NPA MANAGEMENT

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:

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

peak, globally stock markets have tumbled and business itself is
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

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

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.

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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.

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

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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
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

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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.

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Chapter 4

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

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

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

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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.

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

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2000-01 4.0 5.6 3.7 4.5

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

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:

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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.
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

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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

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.

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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.
 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

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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
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

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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
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

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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
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

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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.
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.

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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

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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,
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

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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
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.

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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.
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

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

Sr Name of
No 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

Nationalized
1 6.83 6.0 5.44 5.21 3.26 3.15 2.95 2.16
Banks
State Bank
2 6.52 5.88 5.11 4.39 2.94 2.60 2.35 2.00
Group
3 Total PSBs 6.71 5.95 5.31 4.89 3.14 2.94 2.72 2.42

Private
4 Sector 5.78 5.22 5.14 5.20 3.56 3.27 3.28 3.22
Banks (old)
Private
5 Sector 2.26 1.60 2.05 3.91 1.59 1.08 1.18 2.10
Banks (new)
Foreign
6 3.10 3.16 3.04 2.43 1.10 1.03 0.77 0.82
Banks

Non-Performing Assets as Percentage of Total Advances –

All Scheduled Commercial Banks
Sr Name of
No the Bank Gross N.P.As/Total Advances Net N.P.As/Total Assets

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

Nationalized
1 16.02 13.91 12.16 11.01 8.35 7.80 7.01 6.01
Banks
State Bank
2 15.67 14.08 12.73 11.25 7.74 6.77 6.27 5.45
Group
3 Total PSBs 15.89 13.98 12.37 11.09 8.13 7.42 6.74 5.82
Private
4 Sector Banks 13.06 10.78 10.94 11.01 8.96 7.06 7.30 7.11
(old)
Private
5 Sector Banks 6.19 4.14 5.13 8.87 4.46 2.88 3.09 4.94
(new)
Foreign
6 7.59 6.99 6.84 5.38 2.94 2.41 1.82 1.89
Banks
[Source: RBI Publication - Trends and Progress in Indian Banking 2003]

Chapter 10

Recommendations

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 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-enforcement of ownership rights of the assets they

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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

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profits that will result from the disposal of 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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