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8/9/2019 Final Npa Management
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PREFACE
In order to understand what is the impact of Non
Performing Assets on the banking sector in terms of
banks' asset quality. A high level of NPAs in the
banking system can severely affect the economy in
many ways. Management and financial resources ofthe banking system are diverted to resolution of NPA
causing an opportunity loss for productive use of
resources. Large scale NPAs, when left unattended,
cause continued economic and financial
degradation.
The study will be undertaken based on literature
preview from various resources like national daily
newspapers, financial news papers, web sites of
various entities like RBI, World Bank, and Indian
Bankers association and internet research and a
report got a shape.
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This Report will help the reader to understand impact
of NPAs, various measures taken to improve the
efficiency and profitability and for finding out the real
solution to making realistic provisions based on
assessment of realizations from NPAs towards their
dues.
TABLE OF CONTENTS
11 IInnttrroodduuccttiioonn ttoo NNPPAAss
22 RReesseeaarrcchh MMeetthhooddoollooggyy
33 OObbjjeeccttiivvee aanndd SSccooppee ooffSSttuuddyy
44 FFaaccttoorrss ffoorrRRiissee iinn NNPPAAss
55 IImmppaacctt,, RReeaassoonnss && SSyymmppttoommss ooffNNPPAA
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66 PPrreevveennttiivvee MMeeaassuurreess
77 TToooollss ffoorrRReeccoovveerryy
88 OObbsseerrvvaattiioonn aanndd FFiinnddiinnggss99 AAnnaallyyssiiss
1100 FFiinnddiinngg,, SSuuggggeessttiioonnss && CCoonncclluussiioonnss
1111 BBiibblliiooggrraapphhyy
INTRODUCTION
TO
THEPROJECT
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The accumulation of huge non-performing assets in banks has
assumed great importance. The depth of the problem of bad debts
was first realized only in early 1990s. The magnitude of NPAs in
banks and financial institutions is over Rs.1,50,000 crores.
While gross NPA reflects the quality of the loans made by banks,
net NPA shows the actual burden of banks. Now it is increasingly
evident that the major defaulters are the big borrowers coming
from the non-priority sector. The banks and financial
institutions have to take the initiative to reduce NPAs in a time
bound strategic approach.
Public sector banks figure prominently in the debate not only
because they dominate the banking industries, but also since they
have much larger NPAs compared with the private sector banks.
This raises a concern in the industry and academia because it is
generally felt that NPAs reduce the profitability of a bank,
weaken its financial health and erode its solvency.
For the recovery of NPAs a broad framework has evolved for the
management of NPAs under which several options are provided for
debt recovery and restructuring. Banks and FIs have the freedom
to design and implement their own policies for recovery and
write-off incorporating compromise and negotiated settlements.
WWhhaatt iiss NNPPAA??????
The three letters NPA Strike terror in banking sector and
business circle today. NPA is short form of Non Performing
Asset. The dreaded NPA rule says simply this: when interest or
other due to a bank remains unpaid for more than 90 days, the
entire bank loan automatically turns a non performing asset. The
recovery of loan has always been problem for banks and financial
institution. To come out of these first we need to think is it
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possible to avoid NPA, no can not be then left is to look after
the factor responsible for it and managing those factors.
DDEEFFIINNIITTIIOONNSS::
An asset, including a leased asset, becomes non-performing when
it ceases to generate income for the bank.
A non-performing asset (NPA) was defined as a credit facility
in respect of which the interest and/ or instalment of principal
has remained past due for a specified period of time.
With a view to moving towards international best practices and to
ensure greater transparency, it has been decided to adopt the 90
days overdue norm for identification of NPAs, from the year
ending March 31, 2004. Accordingly, with effect from March 31,
2004, a non-performing asset (NPA) shall be a loan or an advance
where;
Interest and/ or instalment of principal remain overduefor a period of more than 90 days in respect of a
term loan,
The account remains out of order for a period of morethan 90 days, in respect of an Overdraft/Cash Credit
(OD/CC),
The bill remains overdue for a period of more than 90days in the case of bills purchased and discounted,
Interest and/or instalment of principal remains overduefor two harvest seasons but for a period not exceeding
two half years in the case of an advance granted for
agricultural purposes, and
Any amount to be received remains overdue for a periodof more than 90 days in respect of other accounts.
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OOuutt ooff oorrddeerr
An account should be treated as out of order if the outstanding
balance remains continuously in excess of sanctioned limit /drawing
power. in case where the out standing balance in the principal
operating account is less than the sanctioned amount /drawing power,
but there are no credits continuously for six months as on the date
of balance sheet or credit are not enough to cover the interest
debited during the same period ,these account should be treated as
out of order.
OOvveerrdduuee
Any amount due to the bank under any credit facility is overdue if
it is not paid on due date fixed by the bank. As a facilitating
measure for smooth transition to 90 days norm, banks have been advised
to move over to charging of interest at monthly rests, by April 1,
2002. However, the date of classification of an advance as NPA should
not be changed on account of charging of interest at monthly rests.
Banks should, therefore, continue to classify an account as NPA only
if the interest charged during any quarter is not serviced fully
within 180 days from the end of the quarter with effect from April 1,
2002 and 90 days from the end of the quarter with effect from March
31, 2004.
RREESSEEAARRCCHH MMEETTHHOODDOOLLOOGGYY
Type of Research:
The research methodology adopted for carrying out the study
were
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In this project Descriptive research methodologies were use. At the first stage theoretical study is attempted. At the second stage Historical study is attempted. At the Third stage Comparative study of NPA is undertaken.
SSCCOOPPEEOOFFTTHHEE SSTTUUDDYY
Concept of Non Performing Asset Guidelines Impact of NPAs Reasons for NPAs Preventive Measures Tools to manage NPAs
SAMPLING PLAN
To prepare this Project we took five banks from public sector as well
as five banks from private sector.
OBJECTIVES OFTHE STUDY
The basic idea behind undertaking the Grand Project on NPA was to:
To evaluate NPAs (Gross and Net) in different banks. To study the past trends of NPA To calculate the weighted of NPA in risk management in
Banking
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To analyze financial performance of banks at different levelof NPA
To evaluate profitability positions of banks To evaluate NPA level in different economic situation. To Know the Concept of Non Performing Asset To Know the Impact of NPAs To Know the Reasons for NPAs To learn Preventive Measures
Types of NPA
AA.. GGrroossss NNPPAA::
Gross NPAs are the sum total of all loan assets that are
classified as NPAs as per RBI guidelines as on Balance Sheet
date. Gross NPA reflects the quality of the loans made by banks.
It consists of all the non standard assets like as sub-standard,
doubtful, and loss assets.
It can be calculated with the help of following ratio:Gross NPAs Ratio = Gross NPAs
Gross Advances
BB.. NNeettNNPPAA::
Net NPAs are those type of NPAs in which the bank has deducted
the provision regarding NPAs. Net NPA shows the actual burden ofbanks. 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 provisions the banks have to make
against the NPAs according to the central bank guidelines, are
quite significant. That is why the difference between gross and
net NPA is quite high.It can be calculated by following:
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Net NPAs = Gross NPAs Provisions
Gross Advances - Provisions
INCOMERECOGNITION
IInnccoommee rreeccooggnniittiioonn PPoolliiccyy
The policy of income recognition has to be objective andbased on the record of recovery. Internationally income from non-
performing assets (NPA) is not recognised on accrual basis but is
booked as income only when it is actually received. Therefore,
the banks should not charge and take to income account interest
on any NPA.
However, interest on advances against term deposits, NSCs,IVPs, KVPs and Life policies may be taken to income account on
the due date, provided adequate margin is available in the
accounts.
Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be
recognised on an accrual basis over the period of time covered by
the re-negotiated or rescheduled extension of credit.
If Government guaranteed advances become NPA, the intereston such advances should not be taken to income account unless the
interest has been realised.
Reversal of income:
If any advance, including bills purchased and discounted,becomes NPA as at the close of any year, interest accrued and
credited to income account in the corresponding previous year,
should be reversed or provided for if the same is not realised.
This will apply to Government guaranteed accounts also.
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Leased Assets
The net lease rentals (finance charge) on the leased assetaccrued and credited to income account before the asset
became non-performing, and remaining unrealised, should be
reversed or provided for in the current accounting period.
The term 'net lease rentals' would mean the amount offinance charge taken to the credit of Profit & Loss Account
and would be worked out as gross lease rentals adjusted by
amount of statutory depreciation and lease equalisation
account.
As per the 'Guidance Note on Accounting for Leases' issuedby the Council of the Institute of Chartered Accountants of
India (ICAI), a separate Lease Equalisation Account shouldbe opened by the banks with a corresponding debit or credit
to Lease Adjustment Account, as the case may be. Further,
Lease Equalisation Account should be transferred every year
to the Profit & Loss Account and disclosed separately as a
deduction from/addition to gross value of lease rentals
shown under the head 'Gross Income'.
Appropriation of recovery in NPAs
Interest realised on NPAs may be taken to income accountprovided the credits in the accounts towards interest are
not out of fresh/ additional credit facilities sanctioned to
the borrower concerned.
In the absence of a clear agreement between the bank and theborrower for the purpose of appropriation of recoveries in
NPAs (i.e. towards principal or interest due), banks should
adopt an accounting principle and exercise the right of
appropriation of recoveries in a uniform and consistentmanner.
Interest Application:
There is no objection to the banks using their own discretion in
debiting interest to an NPA account taking the same to Interest
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Suspense Account or maintaining only a record of such interest in
performa accounts.
Reporting of NPAs
Banks are required to furnish a Report on NPAs as on 31stMarch each year after completion of audit. The NPAs would
relate to the banks global portfolio, including the
advances at the foreign branches. The Report should be
furnished as per the prescribed format given in the Annexure
I.
While reporting NPA figures to RBI, the amount held ininterest suspense account, should be shown as a deduction
from gross NPAs as well as gross advances while arriving at
the net NPAs. Banks which do not maintain Interest Suspense
account for parking interest due on non-performing advance
accounts, may furnish the amount of interest receivable on
NPAs as a foot note to the Report.
Whenever NPAs are reported to RBI, the amount of technicalwrite off, if any, should be reduced from the outstanding
gross advances and gross NPAs to eliminate any distortion in
the quantum of NPAs being reported.
FACTORS FORRISEIN NPAs
The banking sector has been facing the serious problems of the rising
NPAs. But the problem of NPAs is more in public sector banks when
compared to private sector banks and foreign banks. The NPAs in PSB
are growing due to external as well as internal factors.
EXTERNALFACTORS :-
Ineffective recovery tribunal
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The Govt. has set of numbers of recovery tribunals, which works
for recovery of loans and advances. Due to their negligence and
ineffectiveness in their work the bank suffers the consequence of
non-recover, their by reducing their profitability and liquidity.
Willful Defaults
There are borrowers who are able to payback loans but are
intentionally withdrawing it. These groups of people should be
identified and proper measures should be taken in order to get back
the money extended to them as advances and loans.
Natural calamities
This is the measure factor, which is creating alarming rise in
NPAs of the PSBs. every now and then India is hit by major
natural calamities thus making the borrowers unable to pay back
there loans. Thus the bank has to make large amount of provisions
in order to compensate those loans, hence end up the fiscal with
a reduced profit.
Mainly ours farmers depends on rain fall for cropping. Due to
irregularities of rain fall the farmers are not to achieve the
production level thus they are not repaying the loans.
Lack of demand
Entrepreneurs in India could not foresee their product demand and
starts production which ultimately piles up their product thus
making them unable to pay back the money they borrow to operate
these activities. The banks recover the amount by selling of
their assets, which covers a minimum label. Thus the banks record
the non recovered part as NPAs and has to make provision for it.
Change on Govt. policies
With every new govt. banking sector gets new policies for its
operation. Thus it has to cope with the changing principles and
policies for the regulation of the rising of NPAs. The fallout of
handloom sector is continuing as most of the weavers Co-operative
societies have become defunct largely due to withdrawal of state
patronage. The rehabilitation plan worked out by the Central
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government to revive the handloom sector has not yet been
implemented. So the over dues due to the handloom sectors are
becoming NPAs.
INTERNAL FACTORS :-
Defective Lending process
There are three cardinal principles of bank lending that have
been followed by the commercial banks since long.
i. Principles of safetyii. Principle of liquidityiii. Principles of profitability
Principles of safety :-
By safety it means that the borrower is in a position to repay
the loan both principal and interest. The repayment of loan
depends upon the borrowers:
Capacity to pay depends upon:
y Tangible assetsy Success in business
Willingness to pay depends on:
y Charactery Honesty Reputation of borrower
The banker should, there fore take utmost care in ensuring that the
enterprise or business for which a loan is sought is a sound one and
the borrower is capable of carrying it out successfully .he should be
a person of integrity and good character.
Inappropriate technology
Due to inappropriate technology and management information
system, market driven decisions on real time basis can not be
taken. Proper MIS and financial accounting system is not
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implemented in the banks, which leads to poor credit collection,
thus NPA. All the branches of the bank should be computerized.
Improper SWOT analysis
The improper strength, weakness, opportunity and threat analysis
is another reason for rise in NPAs. While providing unsecured
advances the banks depend more on the honesty, integrity, and
financial soundness and credit worthiness of the borrower.
y Banks should consider the borrowers own capital investment.y it should collect credit information of the borrowers
from:-
a.From bankers.b.Enquiry from market/segment of trade, industry,
business.
c.From external credit rating agencies.y Analyze the balance sheet.True picture of business will be
revealed on analysis of profit/loss a/c and balance
sheet.
When bankers give loan, he should analyze the purpose of the
loan. To ensure safety and liquidity, banks should grant loan for
productive purpose only. Bank should analyze the profitability,
viability, long term acceptability of the project while
financing.
Poor credit appraisal system
Poor credit appraisal is another factor for the rise in NPAs. Due
to poor credit appraisal the bank gives advances to those who are
not able to repay it back. They should use good credit appraisal
to decrease the NPAs.
Managerial deficiencies
The banker should always select the borrower very carefully and
should take tangible assets as security to safe guard its
interests. When accepting securities banks should consider the:-
1. Marketability
2. Acceptability
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3. Safety
4. Transferability.
The banker should follow the principle of diversification of risk
based on the famous maxim do not keep all the eggs in one
basket; it means that the banker should not grant advances to a
few big farms only or to concentrate them in few industries or in
a few cities. If a new big customer meets misfortune or certain
traders or industries affected adversely, the overall position of
the bank will not be affected.
Absence of regular industrial visit
The irregularities in spot visit also increases the NPAs.
Absence of regularly visit of bank officials to the customer
point decreases the collection of interest and principals on the
loan. The NPAs due to willful defaulters can be collected by
regular visits.
Re loaning process
Non remittance of recoveries to higher financing agencies and re
loaning of the samehave already affected the smooth operation of
the credit cycle.
Due to re loaning to the defaulters and CCBs and PACs, the NPAs
of OSCB is increasing day by day.
PROBLEMS DUE TO NPA
1.Owners do not receive a market return on there capital .in theworst case, if the banks fails, owners loose their assets. In
modern times this may affect a broad pool of shareholders.
2.Depositors do not receive a market return on saving. In the worstcase if the bank fails, depositors loose their assets or
uninsured balance.
3.Banks redistribute losses to other borrowers by charging higherinterest rates, lower deposit rates and higher lending rates
repress saving and financial market, which hamper economic
growth.
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4.Non performing loans epitomize bad investment. They misallocatecredit from good projects, which do not receive funding, to
failed projects. Bad investment ends up in misallocation of
capital, and by extension, labour and natural resources.
Non performing asset may spill over the banking system and
contract the money stock, which may lead to economic contraction.
This spill over effect can channelize through liquidity or bank
insolvency:
a) When many borrowers fail to pay interest, banks may experience
liquidity shortage. This can jam payment across the country,
b) Illiquidity constraints bank in paying depositors
.c) Undercapitalized banks exceeds the banks capital base.
The three letters Strike terror in banking sector and business
circle today. NPA is short form of Non Performing Asset. The
dreaded NPA rule says simply this: when interest or other due to
a bank remains unpaid for more than 90 days, the entire bank loan
automatically turns a non performing asset. The recovery of loan
has always been problem for banks and financial institution. To
come out of these first we need to think is it possible to avoid
NPA, no can not be then left is to look after the factor
responsible for it and managing those factors.
Interest and/or instalment of principal remains overduefor two harvest seasons but for a period not exceedingtwo half years in the case of an advance granted for
agricultural purposes, and
Any amount to be received remains overdue for a period ofmore than 90 days in respect of other accounts.
As a facilitating measure for smooth transition to 90 days norm,
banks have been advised to move over to charging of interest at
monthly rests, by April 1, 2002. However, the date of
classification of an advance as NPA should not be changed on
account of charging of interest at monthly rests. Banks should,therefore, continue to classify an account as NPA only if the
interest charged during any quarter is not serviced fully within
180 days from the end of the quarter with effect from April 1,
2002 and 90 days from the end of the quarter with effect from
March 31, 2004.
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Impact of NPA
PPrrooffiittaabbiilliittyy::--
NPA means booking of money in terms of bad asset, which occurreddue to wrong choice of client. Because of the money getting
blocked the prodigality of bank decreases not only by the amount
of NPA but NPA lead to opportunity cost also as that much of
profit invested in some return earning project/asset. So NPA
doesnt affect current profit but also future stream of profit,
which may lead to loss of some long-term beneficial opportunity.
Another impact of reduction in profitability is low ROI (return
on investment), which adversely affect current earning of bank.
LLiiqquuiiddiittyy::--
Money is getting blocked, decreased profit lead to lack of enough
cash at hand which lead to borrowing money for shot\rtes period
of time which lead to additional cost to the company. Difficulty
in operating the functions of bank is another cause of NPA due to
lack of money.
IInnvvoollvveemmeenntt ooff mmaannaaggeemmeenntt::--
Time and efforts of management is another indirect cost which
bank has to bear due to NPA. Time and efforts of management in
handling and managing NPA would have diverted to some fruitful
activities, which would have given good returns. Now days banks
have special employees to deal and handle NPAs, which is
additional cost to the bank.
CCrreeddiitt lloossss::--
Bank is facing problem of NPA then it adversely affect the value
of bank in terms of market credit. It will lose its goodwill and
brand image and credit which have negative impact to the people
who are putting their money in the banks.
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SYMPTOMS OF NPAs
Four categories of early symptoms:-
( 1 ) Financial:
%Non-payment of the very first installment in case of term loan.
% Bouncing of cheque due to insufficient balance in the accounts.% Irregularity in installment.% Irregularity of operations in the accounts.% Unpaid over due bills.% Declining Current Ratio.% Payment which does not cover the interest and principal amountof that installment.
% While monitoring the accounts it is found that partial amount isdiverted to sister concern or parent company.
( 2 ) Operational and Physical:
% If information is received that the borrower has eitherinitiated the process of winding up or are not doing the business.
% Overdue receivables.% Stock statement not submitted on time.% External non-controllable factor like natural calamities in thecity where borrower conduct his business.
% Frequent changes in plan.% Non payment of wages.
( 3 ) Attitudinal Changes:
% Use for personal comfort, stocks and shares by borrower.
% Avoidance of contact with bank.
% Problem between partners.
( 4 ) Others:
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% Changes in Government policies.
% Death of borrower.
% Competition in the market.
Preventive Measurement For NPA
'EEaarrllyyRReeccooggnniittiioonn oofftthhee PPrroobblleemm::--
Invariably, by the time banks start their efforts to get
involved in a revival process, its too late to retrieve the
situation- both in terms of rehabilitation of the project andrecovery of banks dues. Identification of weakness in the very
beginning that is : When the account starts showing first signs
of weakness regardless of the fact that it may not have become
NPA, is imperative. Assessment of the potential of revival may be
done on the basis of a techno-economic viability study.
Restructuring should be attempted where, after an objective
assessment of the promoters intention, banks are convinced of a
turnaround within a scheduled timeframe. In respect of totally
unviable units as decided by the bank, it is better to facilitate
winding up/ selling of the unit earlier, so as to recover
whatever is possible through legal means before the security
position becomes worse.
'IIddeennttiiffyyiinnggBBoorrrroowweerrss wwiitthh GGeennuuiinneeIInntteenntt::--
Identifying borrowers with genuine intent from those who are non-
serious with no commitment or stake in revival is a challenge
confronting bankers. Here the role of frontline officials at the
branch level is paramount as they are the ones who has
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intelligent inputs with regard to promoters sincerity, and
capability to achieve turnaround. Base don this objective
assessment, banks should decide as quickly as possible whether it
would be worthwhile to commit additional finance.
In this regard banks may consider having SpecialInvestigation
of all financial transaction or business transaction, books of
account in order to ascertain real factors that contributed to
sickness of the borrower. Banks may have penal of technical
experts with proven expertise and track record of preparing
techno-economic study of the project of the borrowers.
Borrowers having genuine problems due to temporary mismatch in
fund flow or sudden requirement of additional fund may be
entertained at branch level, and for this purpose a special limit
to such type of cases should be decided. This will obviate the
need to route the additional funding through the controlling
offices in deserving cases, and help avert many accounts slipping
into NPA category.
'TTiimmeelliinneessss aannddAAddeeqquuaaccyyooffrreessppoonnssee::--
Longer is the delay in response, greater the injury to the
account and the asset. Time is a crucial element in any
restructuring or rehabilitation activity. The response decided on
the basis of techno-economic study and promoters commitment, has
to be adequate in terms of extend of additional funding and
relaxations etc. under the restructuring exercise. The package of
assistance may be flexible and bank may look at the exit option.
'FFooccuuss oonnCCaasshhFFlloowwss::--
While financing, at the time of restructuring the banks may not
be guided by the conventional fund flow analysis only, which
could yield a potentially misleading picture. Appraisal for fresh
credit requirements may be done by analyzing funds flow in
conjunction with the Cash Flow rather than only on the basis of
Funds Flow.
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' MMaannaaggeemmeennttEEffffeeccttiivveenneessss::--
The general perception among borrower is that it is lack of
finance that leads to sickness and NPAs. But this may not be the
case all the time. Management effectiveness in tackling adversebusiness conditions is a very important aspect that affects a
borrowing units fortunes. A bank may commit additional finance
to an aling unit only after basic viability of the enterprise
also in the context of quality of management is examined and
confirmed. Where the default is due to deeper malady, viability
study or investigative audit should be done it will be useful
to have consultant appointed as early as possible to examine this
aspect. A proper techno- economic viability study must thus
become the basis on which any future action can be considered.
'MMuullttiipplleeFFiinnaanncciinngg::--
A. During the exercise for assessment of viability and
restructuring, a Pragmatic and unified approach by all the
lending banks/ FIs as also sharing of all relevant information on
the borrower would go a long way toward overall success of
rehabilitation exercise, given the probability of
success/failure.
B. In some default cases, where the unit is still working, the
bank should make sure that it captures the cash flows (there is a
tendency on part of the borrowers to switch bankers once they
default, for fear of getting their cash flows forfeited), and
ensure that such cash flows are used for working capital
purposes. Toward this end, there should be regular flow of
information among consortium members. A bank, which is not part
of the consortium, may not be allowed to offer credit facilities
to such defaulting clients. Current account facilities may also
be denied at non-consortium banks to such clients and violation
may attract penal action. The Credit Information Bureau of India
Ltd.(CIBIL) may be very useful for meaningful information
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exchange on defaulting borrowers once the setup becomes fully
operational.
C. In a forum of lenders, the priority of each lender will be
different. While one set of lenders may be willing to wait for a
longer time to recover its dues, another lender may have a much
shorter timeframe in mind. So it is possible that the letter
categories of lenders may be willing to exit, even a t a cost
by a discounted settlement of the exposure. Therefore, any plan
for restructuring/rehabilitation may take this aspect into
account.
D. Corporate Debt Restructuring mechanism has been
institutionalized in 2001 to provide a timely and transparent
system for restructuring of the corporate debt of Rs. 20 crore
and above with the banks and FIs on a voluntary basis and outside
the legal framework. Under this system, banks may greatly benefit
in terms of restructuring of large standard accounts (potential
NPAs) and viable sub-standard accounts with consortium/multiple
banking arrangements.
TOOLS FOR RECOVERY OF NPAS
CCrreeddiittDDeeffaauulltt
IInnaabbiilliittyyttooPPaayyWiillll ullddeeaaullt
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UUnnvviiaabbllee VViiaabbllee
LLookkAAddaallaatt
DDeebbttRReeccoovveerryy
SSeeccuurriittiizzaattiioonnAAcctt
AAsssseett
RReeccoonnssttrruuccttiioonn
mmpprroommiissee
RReehhaabbiilliittaattiioonn
CCoonnssoorrttiiuummFFiinnaannccee
SSoolleeBBaannkkeerr
oorrppoorraatteeDDeebbttRReessttrruuccttuurriinngg
hhIIssssuueeooff
a
CCoonnvveerrssiioonn
i CT
FFrreesshhWWCCLLiimmiittRReepphhaasseemmeennttooff
RReepaaymmeennttPPeerriioodd
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MANAGEMENT OF NPAS: SECURITIZATION
1. NPAs in India - The Current Scenario
For the past few years, the Indian Banking system has been
struggling to manage the vast portfolio of bad loans, popularly
known as Non-Performing Assets (NPAs). The problem is more acute
in the case of PSU banks. As of March 2003, the total NPAs of the
private and public sector banks put together stood at a whopping
Rs 65,000 crore (Source: Trend and Progress of Banking in India,
RBI).
NPAs, simply defined, are those loans and advances in respect of
which interest and/or principal instalment have not been paid for
180 days from the due date. From April 1, 2004, however, any loan
on which interest or principal installment is not paid for more
than 90 days would be reckoned as NPA. The banking system is,
therefore, sure to see a swelling NPA portfolio in the coming
years. This poses a serious liquidity and credit risk on the
banking system, which unless managed effectively would jeopardize
the same.
Thus, to prevent the collapse of the whole system due to non-
payment of loans by the borrowers, there ought to be some
mechanism in place. Two major steps were taken in this regard -
1.The RBI directed the banks to maintain compulsory provisionsfor different types of NPAs;
2.The Securitization and Reconstruction of Financial Assetsand Enforcement of Security Interest Act, 2002 was enacted.
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The SARFAESI Act allowed the banks and financial institutions to
take possession of the collateral security given by the
defaulting borrowers and sell these assets without having to go
through protracted legal procedures.
2. Securitization
Securitization is the process of conversion of existing assets or
future cash flows into marketable securities. For the purpose of
distinction, the conversion of existing assets into marketable
securities is known as asset-backed securitization and the
conversion of future cash flows into marketable securities is
known as future-flows securitization.
The purpose of the Securitization Act is to promote the setting
up of asset reconstruction / securitization companies to take
over the Non Performing Assets (NPA) accumulated with the banks
and public financial institutions. The Act provides special
powers to lenders and securitization / asset reconstruction
companies, to enable them to take over of assets of borrowers
without first resorting to courts.
The Act was welcomed by the banking community, but resisted by
the borrower community. The validity was challenged in various
courts on the ground that it was predominantly in favor of
lenders. Hence, lenders were unable to enforce the provisions in
full. But the crux of the issue was whether the Act would be an
effective tool to make a drastic difference to the NPA menace.
3. Securitization - Relevance to the Banking Sector
The growth in credit off take of banks has been the second
highest in the last 55 years. But at the same time the
incremental credit deposit ratio for the past one-year has been
greater than one. Thus, for every Rs 100 worth of deposit coming
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into the system more than Rs 100 is being disbursed as credit.
So, the mismatch between the credit given and the funds received
creates an issue of proper management of increased credit off-
take.
One of the measures adopted by the banks to cater to this credit
boom is by selling their investments in government securities and
giving the amount raised as loans. But there is a limit to such
credit funding due to minimum SLR requirements of 25% in
government and semi government securities.
Once the banks reach this level of 25 per cent, they cannot sell
any more government securities to generate liquidity. And giventhe pace of credit off take, some banks could reach this level
very fast. So banks, in order to keep giving credit, need to
ensure that more deposits keep coming in.
Securitization also helps banks to sell off their NPAs to asset
reconstruction companies (ARCs). ARCs, which are typically
publicly / government owned, act as debt aggregators and are
engaged in acquiring bad loans from the banks at a discounted
price, thereby helping banks to focus on core activities. On
acquiring bad loans ARCs restructure them and sell them to other
investors as 'Pass Through Certificates' (PTCs), thereby freeing
the banking system to focus on normal banking activities.
4. Future Outlook
Securitization is expected to become more popular in the near
future in the banking sector. Banks are expected to sell off a
greater amount of NPAs toARCIL by 2007, when they have to shift
to Basel-II norms. Blocking too much capital in NPAs can reduce
the capital adequacy of banks and can be a hindrance for banks to
meet the Basel-II norms. Thus, banks will have two options -
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either to raise more capital or to free capital tied up in NPAs
and other loans through securitization
BASEL II Primer: New Capital Adequacy Framework for
Banks.
Banking industry is the backbone of any country's economy; the
sounder it is, the better the performance of the financial
markets and the economy as a whole. Just like any other industry,
banking industry is susceptible to various types of risks which
might occasionally occur in losses, and at times they tend to be
so severe that they take entire firm down with them. To hedge
against such risks, banks keep a minimum buffer of equity and
provisions (regulatory capital), given a certain amount of
various kinds of risks.
The size of this regulatory capital was determined by Based
Accord (Basel I) earlier and now by Basel II Framework. Basel
Committee on Banking Supervision (BCBS) is responsible to frame
these rules; the committee has members from various (13)
countries that are represented by their respective central banks
or equivalent authority.
Basel II Framework on capital adequacy takes into account the
elements of credit risk in various types of assets in the balance
sheet as well as off-balance sheet business and also attempts to
strengthen the capital base of banks. BCBS released the
"International Convergence of Capital Measurement and Capital
Standards: ARevisedFramework" on 26 June 2004. This was then
updated in November 2005 to include trading activities and the
treatment of double default effects. The revised framework seeks
to arrive at significantly more risk-sensitive approaches to
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viz. sub standard, doubtful, and loss assets. A loan asset is
classified as sub standard if it remains NPA up to a period of 18
months; doubtful if it remains NPA for more than 18 months; and
loss, without any waiting period, where the dues are considered not
collectible or marginally collectible.
Net NPA is gross NPA less provisions. Since in India, bank balance
sheets contains a huge amount 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 NPA according to the central bank guidelines,
are quite significant.
Here, we can see that there are huge difference between gross and net
NPA. While gross NPA reflects the quality of the loans made by banks,
net NPA shows the actual burden of banks. The requirements for
provisions are :
100% for loss assets 100% of the unsecured portion plus 20-50% of the secured portion,depending on the period for which the account has remained in the
doubtful category
10% general provision on the outstanding balance under the substandard category.
FINDINGS & SUGGESTIONS
After the global financial turmoil in 2008, Indian banks begin the new
year with a lurking fear that their Non Performing Assets would go up
with their portfolios coming under severe stress.
There is already a visible strain on consumer, credit card and vehicle
loan portfolios and many banks have taken conscious decision to scale
down their advances to risky sectors. Some banks have also revised
their credit growth targets downwards as the year has come to a close.
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The ongoing financial crisis has had its toll on export-related
sectors like IT, textile and SMEs. This may indirectly impact
banks' asset quality. There is, therefore, a pressing need to
ensure adequate risk-management mechanisms to overcome this
challenge. Indian banks witnessed a sharp jump in their gross
NPAs for the first time in six years in FY08, compelling many of
them to enhance their existing risk assessment tools. Gross NPAs
of commercial banks in FY08 escalated by Rs 6,136 crore (Rs 61.36
billion), according to figures released by the Reserve Bank.
Despite pressures emanating from global financial markets, Indian
banks witnessed a healthy 25 to 29 per cent average growth in
credit disbursals, primarily in housing, auto and infrastructure
loans. Banks witnessed a huge credit demand from their corporate
clients who found their foreign funding sources drying up in the
aftermath of the global meltdown which originated with the
subprime-crisis in America in mid-2007. The growth in credit in
the industry in 2008 was in the range of 25 to 29 per cent on
account of working capital requirements of small, mid and large-
sized industries, bankers expect an average 25 per cent in their
credit in 2009.
While government-owned banks were quick to respond to the recent
signals from policy-makers by reducing interest rates periodically,
many private banks are yet to follow suit, mainly owing to pressure on
their margins.
Government-owned banks have effected an up to 1 to 1.5 per cent
reduction in their Prime Lending Rates in the recent past heeding
calls from the government and the Reserve Bank to do so in order to
ensure a credit pick-up. PLR is the benchmark rate, based on which
private banks lend to their customers.