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Executive Summary:

The Non-Performing Assets (N.P.As) problem is one of the foremost and

the most formidable problems that have shaken the entire banking

industry in India like an earthquake. Like a canker worm, it has been

eating the banking system from within, since long. And like the

dreaded AIDS, banks have not been able to find a reliable cure for this

malady. It has grown like a cancer and has infected every limb of the

banking system.

At macro level, N.P.As have chocked off the supply line of credit

to the potential borrowers, thereby having a deleterious effect on

capital formation and arresting the economic activity in the country. At

the micro level, the unsustainable level of N.P.As has eroded the

profitability of banks through reduced interest income and provisioning

requirements, besides restricting the recycling of funds leading to

serious asset liability mismatches. The problem of N.P.As is not a

matter of concern for the lenders alone. It is a matter of grave concern

to the public as well, as bank credit is the catalyst to the economic

growth of the country and any bottleneck in the smooth flow of credit,

one cause for which is mounting N.P.As, is bound to create adverse

repercussions in the economy. Mounting menace of N.P.As has raised

the cost of credit, made banks more adverse to risk and squeezed

genuine small and medium enterprise from accessing competitive

credit and has throttled their enterprising spirits as well.

The spiraling and the devastating affect of N.P.As on the

economy have made the problem of N.P.As as issue of public debate

and of national priority. Therefore, any measure or reform on this front

would be inadequate and incomprehensive, if it fails to make a dent in

N.P.As reduction and stall their growth in future, as well.

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Chapter 2

Introduction

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Non-Performing Assets - Background:

Introduction:

It's a known fact that the banks and financial institutions in India face

the problem of swelling non-performing assets (N.P.As) and the issue is

becoming more and more unmanageable. In order to bring the

situation under control, some steps have been taken recently. The

Securitisation and Reconstruction of Financial Assets and Enforcement

of Security Interest Act, 2002 was passed by Parliament, which is an

important step towards elimination or reduction of N.P.As.

Meaning of N.P.As:

An asset is classified as non-performing asset (N.P.As) if dues in the

form of principal and interest are not paid by the borrower for a period

of 180 days. However with effect from March 2004, default status

would be given to a borrower if dues are not paid for 90 days. If any

advance or credit facilities granted by bank to a borrower becomes

non-performing, then the bank will have to treat all the

advances/credit facilities granted to that borrower as non-performing

without having any regard to the fact that there may still exist certain

advances / credit facilities having performing status.

Indian economy and N.P.As:

Undoubtedly the world economy has slowed down, recession is at its

peak, globally stock markets have tumbled and business itself is

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getting hard to do. The Indian economy has been much affected due to

high fiscal deficit, poor infrastructure facilities, sticky legal system,

cutting of exposures to emerging markets by FIIs, etc.

Further, international rating agencies like, Standard & Poor have

lowered India's credit rating to sub-investment grade. Such negative

aspects have often outweighed positives such as increasing forex

reserves and a manageable inflation rate.

Under such a situation, it goes without saying that banks are no

exception and are bound to face the heat of a global downturn.

Bankers have realized that unless the level of N.P.As is reduced

drastically, they will find it difficult to survive.

Global Developments and N.P.As:

The core banking business is of mobilizing the deposits and utilizing it

for lending to industry. Lending business is generally encouraged

because it has the effect of funds being transferred from the system to

productive purposes, which results into economic growth.

However lending also carries credit risk, which arises from the failure

of borrower to fulfill its contractual obligations either during the course

of a transaction or on a future obligation.

A question that arises is how much risk can a bank afford to take?

Recent happenings in the business world - Enron, WorldCom, Xerox,

Global Crossing do not give much confidence to banks. In case after

case, these giant corporates became bankrupt and failed to provide

investors with clearer and more complete information thereby

introducing a degree of risk that many investors could neither neither

anticipate nor welcome. The history of financial institutions also

reveals the fact that the biggest banking failures were due to credit

risk.

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Due to this, banks are restricting their lending operations to secured

avenues only with adequate collateral on which to fall back upon in a

situation of default.

Why N.P.As have become an issue for banks and financial institutions in India?

To start with, performance in terms of profitability is a benchmark for

any business enterprise including the banking industry. However,

increasing N.P.As have a direct impact on banks profitability as legally

banks are not allowed to book income on such accounts and at the

same time banks are forced to make provision on such assets as per

the Reserve Bank of India (RBI) guidelines.

Also, with increasing deposits made by the public in the banking

system, the banking industry cannot afford defaults by borrower s

since N.P.As affects the repayment capacity of banks.

Further, Reserve Bank of India (RBI) successfully creates excess

liquidity in the system through various rate cuts and banks fail to

utilize this benefit to its advantage due to the fear of burgeoning non-

performing assets.

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Health Code System:

A critical analysis of a comprehensive and uniform credit monitoring

was introduced in 1985-86 by RBI by way of the Health Code System in

banks, which inter alia, provided information regarding the health of

individual advances, the quality of credit portfolio and extent of

advances causing in relation to total advances. It was considered that

such information would be of immense use to bank management for

control purposes. The RBI advised all commercial banks to introduce

the Health Code Classification indicating the quality of individual

advances in the following eight categories with a health code assigned

to each borrowal account:

1. Satisfactory:

Conduct is satisfactory, all terms and conditions are compiled with, all

accounts are in order, and safety of the account is not in doubt.

2. Irregular:

The safety of the advances is not suspected, though there may be

occasional irregularities, which may be considered to be as a short-

term phenomenon.

3. Sick-Viable:

Advances to units, which are sick but viable under nursing and unit in

respect of which nursing/revival programs are taken up.

4. Sick-Nonviable/Sticky:

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The irregularities continue to persist and there are no immediate

prospects of regularization, the accounts could throw some of the

usual signs of incipient sickness.

5. Advances Recalled:

Accounts where the repayment is highly doubtful and nursing is not

considered worthwhile, includes where decisions have been taken to

recall the advances.

6. Suit Filed Accounts:

Accounts where legal actions or recovery proceedings have been

initiated.

7. Decreed Debts:

Where decrees have been obtained.

8. Bad and Doubtful Debts:

Where the recoverability of the banks’ dues has become doubtful on

account of shortfall in value of security, difficulty in enforcing and

realizing the securities, or inability/unwillingness of the borrowers to

repay the banks’ dues partly or wholly.

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Basis of Non – Performing Assets:

The basis of treating a credit facility as N.P.As is as detailed below:

ASSET- In respect of which interest has remained past due for six

months.

TERM LOAN – Inclusive of unpaid interest, when the installments is

overdue for more than six months/on which interest amount remained

past due for six months.

BILL- Which remains overdue for six months.

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OTHER CURRENT ASSETS – The interest in respect of a debt/income

on a receivable in the nature of short-term loans/advances, which

remains overdue for a period of six months.

SALE OF ASSETS/SERVICE RENDERED – Any dues on account of

these/reimbursement of expenses rendered, which remained overdue

for a period of six months.

LEASE RENTAL/HIRE PURCHASE INSTALMETS – The installments,

which has become overdue for a period of more than twelve months.

OTHER CREDIT FACILITES – The balance outstanding including

interest accrued made available to the borrower/beneficiary in the

same capacity when any of the credit facilities become N.P.A

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Chapter 3

Provisional & Disclosure Norms

Provisional Norms:

Banks will be required to make provisions for bad and doubtful debts

on a uniform and consistent basis so that the balance sheets reflect a

true picture of the financial status of the bank.  The Narsimham

Committee has recommended the following provisioning norms

(i) 100 per cent of loss assets or 100 per cent of out standings for loss

assets;

(ii) 100 per cent of security shortfall for doubtful assets and 20 per

cent to 50 per cent of the secured portion; and

(iii) 10 per cent of the total out standings for substandard assets. 

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A provision of 1% on standard assets is required as suggested by

Narsimham Committee II 1998. Banks need to have better credit

appraisal systems so as to prevent N.P.As from occurring. The most

important relaxation is that the banks have been allowed to make

provisions for only 30 per cent of the "provisioning requirements" as

calculated using the Narsimham Committee recommendations on

provisioning (but with the diluted asset classification). The encouraging

profits recently declared by several banks have to be seen in the light

of provisions made by them. To the extent that provisions have not

been made, the profits would be fictitious.

Disclosure Norms:

Banks should disclose in balance sheets maturity pattern of advances,

deposits, investments and borrowings. Apart from this, banks are also

required to give details of their exposure to foreign currency assets

and liabilities and movement of bad loans. These disclosures were to

be made for the year ending March 2000

In fact, the banks must be forced to make public the nature of N.P.As

being written off.  This should be done to ensure that the taxpayer’s

money given to the banks, as capital is not used to write off private

loans without adequate efforts and punishment of defaulters.

# A Close look: For the future, the banks will have to tighten their

credit evaluation process to prevent this scale of sub-standard and loss

assets.  The present evaluation process in several banks is burdened

with a bureaucratic exercise, sometimes involving up to 18 different

officials, most of whom do not add any value (information or judgment)

to the evaluation.  But whether this government and its successors will

continue to play with bank funds remains to be seen.  Perhaps even

the loan waivers and loan "melas" which are often decried by bankers

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form only a small portion of the total N.P.As.  As mentioned above,

much more stringent disclosure norms are the only way to

increase the accountability of bank management to the

taxpayers.  A lot therefore depends upon the seriousness with which

a new regime of regulation is pursued by RBI and the newly formed

Board for Financial Supervision.

Chapter 4

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Classification Of Assets

Classification of Assets:

While new private banks are careful about their asset quality and

consequently have low non-performing assets (N.P.As), public sector

banks have large N.P.As due to wrong lending policies followed earlier

and also due to government regulations that require them to lend to

sectors where potential of default is high. Allaying the fears that bulk

of the Non-Performing Assets (N.P.As) was from priority sector, NPA

from priority sector constituted was lower at 46 per cent than that of

the corporate sector at 48 per cent.

Loans and advances account for around 40 per cent of the assets of

SCBs. However, delay/default in payment of interest and/or repayment

of principal has rendered a significant proportion of the loan assets

non-performing. As per RBI’s prudential norms, a Non-Performing Asset

(NPA) is a credit facility in respect of which interest/installment has

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remained unpaid for more than two quarters after it has become past

due. “Past due” denotes grace period of one month after it has become

due for payment by the borrower.

Regulations for asset classification

Assets should be classified into four classes - Standard, Sub-standard,

Doubtful, and Loss assets. N.P.As are loans on which the dues are not

received for two quarters. N.P.As consist of assets under three

categories: sub-standard, doubtful and loss. RBI for these classes of

assets should evolve clear, uniform, and consistent definitions.  The

health code system earlier in use would have to be replaced. The

banks should classify their assets based on weaknesses and

dependency on collateral securities into four categories:

Standard Assets: It carries not more than the normal risk attached to

the business and is not an NPA.

Sub-standard Asset: An asset which remains as NPA for a period

exceeding 24 months, where the current net worth of the borrower,

guarantor or the current market value of the security charged to the

bank is not enough to ensure recovery of the debt due to the bank in

full.

Doubtful Assets: An NPA, which continued to be so for a period

exceeding two years (18 months, with effect from March, 2001, as

recommended by Narsimham Committee II, 1998).

Loss Assets: An asset identified by the bank or internal/ external

auditors or RBI inspection as loss asset, but the amount has not yet

been written off wholly or partly.

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The banking industry has significant market inefficiencies caused by

the large amounts of Non Performing Assets (N.P.As) in bank portfolios,

accumulated over several years.  Discussions on non-performing

assets have been going on for several years now.  One of the earliest

writings on N.P.As defined them as "assets which cannot be recycled or

disposed off immediately, and which do not yield returns to the bank,

examples of which are: Overdue and stagnant accounts, suit filed

accounts, suspense accounts and miscellaneous assets, cash and bank

balances with other banks, and amounts locked up in frauds".

The following Table shows the distribution of total loan assets of banks

in the public private sectors and foreign banks for 1997-98 through

1999-2000. It is worth noting that the ratio of incremental standard

assets of SCBs to their total loan assets increased from 83.1 per cent in

1998-99 to 97.2 percent in 1999-2000. In other words, the ratio of

incremental N.P.As of SCBs to their total loan assets declined

significantly from 16.9 per cent in 1998-99 to 2.8 percent in 1999-

2000.  

Classification of Loan Assets of SCBs

(Percentage distribution of total loan assets)

Assets Public Private Foreign SCBs

A. Standard

2000-01 79.0 89.5 91.4 83.4

2001-02 82.5 90.4 92.4 84.5

2002-03 87.9 91.5 91.0 86.4

B. Sub-standard

2000-01 4.0 5.6 3.7 4.5

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2001-02 4.1 5.8 3.9 4.8

2002-03 4.1 3.8 2.7 5.3

C. Doubtful

2000-01 9.1 0.9 1.7 1.8

2001-02 4.0 0.9 2.0 1.9

2002-03 1.7 0.8 1.9 1.6

D. Loss

2000-01 1.9 0.9 1.2 1.8

2001-02 2.0 0.9 2.0 1.9

2002-03 1.7 0.8 1.9 1.6

E. Total Assets (Rs. Crore)

2000-01 284971 36753 30972 352696

2001-02 325328 43049 31059 399436

2002-03 380077 58249 37432 475758

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Chapter 5

Factors Responsible For Non Performing Of Assets

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Factors Responsible for N.P.As:

The dues of the banking sector are generally related to the

performance of the unit/industrial segment. In a few cases, the cause

of NPA has been due to internal factors (to the bank) such as weak

appraisal or follow up of loans but more often than not, it is due to the

factors such as management inefficiency of borrowing funds,

obsolescence, lack of demand, non availability if inputs, environmental

factors, etc.

The main reasons for sickness and the factors leading to N.P.As are as

under:

Internal Factors:

Diversion of Funds – For expansion, modernization, setting up of new

projects, helping or promoting sister concerns.

Time/Cost overruns while implementing the projects.

Business failure like product failing to capture market, inefficient

management, strike/strained labour relations, wrong technology,

technical problems, product obsolescence, etc.

External factors:

Failure, non-payment/overdue, recession in other countries,

externalization problems, adverse exchange rate, etc.

Government policies like excise, import duty changes, deregulation,

pollution control orders, etc. Willful default, siphoning of funds, fraud,

misappropriation, promoter/management disputes, etc.

Deficiencies on the part of the bank, viz, in credit appraisal, monitoring

and follow up, delay in release of limits, delay in settlements

payments/subsidies by government bodies, etc.

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External factors like raw material shortage, raw material/input price

escalation, power shortage, industrial recession, excess capacity,

natural calamities like floods, accidents, etc. Contribution to N.P.As by

factors like siphoning off funds through fraud/misappropriation was

less significant in comparison with other factors.

Incidence of N.P.As on account of deficiencies on the part of

banks such as delay in sanction and disbursement of funds whereby

borrowing units are starved of funds when in need, and delay in

settlement of payments/subsidies by the government bodies was on

the low side in proportion to other factors. Lack of effective co-

ordination between banks and financial institution in respect of large

value projects does contribute to the emergence of N.P.As even at the

implementation stage. RBI had, in February 2000 drawn up certain

ground rules in this regard in consultation with the banks, FII and IBA

and circulated the same among banks and financial institution for

implementation.

Susceptibility of the sanctioning authorities to external pressure,

failings of CEOs and the ineffectiveness of the board to check his ways

also contributed in no small measures to the unusual build up of N.P.As

in some of the banks. One of the most prominent causes for N.P.As, as

often observed by RBI Inspectors, is the slackness on the part of the

credit management staff in their follow up to detect and prevent

diversion of funds in the post disbursement stage.

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Chapter 6

Different Approaches to Valuation Of Non Performing

Assets

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Different Approaches to Valuation of N.P.As:

N.P.As are by-product of most financial systems and the level of N.P.As

is an indicator of the health of the financial system of an economy.

Valuation techniques should present the situation, which maximize the

overall interest of all the concerned parties.

The broad objectives of the valuation framework are essentially:

To set a sound basis for the selling bank/institution to finalize the sale

of assets,

To provide a basis for the fair market value of the assets,

To promote transparency of the valuation processes and,

To comply with internationally accepted practices.

The valuation of an asset or the pool of assets is a precursor to any

restructuring exercise. Any valuation exercise shall attempt to address

the following issues:

The fair market value of the asset should represent the price at which

market participants would undertake a restructuring.

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The transaction value should reflect the potential for income

generation and return of principal, balanced against the applicable risk

profile and market lending margins.

The valuation framework should allow for valuation of specific assets

as well as a portfolio of assets (i.e. portfolio of loans to be acquired

from a bank.) In most cases, a single value will apply to each loan

required. For larger loans, however, an element of risk/return sharing

with the selling bank may be considered.

There are various methodologies used to value the companies or their

debt. Typically, cash flows, assets or replacement values, or a

combination of these, are considered when determining the value of

the company or its debt. The matrix shows the risk profile of the NPA

based on its cash flows and collateral. As shown, stronger the cash

flows and collateral, lower the risk profile of the asset. Some of the

widely used approaches towards valuation of an NPA by the valuation

firms are detailed as under:

Discounted Cash Flows –

One of the commonly used methods for estimating the value of the

company’s debt is the anticipated cash flow. The cash flow stream will

represent the interest and principal payments expected to be received

by the lender, primarily out of the internal cash flow generation from

underlying business activities. Where the asset is a partly completed

project, the cash flow stream will have to take onto account whether

the project will be completed and if so how it will be financed. If certain

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lenders decide to fund through extended facility, this will be taken into

account I the asset’s cash flow stream. Essentially the decision on the

project’s financial viability will be determined by using an incremental

cash flow analysis. Normally, the value of a healthy asset is computed

as the discounted value of the expected future cash flows. However, a

company is distress or an NPA may have negative earnings and may

be likely to incur operating losses for the next few years. For such

companies, the estimation of future cash flows is not so easy, as there

is a strong possibility of bankruptcy. Under such a scenario the asset

valuation is also based on subjective parameters. A company under

financial distress has some or all of the following characteristics:

operating loss, inability to meet the debt obligations and high debt

equity ratio. When dealing with such cases, the credit analysts need to

evaluate the possibility and timing of positive financial performance of

the company of infusion of additional funds and the overall macro

economic environment. If the company is expected to improve its

financial position in the future, the following discounted cash flow

model may be used for the distress companies/ N.P.As

Liquidation Value Approach –

If the loan is in default with no or low expectations of its being

services, the cash flow from liquidation of the asset and collateral will

be the primary approach rather than net present value of the cash

flow. In this case, the take out of the lender is primarily by way of

exercise of their rights on the assets and attached collateral. The

liquidation value of the company is the aggregate of the value of the

assets of the company if solid at the market rates, net of transactions

and legal costs. The estimation of the assets becomes quite

complicated when the assets of the company cannot be easily

separated like in a steel, textile or petrochemical plant. If such assets

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are sold individually, majority of the asset may not fetch a price closer

to their books value. Further, when such sale is to take place at a quick

place, the value of the assets further fall down, as it is more or less

equal to forced sale of the assets. As a result of this forced sale, the

seller has to accept a discount on the fair market value of such assets.

In most cases, such a realization is not able to cover even the secured

debt fully and hence the valuation of the debt would be limited by this

realized value. This approach has been widely used in countries like

Thailand where a significant number of loans were secured by real

estate and other marketable securities of various kinds.

Earning Model -

In performing companies, the P/E ration of the industry or other similar

companies may be used as a tool for determining the market value of

the assets of company. If the debt of the company is more than its

assets, then a proportionate discount may be applied to the debt. The

above approach, however, cannot be used for most of the N.P.As, as

they would have negative EPS. In such cases, the cash earning per

share of the company and cash P/E ratio of the similar companies may

be used to arrive at a market value of the NPA debt.

Case Specific Valuation Model –

Depending on case to case, various models have been evolved and

used for specific requirements. I shall discuss here one of such models

to provide an insight as to how provide varied models can be from the

conventional approaches.

Segmentation into buckets:

For a huge portfolio of small loans, different kind of approach may be

used for arriving at the realistic valuation. One of them is categorizing

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the loans in various buckets and then analyzing a sample picked from

various buckets. Post currency crisis of late 1990’s in Thailand, the

price of real estate had declined to abysmally low levels and majority

of the property-linked loans had become N.P.As in the books of the

local banks. One of the leading financial companies in the world was

contemplating to purchase these loans totaling over 20,000 small

loans. For arriving at the appropriate valuation, they had followed the

following methodology:

Segmentation of the assets in various buckets.

Selection of a sample out of each bucket.

Detailed analysis of each sample.

Statistical extrapolation of the sample to the entire bucket.

Arriving at the final range of the valuation of the portfolio.

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Chapter 7

Managing Non Performing Assets

Managing N.P.As:

The primary aim of any business is to make profits. Therefore, any

asset created in the course of the conduct of business should generate

income for the business. This applies equally to the business of

banking. The banks the world over deal in money, by accepting

deposits (liabilities) and out of such deposits (liabilities) lend/create

loans (assets). If for any reason such assets created do not generate

income or become sticky and difficult of recovery, then the very

position of the banks in repaying the deposits (liabilities) on the due

dates would be at stake and in jeopardy. Banks with such assets

portfolio would become weak and naturally such weak banks will lose

the faith and confidence of the investors.

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With the introduction of prudential norms for income recognition,

assets classification and provisioning, banks have become quite

sensitive and are taking all possible steps to strengthen their assets

acquisition and monitoring systems. There is also a growing awareness

to bring down non-performing assets as these are having adverse

impact on their profitability due to de-recognition of interests as well

as requirement of heavy loan loss provisions on such assets. Therefore

it would be prudent for banks to manage their assets in such a manner

that they always remain healthy, generate sufficient income and

capable of repayment/recovery on the due dates. Management of

performing/non-performing assets in banks has become an `art and

science' and virtually `a battle of wits' between the banker and the

borrower with the latter demanding write off or at least a major

sacrifice from the bankers side irrespective of whether he is in a

position to pay or not.

Management of non-performing assets of the financial sector was put

on fast track recently with the Union Cabinet approving the

promulgation of an ordinance to facilitate securitisation and

reconstruction of financial assets.

Besides enabling banks and financial institutions to create a market for

the securitised assets and improve their asset liability management,

the Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Ordinance would also assist in setting

up Asset Reconstruction Companies. Though this is a welcome

development, the bankers have to do their basic homework and to

utilize this opportunity to clean up and recover their dues at an early

date.

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Chapter 8

Measures to Recover N.P.As

Over the last few years Indian banking in its attempt to integrate itself

with the global banking has been facing lots of hurdles in its way due

to its inherent weaknesses, despite its high sounding claims and lofty

achievements. One of the major hurdles, the Indian banking is facing

today, is its ever-growing size of non-performing assets over which the

top management of almost each bank is baffled. On account of the

intricacies involved in handling the N.P.As the ticklish task of assets

management of the bank has become a tight rope walk affair for the

controlling heads, because a little wavering ‘this or that side’ may land

the concern bank in trouble. The growing N.P.As is a potent source of

worry for the finance minister as well, because in a developing country

like ours, banking is seen as an important instrument of development,

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while with the backbreaking N.P.As banks have become helpless

burden on the economy.

N.P.As with outstanding up to 5 crore:

In case of doubtful and loss assets, through the modified schemes, the

banks have been directed to follow up a settlement formula under

which the minimum amount to be recovered, amounts to be entire

outstanding running ledger balances as on the date the account was

identified as NPA i.e. the date from which the interest was not charged

to the running ledger, an analysis of the given formula shows that RBI

has been very much generous in granting huge relaxation to the

borrowers who were not coming forward for setting their overdue loans

due to one or other reason. The scheme is of high practical value as it

protects the borrowers who were having genuine problems in clearing

their dues because the interest component constituted a multiplied

amount of principal outstanding. On the other hand, the concerned

banks were also finding in difficult to sacrifice the entire interest

component, but outstanding in the dummy ledger. Now as per the

provision to the scheme, they will be ready to grant such relaxation in

favour of the borrowers. These guidelines have come as a windfall for

borrowers who after a lot of negotiations were almost ready to repay

back their principal as well as part of the interest component to settle

their accounts, as under the modified scheme, they would be able to

save the interest component. To that extent the concerned bank

stands to lose.

In the case of sub standard assets, the settlement formula as

given in the modified scheme states that the minimum sum to be

recovered must contain the entire running ledge outstanding balance

as on the date of the account was identified as NPA i.e. the date from

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the which interest was not charged to the running ledger + interest at

the existing prime lending rate of the bank. As per the modified sac

scheme, the terms suggested for the payment of settlement amount

NPA are simple and pragmatic. As per the terms of the scheme, the

settlement amount should be paid in lump sum by the borrower.

However in case of the borrower is unable to repay back in a lump

sum, the scheme allows sufficient breathing period to enable him to

arrange the funds and clear at least 25 percent of the settlement

amount to be paid upfront and the remaining amount to be recovered

in installments spread over a period of one year along with interest at

the existing PLR from the date of settlement up to the date of final

payment.

N.P.As with outstanding over Rs. 5 crores:

For recovery of N.P.As over Rs. 5 crore, RBI has left the matter to the

concerned banks and advised that the concerned banks may formulate

policy guidelines regarding their settlement and recovery. The

freedom, in such cases, is given to the banks, because the attending

circumstances in each case may vary from the other. Therefore it was

in the right direction that adopting a generalized approach was not

thought appropriate. In cases, where the amount involved is above Rs.

5 crore, RBI expects CMD of each bank to supervise the NPA

personally. The CMDs of the concerned banks are advised to review all

such cases within a given timeframe and decide the course of action in

terms of rehabilitation/restructuring. RBI also desires the submission of

a quarterly report of all N.P.As above Rs. 5 crore from PSU banks. Thus

by putting up the cut-off dates for the implementing of the scheme,

RBI desires the banks to realize the seriousness of the issue and gear

up to sweep away the N.P.As in one go.

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For commercial banks, it is a golden opportunity to clear the

mess, consolidate and come out on a track leading t the path of global

banking. The time given for weeding out the disastrous N.P.As is

neither too long nor too short and the banks, with proper planning and

follow up can drastically reduce their N.P.As, if they firmly resolve to do

so. RBI expects the commercial banks to follow the guidelines in letter

and spirit without any discrimination or discretion as a slight dilution

may jeopardize their interest. A proper monitoring system is also

desired to be evolved for monitoring the progress of the scheme. As

this is a rare opportunity given to the defaulting borrowers so that they

can avail the chance given for the settlement of their loans. Without

adequate publicity of the scheme the response from the defaulting

borrowers may not be there to the expected level.

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Chapter 9

Trends In Non Performing Assets

Non-Performing Assets as Percentage of Total Assets - All Scheduled Commercial Banks

SrNo

Name of the Bank Gross N.P.As/Total Assets Net N.P.As/Total Assets

    1999-00 2000-2001 2001-02 2002-03 1999-00 2000-01 2001-02 2002-03

1Nationalized Banks

6.83 6.0 5.44 5.21 3.26 3.15 2.95 2.16

2State Bank Group

6.52 5.88 5.11 4.39 2.94 2.60 2.35 2.00

3 Total PSBs 6.71 5.95 5.31 4.89 3.14 2.94 2.72 2.42

4Private Sector Banks (old)

5.78 5.22 5.14 5.20 3.56 3.27 3.28 3.22

5 Private 2.26 1.60 2.05 3.91 1.59 1.08 1.18 2.10

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Sector Banks (new)

6Foreign Banks

3.10 3.16 3.04 2.43 1.10 1.03 0.77 0.82

Non-Performing Assets as Percentage of Total Advances – All Scheduled Commercial Banks

SrNo

Name of the Bank Gross N.P.As/Total Advances Net N.P.As/Total Assets

    1999-00 2000-2001 2001-02 2002-03 1999-00 2000-2001 2001-02 2002-03

1Nationalized Banks

16.02 13.91 12.16 11.01 8.35 7.80 7.01 6.01

2State Bank Group

15.67 14.08 12.73 11.25 7.74 6.77 6.27 5.45

3 Total PSBs 15.89 13.98 12.37 11.09 8.13 7.42 6.74 5.82

4Private Sector Banks (old)

13.06 10.78 10.94 11.01 8.96 7.06 7.30 7.11

5Private Sector Banks (new)

6.19 4.14 5.13 8.87 4.46 2.88 3.09 4.94

6Foreign Banks

7.59 6.99 6.84 5.38 2.94 2.41 1.82 1.89

[Source: RBI Publication - Trends and Progress in Indian Banking 2003]

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Chapter 10

Recommendations

Studies have shown that management of N.P.As rather than

elimination is prudent. India’s growth rate and bank spreads are higher

than western nations. As a result we can support a non-zero levels of

N.P.As, which balances the risk vis-à-vis return appropriate to the

Indian context.

Concerns have been raised about the relevance to India. A significant

percentage of the N.P.As of the PSBs are in the priority sectors. Loans

in rural areas are difficult to collect and banks by virtue of their sheet

reach are better placed to recover these loans. Lok Adalats and debt

recovery tribunals are other effective mechanism to handle this risk.

ARCs should focus on borrowers. Further, there is a need for private

sector and foreign participation in the ARC. Private parties will look for

active resolution of the problem and not merely regard it as a book

transaction. Moving N.P.As to an Arc doesn’t get rid of the problem. In

china, potential investors are still worried about the risks of non-

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enforcement of ownership rights of the assets they purchase from the

ARCs. Actions and measures have to be taken to build investors

confidence.

Numerous papers have stressed the criticality of a well-developed

capital market in the restructuring process. A capital market brings

liquidity and mechanism for write off loans. Without this a bank may

postpone the NPA problem for fear pf capital adequacy problems and

resort to tactics like ever greening. Monitoring by bondholders is better

as they have no motive to sustain uneconomic activity. Further the

banks can manage credit risk better as it is easier to sell or securities

loans and negotiate credit derivatives. Indian debt markets is relatively

under developed and attention should be focused on building liquidity

and volumes.

Regulations must incorporate a contextual perspective (like temporary

cash flow problems) and clients should be handled in a manner, which

reflects true value of their assets and future potential to pay. The top

management should delegate authority and back decision of this kind

taken by middle level managers.

This has been extensive in China, Japan, and Korea and has attracted

international participants due to lower liquidity risks. The resolution

trust corporation has helped develop the securitisation market in Asia

and has taken over around $ 460 bn as bad debts from 750 failed

banks. Its highly standardized products appeal a broad investor base.

Securitisation in India is still in a nascent stage but the potential in the

areas of Mortgage Backed Securities.

There is a fear that disposal through the provision of excessive

reserves may result in a deflationary spiral. A through provision of

reserves will have no negative impact on the long-term dividends paid

to the shareholders. Firstly, it helps restore credibility in the financial

systems. Further, an adjustments mechanism can be created by which

the capital gains and future profits that will result from the disposal of

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N.P.As will pass back to the creditors as the tax payers who incurred

the losses today. The swift disposal of N.P.As during the Great

Depression in the middle of a severe current helped restore the

credibility of the financial system.

Some experts argues that the current organizational competencies,

regulatory framework, quality of disclosure and incentive structure

produce an inconsistent framework, which leads to an unsustainable

performance level for a bank. Macro level issues will have to be

addressed in order to root out the problem. Processes at every stage of

an assets life impact the overall quality of the intermediation process

and so a consistent set of procedures are necessary to handle the

problem.

There have been instances of banks extending credit to doubtful

debtors (who willfully default on debt) and getting kickbacks for the

same. Ineffective legal mechanism and inadequate internal control

mechanism have made this problem grow quick actions has to be

taken on both counts so that both the defaulters and the authorizing

officer are punished heavily. Without this, all the mechanism

suggested above may prove to be ineffective.

Conclusion

To conclude with, till recent past, corporate borrowers even after

defaulting continuously never had any real fear of bank taking any

action to recover their dues despite the fact that their entire assets

were hypothecated to the banks. This is because there was no legal

Act framed to safeguard the real interest of banks.

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However with the introduction of Securitisation Act, 2002 banks can

now issue notices to their defaulters to repay their dues or else make

defaulters face hard and tough actions under the aforementioned Act.

This enables banks to get rid of sticky loans thereby improving their

bottom lines. Also a hallmark of a good business is approaching it with

a fresh, new perspective and requires management that is fully awake,

fully alive and of course fully focused on making things better.

Also, the passing of the Securitisation Act, 2002 came as a bonanza for

investors in banking sector stocks that in turn resulted into an

improvement in their share prices.

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CHAPTER 11

BIBLIOGRAPHY

Books –

Panday I.M. – Financial Management

Indian Banking – R. Parameswaran

Credit and Banking – K.C. Nanda.

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Websites –

www.indiainfoline.com

www.rbi.org.com

www.economictimes.com

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