.1 7 9.1 14.4 23.3 31.9 34.3 34.4
Italy 7.8 7 6.6 5.8 6.3 9.4 10 11.7 13.7 16.5 17.3 -
Japan 5.3 1.8 1.8 1.5 1.4 2.4 2.5 2.4 2.4 2.3 1.9 1.6
Spain 1.2 0.8 0.7 0.9 2.8 4.1 4.7 6 7.5 9.4 8.5 7
United
Kingdo
m
2.5 1 0.9 0.9 1.6 3.5 4 4 3.6 3.1 1.8 -
United
States
1.1 0.7 0.8 1.4 3 5 4.4 3.8 3.3 2.5 2 1.7
Emerging Economies
Argentin
a
16 5.2 4.5 3.2 2.7 3.5 2.1 1.4 1.7 1.7 2 1.9
Brazil 8.3 3.5 3.5 3 3.1 4.2 3.1 3.5 3.4 2.9 2.9 3.1
Chile 1.7 0.9 0.7 0.8 1 2.9 2.7 2.3 2.2 2.1 2.1 2
China 22.4 8.6 7.1 6.2 2.4 1.6 1.1 1 1 1 1.2 -
India 12.8 5.2 3.5 2.7 2.4 2.2 2.4 2.7 3.4 4 4.3 4.3
Malaysia 15.4 9.4 8.5 6.5 4.8 3.6 3.4 2.7 2 1.8 1.6 1.6
Russian
Federati
on
7.7 2.6 2.4 2.5 3.8 9.5 8.2 6.6 6 6 6.7 7.4
South
Africa
4.3 1.8 1.1 1.4 3.9 5.9 5.8 4.7 4 3.6 3.3 3.2
Thailand 17.7 9.1 8.1 7.9 5.7 5.2 3.9 2.9 2.4 2.3 2.5 2.5
Source: World Bank database at <data.worldbank.org>.
When the international comparison with regard to the ratio of Non-Performing
Loans to Gross Loans we will find that event the advanced economies are also
suffering from this menace. But there are certain advanced economies which are
having a high level of Non-Performing Assets. When the data is analysed for
the Australia from 2004 to 2016 it is found that the percentage is varying from
2004- 2007 it was near about 0.5 percentage. From 2008-2016 the percentage
has been between 1to 2 percent. Belgium has high fluctuation between two
percent to four percent. Canada is able to manage better as the percentage is
165
lying from 0.4 to one percent only. France is having higher percentage as
varying from three percentages to five percentage. Germany is witnessing a
different trend it percentage is lowering own from a period between 2010-2016.
Greece has highest percentage of NPAs and there is exponential growth in the
last decade and in 2016 the level has reached to thirty four percentages. Japan is
able to control the Non-performing assets well in the last decade and the level
for the decade is around and below two percentage. While the rate of NPAs is
growing in Spain in the last five years and there is consistent rise. While in the
United States of America and United Kingdom the percentage level in
manageable and there is not variations in the level of NPAs in the five years.
While the situation is different in the emerging economies. From 2004 to 2007
in the emerging economies the percentage ratio of the non-performing loan was
higher ranging from twenty percentage to twenty five while situation has
improved from 2008 onwards till 2016. For the last five years the ratio is under
five percentage from 2008 to 2016.
Summary of the chapter
As per the mandate of the report of Narasimhan Committee 1991 and Basel
Accord capital standards were to be adopted April 1992. The 8% of capital
adequacy ratio had to be met by foreign banks operating in India by the end of
March 1993; Indian banks with a foreign presence had to reach the 8% by the
end of March 1994 while purely domestically operating banks had until the end
of March 1996 to implement the requirement. In 1994 various changes were
also made to deal with this problem the rules guiding their recognition were also
tightened.
The period of 1994-1998 saw Non-performing loans as a major problem in
Indian banks. It ranged from 24.8% in 1994 to 16% in 1998 in public sector
banks. This scenario was not confined only to Public Sector Banks; even Private
sector banks were also having NPA of 10.7% during 1997 and 4.3% of NPA
was handled by foreign banks also. In 1998 the Narasimhan Committee II
submitted its report and recommend the changes under the various heads such
as measures for enhancing competition, Measures for enhancing role of Market
166
Forces, introduction of prudential norms as per international best practices,
Legislative and institutional measures, measures for supervision of banks,
According to Reserve Bank of India, an asset, including a leased asset, becomes
non-performing when it ceases to generate income for the bank. In other words,
NPA refers to a debt obligation where the borrower has not paid any previously
agreed upon interest and principal repayments to the designated lender for an
extended period of time.
Various steps have been taken by Reserve bank of India which is pushing banks
in India to be more proactive in in recognition of stress and to take remedial
steps so as to preserve the economic value of assets. As a part of such efforts,
special mention accounts (SMAs) classification has been recently introduced
coupled with defining a time bound procedure towards deciding the course and
nature of remedial actions.
The RBI is also strengthening the NPA resolution ecosystem in India including
increase in foreign participation rules in ARCs in India and bringing a sunset
clause to the regulatory forbearance accorded to restructured accounts up to
March 2017. There is also an increasing demand from industry to keep MSMEs
out of the ambit of SMAs.
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