NPA management biggest challenge for banks in 2009Press Trust Of India / Mumbai December 30, 2008, 0:17 IST

After the global financial turmoil in 2008, Indian banks begin the new year with a lurking fear that their Non Performing Assets (NPA) 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.

“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,” State-owned Bank of Baroda’s (BoB) Chairman and Managing Director M D Mallya said.

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, according to figures released by the Reserve Bank. Though there was no need to be unduly alarmed, banks need to follow certain standard parameters to ensure the quality of their lending portfolios, Mallya said. Similar view was echoed by ICICI Bank’s CEO-elect Chanda Kochhar who said the lender has taken a conscious decision “to follow certain parameters” to ensure asset quality.

Despite pressures emanating from global financial markets, Indian banks witnessed a healthy 25-29 per cent average growth in credit disbursals, primarily in housing, auto and infrastructure loans.

IndusInd Bank’s Head of Wholesale Banking Group, J Moses Harding supported this view saying that the present economic downturn has affected the repayment capacities of small firms, exerting pressure on the banks’ lending portfolios. “There is a pressure on SMEs as many of them are unable to repay their advances in the current scenario. This situation is likely to last in the short term. Banks need to adjust their risk management mechanisms to face the situation,” Harding said. 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 25-29 per cent on account of working capital reuirements of small-, mid- and large-size industries, and the bankers expect an average 25 per cent rise in their credit in 2009. While state-owned banks were quick to respond to the recent signals from policy-makers by reducing interest rates periodically, many Private Sector Banks (PSB) are yet to follow the suit, mainly owing to pressure on their margins.

NPA

ABSTRACT

A strong banking sector is important for flourishing economy. The failure of the banking sector may have an adverse impact on other sectors. Non-performing assets are one of the major concerns for banks in India.

NPAs reflect the performance of banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also erodes the value of the asset. The NPA growth involves the necessity of provisions, which reduces the over all profits and shareholders value.

The issue of Non Performing Assets has been discussed at length for financial system all over the world. The problem of NPAs is not only affecting the banks but also the whole economy. In fact high level of NPAs in Indian banks is nothing but a reflection of the state of health of the industry and trade.

The paper deals with understanding the concept of NPAs, its magnitude and major causes for an account becoming non-performing, projection of NPAs over next three years in Public sector banks and concluding remarks.

CAUSES FOR NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS

Introduction

Granting of credit for economic activities is the prime duty of banking. Apart from raising resources through fresh deposits, borrowings and recycling of funds received back from borrowers constitute a major part of funding credit dispensation activity. Lending 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 a risk called credit risk, which arises from the failure of borrower. Non-recovery of loans along with interest forms a major hurdle in the process of credit cycle. Thus, these loan losses affect the banks profitability on a large scale. Though complete elimination of such losses is not possible, but banks can always aim to keep the losses at a low level.

Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures affected under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports in this contemporary period have been neutralized by the ill effects of this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by Nationalised Banks, followed by the SBI group, and the all India Financial Institutions.

Objectives of the study i. To understand the meaning & nature of NPAs. ii. To examine the causes for NPAs in public sector banks. iii. To project the NPAs in public sector banks over next three years using Trend Analysis as a tool.

Methodology

In order to meet the Third objective, the method of Moving Averages is been used, from which we arrive at a Trend Analysis. While the rationale behind selection of 'Three year Moving Average' method is because of the availability of the data. The data available was from the ten years and needless to say that for such a data a 'Six year Moving average' or a 'Eight year Moving Average' will not work out.

Meaning of NPAs

An asset is classified as Non-performing Asset (NPA) if due 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 banks 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.

Though the term NPA connotes a financial asset of a commercial bank, which has stopped earning an expected reasonable return, it is also a reflection of the productivity of the unit, firm, concern, industry and nation where that asset is idling. Viewed with this perspective, the NPA is a result of an environment that prevents it from performing up to expected levels.

The definition of NPAs in Indian context is certainly more liberal with two quarters norm being applied for classification of such assets. The RBI is moving over to one-quarter norm from 2004 onwards.

Magnitude of NPAs

Inn India, the NPAs that are considered to be at higher levels than those in other countries have of late, attracted the attention of public. The Indian banking system had acquired a large quantum of NPAs, which can be termed as legacy NPAs.

NPAs seem to be growing in public sector banks over the years.

A distinction is often made between Gross NPA and Net NPA. Net NPA is obtained by deducting items like interest due but not recovered, part payment received and kept in suspense account etc., from Gross NPA.

As shown in the above table –1 over the years the NPAs as a percentage of net advances and total assets have been declining but actual numbers are increasing.

Dealing with NPAs involves two sets of policies

1. Relating to existing NPAs 2. To reduce fresh NPA generation.

As far as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMCs to clean up its balance sheet. For preventing fresh NPAs, the bank itself should adopt proper policies.

Causes for Non Performing Assets

A strong banking sector is important for a flourishing economy. The failure of the banking sector may have an adverse impact on other sectors. The Indian banking system, which was operating in a closed

economy, now faces the challenges of an open economy.

On one hand a protected environment ensured that banks never needed to develop sophisticated treasury operations and Asset Liability Management skills.

On the other hand a combination of directed lending and social banking relegated profitability and competitiveness to the background. The net result was unsustainable NPAs and consequently a higher effective cost of banking services.

One of the main causes of NPAs into banking sector is the directed loans system under which commercial banks are required a prescribed percentage of their credit (40%) to priority sectors. As of today nearly 7 percent of Gross NPAs are locked up in 'hard-core' doubtful and loss assets, accumulated over the years.

The problem India Faces is not lack of strict prudential norms but

i. The legal impediments and time consuming nature of asset disposal proposal. ii. Postponement of problem in order to show higher earnings. iii. Manipulation of debtors using political influence.

Macro Perspective Behind NPAs

A lot of practical problems have been found in Indian banks, especially in public sector banks. For Example, the government of India had given a massive wavier of Rs. 15,000 Crs. under the Prime Minister ship of Mr. V.P. Singh, for rural debt during 1989-90. This was not a unique incident in India and left a negative impression on the payer of the loan.

Poverty elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on various grounds in meeting their objectives. The huge amount of loan granted under these schemes were totally unrecoverable by banks due to political manipulation, misuse of funds and non-reliability of target audience of these sections. Loans given by banks are their assets and as the repayment of several of the loans were poor, the quality of these assets were steadily deteriorating. Credit allocation became 'Lon Melas', loan proposal evaluations were slack and as a result repayment were very poor.

There are several reasons for an account becoming NPA.

* Internal factors * External factors

Internal factors:

1. Funds borrowed for a particular purpose but not use for the said purpose. 2. Project not completed in time. 3. Poor recovery of receivables. 4. Excess capacities created on non-economic costs. 5. In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets. 6. Business failures. 7. Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns. 8. Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-appropriation etc., 9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delay in settlement of payments\ subsidiaries by government bodies etc.,

External factors:

1. Sluggish legal system -

Long legal tangles Changes that had taken place in labour laws Lack of sincere effort. 2. Scarcity of raw material, power and other resources. 3. Industrial recession. 4. Shortage of raw material, raw material\input price escalation, power shortage, industrial recession, excess capacity, natural calamities like floods, accidents. 5. Failures, non payment\ over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc. 6. Government policies like excise duty changes, Import duty changes etc.,

Conclusion Regarding Contributory Reasons

The study of about 900 top NPA accounts in 27 public sector banks that has been tabulated from the available information revealed by RBI, that the following are the important factors for units becoming sick/weak and constantly accounts turning NPA in the order of prominence:

* Diversification of funds (No. 7 above – Internal factor), mostly for expansion \diversification \ modernization, taking up of new projects, is the single most prominent reason. Besides being so, this factor also has significant proportion of cases, when compared to other factors.

* Internal factor (No. 6 above), failure of business (product), inefficient management, inappropriate technology, product obsolescence.

* External factor (No. 3 above), comprising industrial recession, price escalation, power shortage, accidents etc.,

* Time \ cost overrun during the project implementation stage leading to liquidity strain and turning NPA into next factor (No. 2 above – Internal factor).

* Other factors in order or prominence are Government Policies like changes in Import \ Excise duties etc., (No 5 above – External factor), willful default, fraud \ misappropriation, disputes etc., (No. 8 above – Internal factor) and lastly, deficiencies on the part of banks delays in release of limits and delay in settlement of payments by government bodies (No. 6 above – External factor).

(Exhibit – 1)

Causes for an Account becoming NPA

Those Attributable to Borrower Causes Attributable to Banks Other Causes

a) Failure to bring in Required capital b) Too ambitious project

c) Longer gestation period d) Unwanted Expenses e) Over trading f) Imbalances of inventories g) Lack of proper planning h) Dependence on single customers i) Lack of expertise j) Improper working Capital Mgmt. k) Mis management l) Diversion of Funds m) Poor Quality Management n) Heavy borrowings o) Poor Credit Collection p) Lack of Quality Control a) Wrong selection of borrower b) Poor Credit appraisal c) Unhelpful in supervision d) Tough stand on issues e) Too inflexible attitude f) Systems overloaded g) Non inspection of Units h) Lack of motivation i) Delay in sanction j) Lack of trained staff k) Lack of delegation of work l) Sudden credit squeeze by banks m) Lack of commitment to recovery n) Lack of technical, personnel & zeal to a) Lack of Infrastructure b) Fast changing technology c) Un helpful attitude of Government d) Changes in consumer preferences e) Increase in material cost f) Government policies g) Credit policies h) Taxation laws i) Civil commotion j) Political hostility k) Sluggish legal system l) Changes related to Banking amendment Act

Projection of NPAs over next three years in public sector Banks

The paper focuses on projecting the Non Performing Assets of Public Sector Banks over next three years. The method used for this study is "Trend Analysis – Three year Moving Average Method."

The study focused on measuring the Trend for four aspects:

1. Gross NPAs to Gross Advances 2. Gross NPAs to Total Advances 3. Net NPAs to Net Advances 4. Net NPAs to Total Advances

The formula used for "Three year Moving Average" is: A+b+c , b+c+d , c+d+e , d+e+f , ……. 3 3 3 3

This is one of the flexible methods of measuring the trend. While applying this method, it is necessary to select a period for moving average appropriately depending upon the availability of the data. In this case the data available was ten years and hence the Three-year moving average found to be suitable for projecting the future trend.

Assumptions

While measuring the future trend of NPAs for next three years in public sector banks, the following are the key issues, which are assumed to be constant.

* It is to be noted that the norms for recognizing NPAs are changing every year. Previously it was four quarters, then it was made to three quarters and now from come 2004 it will be only one quarter.

* For commercial Banks the Capital Adequacy Norms are been prescribed recently, which were not mentioned in the early 90's.

* Norms regarding Provisions have changed over the last decade.

* Income Recognition norms were introduced in mid 90's.

* According to Basel committee Prudential Norms were introduced.

* Asset Liability Management Guidelines is expected to be issued by RBI.

Final Analysis

The future picture of Commercial banks more so the public sector banks seem to be rosy. As the Trend Line suggests that the NPAs of public sector banks will decline marginally both in terms of Gross and Net figures over next three years. This may be due to higher provisions, which the public sector banks have been providing. The real issue to be identified is though the NPAs, as a percentage seems to be declining over the years but the absolute figures seems to be increasing. In this vein it would be interesting to see the NPAs both in terms of absolute figures and in terms of percentage of public sector banks in the coming three years.

Concluding Remarks

A strong banking sector is important for a flourishing economy. The failure of the banking sector may have an adverse impact on other sectors.

Over the years, much has been talked about NPAs and the emphasis so far has been only on identification and quantification of NPAs rather than on ways to reduce and upgrade them.

There is also a general perception that the prescription of 40% of net bank credit to priority sectors have led to higher NPAs, due to credit to these sectors becoming sticky. Managers of rural and semi-urban branches generally sanction these loans. In the changed context of new prudential norms and emphasis on quality lending and profitability, managers should make it amply clear to potential borrowers that banks resources are scarce and these are meant to finance viable ventures so that

these are repaid on time and relevant to other needy borrowers for improving the economic lot of maximum number of households. Hence, selection of right borrowers, viable economic activity, adequate finance and timely disbursement, correct end use of funds and timely recovery of loans is absolutely necessary pre conditions for preventing or minimizing the incidence of new NPAs.

However, banks are yet another sector where the rot has already set in!..

It is high time to take stringent measures to curb NPAs and see to it that the

Non-Performing Assets may not turn banks into Non-Performing Banks; instead steps should be taken to covert Non-Performing Assets into Now-Performing Assets.

It's now or never

Asset Classification :

The RBI has issued guidelines to banks for classification of assets into four categories.

1. Standard assets:These are loans which do not have any problem are less risk.

2. Substandard assets:These are assets which come under the category of NPA for a period of less then 12 months.

3. Doubtful assets:These are NPA exceeding 12 months

4. Loss assets:These NPA which are identified as unreliable by internal inspector of bank or auditors or by RBI.

Bank NPA’s up by 26% in the second quarter of FY 2010

November 08, 2009: If Non-performing Assets (NPAs) and Capital Adequacy Ratio (CAR) reported by commercial banks are an indication of their financial strength, the second quarter results of Indian banking sector portray a mixed picture.

This is because the net non-performing assets have risen by an average 26 per cent while capital adequacy ratio improved by 1.60 percentage points in Q2 of current fiscal as compared to the corresponding period of previous year.

Improvement in CAR reflects better financial health of banks and government recent move to recapitalize weak PSUs bank is a right move while increase in NPAs is a matter of concern as it directly affects the solvency and profitability of banks.

According to ASSOCHAM, the increase in NPA of the compared period should inspire government to quickly move towards banks consolidation as it will bring down their risks and expand banks balance sheet size to global standard to take on emerging challenges in the financial sector, said ASSOCHAM

President, Dr. Swati Piramal.

Solvency Analysis of Indian Banking Sector as carried out by ASSOCHAM reveals that on an average 26 per cent rise in net non performing assets (NPAs) have been registered by 21public sector and commercial banks during the second quarter of the FY’10 as against Q2-FY’09.

However, the average capital adequacy ratio (CAR) of the banks improved to 13.68 per cent in Q2-FY ‘10 from 12.08 per cent in the previous year, added Dr. Piramal.

The analysis of the Indian banking sector was based on the quarterly results posted by 21 Indian banks For a macro analysis, the total 21 banks included an aggregation of 19 public sector banks (PSBs) and 2 major private sector banks.

It is also based on two broad parameters including net non performing assets and capital adequacy ratio and also the new enhanced provisioning coverage ratio and additional provisioning on commercial real estate standard assets.

“Although the Indian banking sector has remained insulated from the global financial crisis, the emerging trends show mixed signals”, said Dr. Piramal.

As per the analysis, the aggregate net non-performing assets (NPA) of 21banks increased by 26 per cent to Rs 25137 crore in second quarter of 20010 from Rs 19920 crore in the same period of FY’09.

In terms of capital adequacy ratio, out of the 21 banks posting their results for the quarter ending September 2009-10 it was found that 4 banks witnessed a fall in their CAR from the previous fiscal, but they still managed to remain above the prescribed limit of nine per cent posed by the Basel II accord.

The latest move by RBI asking banks to increase their provisioning coverage ratio to a minimum of 70% by the end of Sept., 10 is going to impact the profits of large number of banks. As against the PCR of 56% as on Sept., 2009, the additional burden on this count , by one estimate ,will be around Rs 13000 crores.

More so the RBI has increased general provisioning on Commercial real estate from 0.4% to 1.0 % on standard assets will drive the borrowing cost as well as additional provisioning. The slow credit growth is further likely to impact the bottom lines of banks. Therefore the banking sector is likely to see rough weather until the credit expansion takes a fast track

Title: NON PERFORMING ASSET OF BANK (ICICI)

 

Abstract:

A strong banking sector is important for flourishing economy. The failure of the banking sector may have an

adverse impact on other sectors. Non-performing assets are one of the major concerns for banks in India.

NPAs reflect the performance of banks. A high level of NPAs suggests high probability of a large number of

credit defaults that affect the profitability and net-worth of banks and also erodes the value of the asset. The

NPA growth involves the necessity of provisions, which reduces the overall profits and shareholders’ value.

The issue of Non Performing Assets has been discussed at length for financial system all over the world. The

problem of NPAs is not only affecting the banks but also the whole economy. In fact high level of NPAs in

Indian banks is nothing but a reflection of the state of health of the industry and trade.

This report deals with understanding the concept of NPAs, its magnitude and major causes for an account

becoming non-performing, projection with special reference to ICICI bank.

 

Objectives:

The main objective of the research is to understand the concept of nonperforming assets. What is the

definition of nonperforming assets. Why they are increasing? What are the causes of NPA’s? How we can

control this thing? Through this project we can also analyse the banking industry. What type of challenges

this industry is facing. I also include Basel committee report in my project which tells about the risk

management in the banks. I choose ICICI BANK for my study of NPA. It is the leading private sector bank.

They control NPA in very good manner. That why it is interesting to know how they able to do this one, To

carry out my project I have used the descriptive research. Descriptive research includes surveys and fact-

finding enquiries of different kinds. The major purpose of descriptive research is description of the state of

affairs, as it exists at present. The main characteristic of this method is that the researcher has no control

over the variables; he can only report what has happened or what is happening. It is also called as ex post

facto research. Most ex post facto research projects are used for descriptive studies in which researcher

seeks to measure such items as, for example, frequency of shopping, preferences of people, or similar data.

Descriptive research also includes attempts by the researcher to discover causes even when they cannot

control the variables. The methods of research utilized in descriptive research are survey methods of all

kinds.

 

Limitations:

The limitations that I felt in my study are:

It was critical for me to gather the financial data of the every bank of the Public Sector Banks so the better

evaluations of the performance of the banks are not possible.

Since my study is based on the secondary data, the practical operations as related to the NPAs are adopted

by the banks are not learned.

Since the Indian banking sector is so wide so it was not possible for me to cover all the banks of the Indian

banking sector.

Provision for the classification of the Assets / NPA’s differs within each public sector bank & this information

is not available Publicly.

The RBI norms for the classification of assets / NPA’s  are available on a pay site & not publicly available

through any source .

 

Conclusion and Suggestions

The issue of Non-Performing Assets (NPAs) in the financial sector has been an area of concern for all

economies and reduction in NPAs has become synonymous with functional efficiency of financial

intermediaries. Although NPAs are a balance sheet issue of individual banks and financial institutions, it has

wider macroeconomic implications. It is important that, if resolution strategies for recovery of dues from

NPAs are not put in place quickly and efficiently, these assets would deteriorate in value over time and only

scrap value would be realized at the end. It should, however, be kept in mind that NPAs are an integral part

of the business financial sector and the players are in as they are in the business of taking risk and their

earnings reflect the risk they take. They operate in an environment, where there would be defaults as well as

deterioration in portfolio value, as market movements can never be predicted with certainty. It is in this

context, that countries have adopted regulatory measures and the guiding structure has been provided by

the Basel guidelines

.There are various reasons for assets turning non-performing and there can be alternative resolution

strategies. Identification of the reasons and timely action are the key to improved profitability of financial

sector intermediaries. In this context, the details of the CAMEL model that RBI introduced for evaluating

performance of banks and the need for this arose from the systemic generation of large volume of NPAs.

CAMEL covers capital adequacy, asset quality, management quality, earnings ability and liquidity.

Non-performing Asset Management for Banks in India - Part IOctober 27, 2007S. Ramaswamy, Evolvus Solutions

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Non-performing assets (NPAs) have been a great worry for India's public sector banks (PSBs), which are either wholly or partly owned by the Indian government. Increasing provisions for NPAs every year have been a drain on the profitability of these banks. With the countdown started for the adoption of Basel II norms, fear of breaching the minimum level of capital adequacy looms large for some of these banks. Some of them have gone to the public with initial and subsequent offer of equity shares and have improved their Tier I capital. No doubt the banks' profits are higher as a result of increased levels of credit in a buoyant economy. Some have raised their Tier II capital through bond issuance. Net NPAs of these banks have been decreasing.

However, sooner or later the NPA bubble may burst and mar the balance sheets of these banks unless they prevent further slippage to NPAs by means of better credit monitoring. With the increase in retail credit, and the scope for further increase, banks must improve their credit monitoring systems and practices. It is common knowledge that an account does not become an NPA overnight. There will be advance-warning signals that prudent bankers should heed and act upon.

On Basel II, India's central bank, the Reserve Bank of India (RBI), has advised that the foreign banks operating in India, and domestic banks with a presence outside India, are to migrate to the standardized approach for credit risk and the basic indicator approach for operational risk with effect from 31 March 2008. All other scheduled commercial banks were encouraged to migrate to these approaches under Basel II in alignment with them but in any case not later than 31 March 2009.

The Basel Committee on Banking Supervision (BCBS) had undertaken the Fifth Quantitative Impact Study (QIS-5) to assess the impact of adoption of the revised Framework. Eleven Indian banks, accounting for about 50% of market share (by assets), participated in the QIS-5 exercise. It transpired from an empirical analysis that the combined capital adequacy ratio of these banks is expected to come down by about 100 basis points when these banks apply Basel II norms.

If the capital adequacy breaches the minimum level, besides the RBI stepping in with various measures of prompt corrective action, a spate of problems would arise for the banks in the international market. Those banks will not be able to increase their asset base etc.

How Can Banks Prevent the Slide in Capital Adequacy?

Banks can improve their capital adequacy in three ways: by increasing the Tier I capital through a public issue or private placement of equity shares, by increasing Tier II capital by issuing bonds/preference shares and, thirdly, by improving their net worth by increased profits.

Profits can be increased by procuring more low and no-cost deposits, by increasing advances, by improving income from other sources and by reducing costs. With better credit appraisal and monitoring, the bank can decrease its amount of NPAs. Fewer NPAs result in less provisioning requirements and improved profits. Provisions can be

reduced if slippages to NPAs are arrested. When recoveries are made in NPAs and provisions made are reversed, profits improve.

Before we go into the management of NPAs let us see how the NPA levels of banks in India compared with some developing and developed countries.

Figure 1: How do NPA Levels of Banks in India Compare with Developing and Developed Countries?

Country

Return on AssetsRegulatory capital to risk-weighted Assets

Non-Performing Assets to total Assets.

2005 2006 2005 2006 2005 2006

Emerging Markets

           

Argentina 0.9 1.9 NA NA 5.2 4.7

Brazil 2.1 2.3 17.4 NA 4.4 ...

Mexico 2.4 2.4 14.3 16.0 1.8 1.7

Korea 1.2 1.3 12.8 13.1 1.2 1.2

South Africa 1.1 NA 12.3 12.6 1.5 1.3

Developed Countries

           

US 1.3 1.4 13.0 13.1 0.7 0.7

UK 0.8 NA 12.8 NA 1.0 NA

Japan 0.5 NA NA NA 1.8 NA

Canada 0.7 NA 12.9 13.0 0.5 NA

Australia 1.8 NA 10.3 NA 0.2 NA

Memo:            

India * 0.9 0.9 12.8 12.4 5.2 3.3

NA - details not available.note: Data relating to Brazil, UK and Australia relate to the end-December, 2005 and 2006.source: Global Financial Stability Report (GFSR), September 2006.

It may be observed from the above that there is much to be done by the Indian banks to catch up with developed countries.

NPA Management Systems in Vogue Now

Several institutional mechanisms have been developed in India to deal with NPAs such as tightening of legal provisions; the passing of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act 2002; introduction of debt recovery tribunals (DRTs); lok adalats (public courts); corporate debt restructuring (CDR) mechanism for large advances to corporate borrowers; etc.

However, effective management of NPAs requires appropriate internal checks and balances and effective use of computerization in these banks. Most of the public sector banks in India have brought at least 90% of their branches under the core banking solution. With the existing levels of infrastructure available, the public sector banks can monitor credit and manage NPAs better than they do now.

Most banks have introduced or updated their know your customer (KYC) profiles. Credit rating exercises are generally done by the branches or controlling offices at the time of sanction or review/renewal of existing credit facilities - generally once a year. As far as credit monitoring is concerned, besides regulation of drawing power with the periodical stock statements submitted by the borrower and periodical inspection of stocks by a supervisory official of the branch, banks have reporting systems for accounts with working capital credits of Rs10m and over, by way of continuous surveillance system (CSS) reports and quarterly information systems (QIS). Although these reports are system generated, they receive scant attention either at the branch or at the controlling office. Sometimes these reports are handwritten. There is no proper check of stock statements, QIS or the CSS and the inspection is done in a haphazard manner. Operations in the account need to be checked by the branch officials to ensure that the account shows healthy fluctuations and there is no diversion of funds.

Reserve Bank of India has asked banks to introduce Watch/Special Watch category accounts to segregate accounts, which show signs of sickness. An account has to pass through this stage before it is classified as NPA. But, in practice, this does not often happen. This can lead to surprises at the end of the year for controlling offices, statutory auditors and the RBI, who then point out that an account has become an NPA, that provision needs to be made and a memorandum of change in provision given by the auditor or the central bank. It often transpires that the account had not passed through the Watch category stage. It is possible that the branch management either overlooked it, or thought that the statutory auditor would also overlook it. The branch management fights last minute duels with the auditor or RBI justifying lower provision. The controller, namely the RBI, does not agree and ultimately provision is made for a higher amount as insisted by the RBI. In the interest of corporate governance and proper disclosure, it is necessary that the systems are more transparent and reflect the true state of affairs.

Banks now have a monthly NPA recovery management information system (MIS), which gives the NPA level at the beginning and end of the month, and includes other additions, cash recoveries and upgrades during the month. This MIS is not system-generated but prepared manually. Budgets are given for branches for cash recovery and the position is monitored at the end of the month. Identification of staff lapses and accountability when an account becomes bad is still a relative term with PSBs. There is still no foolproof system at PSBs for identification of staff lapses. But how can you prevent an account becoming an NPA when it throws early warning signals and how can you manage an NPA better?

Why and How Does an Account Become an NPA?

An account does not become an NPA overnight. It gives signals sufficiently in advance that steps can be taken to prevent the slippage of the account into NPA category. An account becomes an NPA due to causes attributable to the borrower, the lender and for reasons beyond the control of both. The following is a list of factors attributable to the borrower, which could account for the borrower's accounts becoming non-performing assets:

Financial losses for two years consecutively. Poor management and marketing strategy, poor assessment of demand, over capacity for the product, lack

of commitment, entering a declining market, price war, etc. Diversion of funds within and outside the business or project. Sometimes funds are diverted for another

project. Differences and disputes among promoters/directors. The bandwagon effect. People with little experience in the field enter a profession just because others have

succeeded recently. This is common in the construction, real estate and hospitality industries. High cost base evidenced by labour costs, low productivity, distribution costs, raw material cost, high

reorganization cost. Inadequate financial control demonstrated by poor debt management/structure.

Inadequate information which is demonstrated by the following - poorly prepared budgets or no budgets, no costing/unit costs, limited analysis/planning for stocks, capital expenditure not planned/budgeted.

Time and cost overrun due to poor supervision and control over the project by the promoters. Increasing low margin sales, debtor provisions, currency losses, creditor pressure, and short-term debt.

Emphasis on cash sales with little regard for profit. Borrowing to pay operational expenses like electricity, wages, etc. Recurrence of problems previously resolved. Maintenance of expensive offices/keeping premises in a continuous state of neglect. Short term loans/ad hoc loans/excess over limits continuing beyond due date. Qualified audit opinion. Unable to comply with loan covenants. Liquidity ratios reveal deteriorating trends. Increase in creditors days outstanding. Speculative investments

However, there are also external factors over which the borrower has no control and these could also lead to non-performing assets. These external factors could include:

Delay in financial closure. Delay in realization of receivables. Exchange rate fluctuations. Depressed capital market. General recession in the particular industry. Changes in personal habits of promoters/key people.

Fraud is also a contributory factor to cases of NPAs. The following are all signs of fraud that need to be recognised in order to prevent NPAs.

Sales/inventory/assets overstated, liabilities understated. Audits cease. Abnormally large fund transfers. Significant cash balances in non-interest earning accounts. Management overrides internal controls. Sale of assets to related parties. Unusual supplier relationships. Staff working unusually long working hours. Any sign of deceit, inappropriate attitude and reaction to questions.

There are also causes of NPAs that are directly attributable to the bank, such as:

First class project in the hands of a second-class promoter. Poor credit appraisal. Delayed and inadequate credit dispensation. Denial of genuine request for ad hoc facilities can kill an

account. Defective documentation. Not heeding warning signals portrayed in the operation of the account. Lack of expertise to finance and monitor peculiar types of advances, such as against tobacco, tea etc.

While factors external to the bank could include:

Lack of free exchange of information among bankers, FIs. Unrealistic discretionary powers to grant advances or inability to take possession of securities.

Causes that are beyond the control of both the borrower and the bank include:

Delayed receipt of government subsidies. Changes in government policies. Political uncertainties. Non-compliance of pollution and environmental policies due to sudden changes. Law and order problems. Court judgments and injunction orders. Inadequate infrastructure facilities particularly water.

Having seen why and how an account becomes an NPA, part two of this article will look at the warning signs that will allow a lender to take remedial steps against NPAs.

Copyright © ChinaForum 2008

How to Prevent Slippage and Manage NPAs Better

As mentioned in Non-performing Asset Management for Banks in India - Part I, non-performing assets (NPAs) have been a great worry for India's public sector banks. Increasing provisions for NPAs every year have been a drain on the profitability of these banks, but there are methods of preventing NPAs. This article outlines various ways of achieving better information management and credit monitoring.

Basic borrower data

The job begins with the know-your-customer (KYC) and credit appraisal stage itself. The banks must first get the basic data on the borrower and this includes details such as name and address of the business unit, name and addresses of business partners, directors, guarantor, details of any authorised advance, credit rating score, details of credit facilities, and other relevant documentation. This should be prepared by the credit officer and approved by the branch head. A monthly MIS to be generated for the branch.

Daily account activity

Details of any unusual transactions or large value transactions in the account, if there is no activity in the account for more than seven days. This should be a daily MIS for the branch management. Unusual transactions would be checks favoring any new customer not already disclosed by the borrower at the time of proposal, checks for round amounts etc. Large value transactions would vary according to the size of the company and the limit or line of credit sanctioned.

Continuous surveillance every quarter

This would have details such as name of the account. Limits sanctioned, drawing power as at the end of the month and outstanding, details of arrival of drawing power - should show clearly value of unpaid stocks not reckoned for drawing power, details of debits over a particular amount in the account with purpose, details of insurance held for securities and expiry date, details of production in the quarter vis-a-vis projections. There should also be surveillance of any shortfall, and all pertinent details, such as whether reasons for it were discussed with the borrower, sales and profit during the quarter vis-a-vis projection, how it compares with the same period for the previous year, or whether the unit would achieve the projected sale for the year based on the performance so far. An analysis of quarterly results of the company should be made. The continuous surveillance statement must be seen and verified by the credit officer and the branch head and would be available as a tool for ascertaining staff lapses in case the account goes bad. If the account had thrown signals and the statement also reflected the same and despite that if prompt action is not taken to prevent slippage it becomes easier to identify staff lapses in monitoring.

Daily statement of check returns both inward and outward

This must be verified everyday by the credit officer and the branch manager. It must have a column for their comments where they must record the details of discussion with the borrower about the reasons for the frequent return of check.

Overdue term loans

A daily statement to be generated, indicating name of the account, limit sanctioned, drawing power, outstanding, date and amount of instalment/interest due, date of last inspection of the unit by branch official and name.

A weekly and monthly summary of overdue term loans

This should indicate in addition to the above the details of outstandings in other borrower accounts of the same party and overdues, if any, in such accounts. The monthly statement beyond a cut-off limit should be available to the controlling office simultaneously. The monthly statements should also generate simultaneously a pre programmed politely worded reminder letter to the borrower.

Loan concentration statements

A monthly statement should be generated to show portfolio concentrations by industry, geography and borrower segments. This would just have under each head the name of the borrower, limits sanctioned and outstanding as at the end of every month.

Weekly statement of overdue bills purchased and discounted

This must give the bills outstanding beyond due date for usance bills and 21 days for demand bills. This must have information on name and address of the drawee, whether demand or usance and if usance the tenor, whether a satisfactory credit report has been obtained on the drawee and if not who authorized the purchase or discount without the credit report, whether bills purchased on the drawee have been delayed before or returned earlier. The system should generate a reminder to the bank for all bills outstanding beyond seven days from the due date with a copy to the customer for his follow up. The system should reject purchase bills on drawees whose bills have been returned more than once. Monthly statement of overdue bills purchased and discounted should have an additional column for fate of goods covered by the respective consignments and whether this was discussed with the borrower. Similar statements as above have to be generated for foreign bills purchased and discounted - weekly and monthly separately for letter of credit (LC) bills and non-LC bills.

Monthly statement of insurance for securities due for renewal

A letter to the borrower to provide necessary funds for debit and a letter to the insurance company asking for renewal premium should be generated on the first day of every month. This has to be pursued by the credit officer till renewal.

Limits due for renewal

A monthly statement should be generated for the credit officer. It should also be seen by the branch head. A quarterly statement of lapsed limits should be generated with the above details with an extra column for the date of visit by the credit officer and the branch head to the unit for discussions on renewal of limits.

Watch category statement

Accounts with funds overdue of Rs1m (approximately US$25,430) and above are to be included on this statement to be generated on the 15th and 30th of every month. From all the above data a watch category statement is to be generated at the end of every fortnight to the branch head who has to add his comments the same day and a monthly statement should be available to the controlling office on the first working day of every month. The fortnightly statement for the branch and the monthly statement for the controlling office should have the following details: name and address of the unit, date of first sanction and by whom, date of renewal, details of limits sanctioned, drawing power, outstanding, extent of irregularity, reasons for irregularity, when the unit was last inspected, whether the unit is working, whether the documents are in order and when the account is expected to be regularized, what the branch proposes to do to regularize the account and the amount of penal interest recovered. If the account remains overdue for more than six months and remains in watch category for more than nine months with persisting overdues the account is to be transferred to assets recovery or reconstruction department for further course of action.

Assets classification and downgrade statement

This should be generated once every three months - where a downgrade or slippage is likely, but the loans are assessed as acceptable to the bank, the credit officer should send a mitigation report to the branch head as to why the credit is still acceptable to the bank. It should detail the risks and the mitigants for the same. This would be a monthly statement for the credit officer and the branch head.

Assets recovery/reconstruction

The assets recovery/reconstruction department gets the account for its follow up in the 10th month from the date it fell overdue. Immediately on receipt of the account this department should start the recovery proceedings. The first step would be to visit the unit for a discussion to explore the possibility of resurrecting the unit from its illness and retransfer the account to the branch. The credit officer of the branch or its branch head should also accompany the assets reconstruction department people for the discussion. This branch should actively involve itself in the recovery efforts of the assets reconstruction department because they know the borrower better. The visiting official should record his findings. On the ninth month from the date it became overdue the statement should indicate whether efforts for a one-time settlement with the unit was made. At the end of 12 months the assets reconstruction department should explore the possibility of selling the account to any assets reconstruction corporation for a price. If that is not possible at the end of 18 months they should initiate legal steps if their efforts for an OTS or for revival or for sale to an ARC had failed. If the unit is found to be a willful defaulter then a report should be generated for the RBI. The name and address of the unit and the directors and partners should be blacklisted and any unit in which they are interested which also has received finance from the bank should also be put on the watch category list for an in-depth analysis.

Statement of recoveries

A monthly statement of recoveries made in NPA accounts indicating total NPAs as at the beginning of the month, cash recoveries made during the month, slippage during the month, up gradation during the month, NPA level as at the end of the month to be generated for the branch head. Accounts falling under corporate debt restructuring mechanism should be handled only by the branch and not transferred to the assets reconstruction branch.

Conclusion

Nearly 90% of the operations of the banks in India are now computerized. KYC norms are in place. The banks have introduced credit rating models acquired from credit rating agencies like the CRISIL. Although the banks do not price their credit products based on the conclusions derived from the credit rating models but have their own archaic rating exercise for pricing, the contents and conclusions derived from the credit rating models would be very useful for credit monitoring. CBS is available at almost all the medium, large and very large branches where 90% of a bank's total credit is concentrated. With existing computer systems, the banks can put in place the above systems.