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MANAGEMENTOFNON-PERFORMINGASSETS

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DEFINITION OF NPAS• A NPA is a loan or an advance where;

– Interest and/ or installment of principal remainoverdue for a period of more than 90 days inrespect of a term loan,

– The account remains “out of order” in respect ofan overdraft/ cash credit

– The bill remains overdue for a period of more than90 days in the case of bills purchased anddiscounted

– The installment or interest remains overdue for twocrop seasons in case of short duration crops andfor one crop season in case of long duration crops

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CATEGORIES OF NPA• Substandard Assets – Which has remained

NPA for a period less than or equal to 12months.

• Doubtful Assets – Which has remained inthe sub-standard category for a period of12 months

• Loss Assets – where loss has beenidentified by the bank or internal or externalauditors or the RBI inspection but theamount has not been written off wholly.

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PROVISIONING NORMS• Standard Assets – general provision of a

minimum of 0.25%• Substandard Assets – 10% on total outstanding

balance, 10 % on unsecured exposures identifiedas sub-standard & 100% for unsecured“doubtful” assets.

• Doubtful Assets – 100% to the extent advance notcovered by realizable value of security. In case ofsecured portion, provision may be made in therange of 20% to 100% depending on the period ofasset remaining sub-standard

• Loss Assets – 100% of the outstanding4

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FACTORS CONTRIBUTING TONPAS

• Poor Credit discipline• Inadequate Credit & Risk Management• Diversion of funds by promoters• Funding of non-viable projects• In the early 1990s PSBs started suffering from

acute capital inadequacy and lower/ negativeprofitability. The parameters set for theirfunctioning did not project the paramount need forthese corporate goals.

• The banks had little freedom to price products,cater products to chosen segments or investfunds in their best interest 5

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FACTORS CONTRIBUTING TONPAS

• Since 1970s, the SCBs functioned as units cut offfrom international banking and unable toparticipate in the structural transformations andnew types of lending products.

• Audit and control functions were not independentand thus unable to correct the effect of seriousflaws in policies and directions

• Banks were not sufficiently developed in terms ofskills and expertise to regulate the humongousgrowth in credit and manage the diverse risks thatemerged in the process

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FACTORS CONTRIBUTING TONPAS

• Inadequate mechanism to gather and disseminatecredit information amongst commercial banks

• Effective recovery from defaulting and overdueborrowers was hampered on account of sizeableoverhang component arising from infirmities in theexisting process of debt recovery, inadequatelegal provisions on foreclosure and bankruptcyand difficulties in the execution of court decrees.

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IMPACT OF NPAS ONOPERATIONS

• Drain on Profitability• Impact on capital adequacy• Adverse effect on credit growth as the

banker’s prime focus becomes zero percentrisk and as a result turn lukewarm to freshcredit.

• Excessive focus on Credit Risk Management• High cost of funds due to NPAs

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STATUS OF NPAS 2005-06• All SCB’s average Net NPA Ratio for 2005-06 is

1.22 (As per RBI’s Statistics)• The banks have been able to report lower NPA

percentage mostly by providing against or writingoff NPAs.

• The provision to certain extent was facilitated byhigher profits on account of treasury management

• The better Net NPA ratio was also facilitated byhigher credit off take resulting in larger assetportfolio/ book size.

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NPA MANAGEMENT – PREVENTIVEMEASURES• Formation of the Credit Information Bureau

(India) Limited (CIBIL)• Release of Wilful Defaulter’s List. RBI also

releases a list of borrowers with aggregateoutstanding of Rs.1 crore and above againstwhom banks have filed suits for recovery oftheir funds

• Reporting of Frauds to RBI• Norms of Lender’s Liability – framing of Fair

Practices Code with regard to lender’s liabilityto be followed by banks, which indirectlyprevents accounts turning into NPAs onaccount of bank’s own failure

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NPA MANAGEMENT – PREVENTIVEMEASURES• Risk assessment and Risk management• RBI has advised banks to examine all cases of

wilful default of Rs.1 crore and above and filesuits in such cases. Board of Directors arerequired to review NPA accounts of Rs.1 croreand above with special reference to fixing ofstaff accountability.

• Reporting quick mortality cases• Special mention accounts for early

identification of bad debts. Loans andadvances overdue for less than one and twoquarters would come under this category.However, these accounts do not needprovisioning 11

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NPA MANAGEMENT -RESOLUTION

• Compromise Settlement Schemes• Restructuring / Reschedulement• Lok Adalat• Corporate Debt Restructuring Cell• Debt Recovery Tribunal (DRT)• Proceedings under the Code of Civil Procedure• Board for Industrial & Financial Reconstruction

(BIFR)/ AAIFR• National Company Law Tribunal (NCLT)• Sale of NPA to other banks• Sale of NPA to ARC/ SC under Securitization and

Reconstruction of Financial Assets and Enforcementof Security Interest Act 2002 (SRFAESI)

• Liquidation 12

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Compromise SettlementSchemes

• Banks are free to design and implementtheir own policies for recovery and writeoff incorporation compromise andnegotiated settlements with boardapproval

• Specific guidelines were issued in May1999 for one time settlement of smallenterprise sector.

• Guidelines were modified in July 2000for recovery of NPAs of Rs.5 crore andless as on 31st March 2007. 13

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Restructuring and Rehabilitation• Banks are free to design and implement

their own policies for restructuring/rehabilitation of the NPA accounts

• Reschedulement of payment of interestand principal after considering the Debtservice coverage ratio, contribution ofthe promoter and availability of security

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Lok Adalats• Small NPAs up to Rs.20 Lacs• Speedy Recovery• Veil of Authority• Soft Defaulters• Less expensive• Easier way to resolve

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Corporate DebtRestructuring

• The objective of CDR is to ensure a timely and transparentmechanism for restructuring of the debts of viablecorporate entities affected by internal and external factors,outside the purview of BIFR, DRT or other legalproceedings

• The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All participants in the CDRmechanism must enter the ICA with necessaryenforcement and penal clauses.

• The scheme applies to accounts having multiple banking/syndication/ consortium accounts with outstandingexposure of Rs.10 crores and above.

• The CDR system is applicable to standard and sub-standard accounts with potential cases of NPAs getting apriority.

• Packages given to borrowers are modified time & again• Drawback of CDR – Reaching of consensus amongst the

creditors delays the process16

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DRT Act• The banks and FIs can enforce their securities by initiating

recovery proceeding under the Recovery if Debts due toBanks and FI act, 1993 (DRT Act) by filing an applicationfor recovery of dues before the Debt Recovery Tribunalconstituted under the Act.

• On adjudication, a recovery certificate is issued and thesale is carried out by an auctioneer or a receiver.

• DRT has powers to grant injunctions against the disposal,transfer or creation of third party interest by debtors in theproperties charged to creditor and to pass attachmentorders in respect of charged properties

• In case of non-realization of the decreed amount by way ofsale of the charged properties, the personal properties ifthe guarantors can also be attached and sold.

• However, realization is usually time-consuming• Steps have been taken to create additional benches

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Proceeding under Code of CivilProcedure• For claims below Rs.10 lacs, the banks and FIs can initiate

proceedings under the Code of Civil Procedure of 1908, asamended, in a Civil court.

• The courts are empowered to pass injunction ordersrestraining the debtor through itself or through itsdirectors, representatives, etc from disposing of, partingwith or dealing in any manner with the subject property.

• Courts are also empowered to pass attachment and salesorders for subject property before judgment, in casenecessary.

• The sale of subject property is normally carried out by wayof open public auction subject to confirmation of thecourt.

• The foreclosure proceedings, where the DRT Act is notapplicable, can be initiated under the Transfer of PropertyAct of 1882 by filing a mortgage suit where the procedureis same as laid down under the CPC.

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BIFR AND AAIFR• BIFR has been given the power to consider revival and

rehabilitation of companies under the Sick IndustrialCompanies (Special Provisions) Act of 1985 (SICA),which has been repealed by passing of the SickIndustrial Companies (Special Provisions) Repeal Bill of2001.

• The board of Directors shall make a reference to BIFRwithin sixty days from the date of finalization of the dulyaudited accounts for the financial year at the end ofwhich the company becomes sick

• The company making reference to BIFR to prepare ascheme for its revival and rehabilitation and submit thesame to BIFR the procedure is same as laid down underthe CPC.

• The shelter of BIFR misused by defaulting anddishonest borrowers

• It is a time consuming process19

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NATIONAL COMPANY LAWTRIBUNAL• In December 2002, the Indian Parliament passed the

Companies Act of 2002 (Second Amendment) torestructure the Companies Act, 1956 leading to a newregime of tackling corporate rescue and insolvency andsetting up of NCLT.

• NCLT will abolish SICA, have the jurisdiction and powerrelating to winding up of companies presently vested inthe High Court and jurisdiction and power exercised byCompany Law Board

• The second amendments seeks to improve upon thestandards to be adopted to measure the competence,performance and services of a bankruptcy court byproviding specialized qualification for the appointment ofmembers to the NCLT.

• However, the quality and skills of judges, newly appointedor existing, will need to be reinforced and no provision hasbeen made for appropriate procedures to evaluate theperformance of judges based on the standards

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SALE OF NPA TO OTHER BANKS• A NPA is eligible for sale to other banks only if it has

remained a NPA for at least two years in the books of theselling bank

• The NPA must be held by the purchasing bank at least fora period of 15 months before it is sold to other banks butnot to bank, which originally sold the NPA.

• The NPA may be classified as standard in the books of thepurchasing bank for a period of 90 days from date ofpurchase and thereafter it would depend on the record ofrecovery with reference to cash flows estimated whilepurchasing

• The bank may purchase/ sell NPA only on withoutrecourse basis

• If the sale is conducted below the net book value, theshort fall should be debited to P&L account and if it ishigher, the excess provision will be utilized to meet theloss on account of sale of other NPA.

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SARFESI Act 2002• SARFESI provides for enforcement of security

interests in movable (tangible or intangible assetsincluding accounts receivable) and immovableproperty without the intervention of the court

• The bank and FI may call upon the borrower by way ofa written legal notice to discharge in full his liabilitieswithin 60 days from the date of notice, failing whichthe bank would be entitled to exercise all or any of therights set out under the Act.

• Another option available under the Act is to takeoverthe management of the secured assets

• Any person aggrieved by the measures taken by thebank can proffer an appeal to DRT within 45 daysafter depositing 75% of the amount claimed in thenotice.

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SARFESI Act 2002• Chapter II of SARFESI provides for setting up of

reconstruction and securitization companies foracquisition of financial assets from its owner, whetherby raising funds by such company from qualifiedinstitutional buyers by issue of security receiptsrepresenting undivided interest in such assets orotherwise.

• The ARC can takeover the management of thebusiness of the borrower, sale or lease of a part orwhole of the business of the borrower andrescheduling of payments, enforcement of securityinterest, settlement of dues payable by the borroweror take possession of secured assets

• Additionally, ARCs can act as agents for recoveringdues, as manager and receiver.

• Drawback – differentiation between first chargeholders and the second charge holders 23

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Whether SecondAmendment to CompaniesAct and SARFESI Provideeffective and compatibleenforcement

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Second Amendment &SARFESI

• The second amendment and SARFESI are aleap forward but requirement exists to makethe laws predictable, transparent andaffordable enforcement by efficientmechanisms outside of insolvency

• No definite time frame has been provided forvarious stages during the liquidationproceedings

• Need is felt for more creative and commercialapproach to corporate entities in financialdistress and attempts to revive rather thanapplying conservative approach of liquidation25

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Second Amendment &SARFESI

• Tribunals have largely failed to serve thepurpose for which they were set up.NCLT(National Co. Law Tribunal) wouldbe over-burdened with workload. Changein eligibility criteria for making areference would itself generate a greaterworkload.

• The second amendment stops short ofproviding a comprehensive bankruptcycode to deal with corporate bankruptcy.

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Second Amendment &SARFESI

• Does not introduce the required roadmap ofthe bankruptcy proceeding viz:– Application for initiating– Appointments & empowerment of trustee– Operational and functional independence– Accountability to court– Monitoring and time bound restructuring– Mechanism to sell off– Number of time bound attempts for restructuring– Decision to pursue insolvency and winding up– Strategies for realization and distribution

• Need for new laws & procedures to handlebankruptcy proceedings in consultation withRBI

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NEGOTIATION PROCESSFOR SETTLEMENT OFNON PERFORMINGASSETS

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Factors Affecting the Acceptanceof Proposal by Bank• Bank’s Documentation.• Security value. Realizable sale value.• Bank’s ability to sell.• Ability & Source of the borrower.• Ability & Source of the guarantor.• Vulnerability of the borrower/guarantor.• Time frame.• Strength and Zeal of bank's field staff.• What message is bank sending out (No in a fraud

case.)• Banks Policy.• Success rate. 29

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Preparation Stage• Thorough study of the case• Find out our strengths and weaknesses in the

case.• Find out the vulnerable point/weaknesses of

the borrower.• Follow-up with the Borrower and Guarantors.• Visit factory/Collaterals/residence.• Find out properties not charged to the bank.• Indicate that Bank is willing to compromise.

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ROLE OF CHARTEREDACCOUNTANTS• Assist and Prepare Viability study• Conduct Business, Assets & Share Valuation• Carry out Due Diligence Study for Business

Restructuring• Verification and Vetting of Documents• Preparation of Scheme of Arrangement• Consultancy on Taxation aspects• Monitoring of Accounts• Credit Audit of borrowers• Stock Audits

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