CHAPTER 1

INTRODUCTION

INTRODUCTION
Since the introduction of economic liberalization and financial sector reforms, Banks are under
growing pressure to bring down their NPAs so as to improve their performance and viability.
What is bothering the bankers today is the management of Non-performing Assets. Over the
period this problem has aggravated alarmingly and therefore needs urgent remedial actions, so in
this context a good number of circular instruction/guidelines have been issued by bank/Reserve
Bank of India.
Reserve Bank of India, in the year 1991, appointed a committee under the Chairmanship of Sh.
M.Narsimham to examine and give recommendation for Income Recognition, Asset
Classification and Provisioning of loan assets of Banks and Financial Institutions. The
Committee examined the issues and recommended that a policy of Income Recognition should
be objective and based on record of recovery rather than on subjective considerations. On the
basis of the recommendations of the Narsimhan Committee, RBI had issued guidelines to all
Scheduled Commercial Banks on Income Recognition, Assets Classification and Provisioning in
April, 1992 which have been modified from time to time by the RBI on the basis of experience
gained and suggestions received from various quarters. The Prudential Norms for Income
Recognition, Asset Classification and Provisioning have come into effect from the accounting
year 31.03.1993.
Similarly, guidelines were issued by the Reserve Bank of India in March, 1994 to All India
Financial Institutions viz. IDBI,ICICI, IFCI, AXIS Bank and IIBI. Separate guidelines were also
issued by the RBI on Prudential Norms to Non-Banking Financial Companies in June, 1994 and
to Regional Rural banks in March, 1996. They have adopted these guidelines for the purpose of
Income Recognition and Assets Classification from the accounting year 1995-96. However,
guidelines relating to provisioning for RRBs have been made effective from the financial' year
ended 31.03.1997. The definition of NPAs is also gradually becoming tough for RRBs to cover
1

all advances like Commercial Banks. Although most of-the guidelines relating to RRBs are
similar to that of Commercial Banks, they have been made applicable in a phased manner for
RRBs.
INDIAN BANKS FUNCTIONALLY diverse and geographically widespread, have played a
crucial role in the socio- economic progress of the country. Banks extend credit to different types
of borrowers for many different purposes. For most customers, bank credit is the primary source
of available debt financing.
For banks good loans are the most profitable assets. Return comes in the form of loan interest,
fee income and investment and the most prominent assumed risk is credit risk. Credit risk
involves inability or unwillingness of customer or counterpart to meet commitments in relation
to lending once a loan is overdue and ceases to yield income it would become a Non Performing
Asset.
Proper management and speedy disposal of NPAs is one of the most critical tasks of banks
today. The problem of Non Performing Assets [NPAs] in banks and financial institutions has
been a matter of grave concern not only for the banks but also the real economy in general, as
NPAs can choke further expansion of credit which would impede the economic growth of the
country. Any bottleneck in the smooth flow of credit is bound to create adverse repercussions in
the economy. NPAs are not therefore the concern of only lenders but also the public at large.
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 insurability
2

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.

MEANING OF NPA
A Non-performing asset (NPA) is defined as a credit facility in respect of which the interest
and/or installment of Bond finance principal has remained past due for a specified period of
time. NPA is used by financial institutions that refer to loans that are in jeopardy of default. Once
the borrower has failed to make interest or principle payments for 90 days the loan is considered
to be a non-performing asset. Non-performing assets are problematic for financial institutions
since they depend on interest payments for income. Troublesome pressure from the economy can
lead to a sharp increase in non-performing loans and often results in massive write-downs.
With a view to moving towards international best practices and to ensure greater transparency, it
has been decided to adopt the 90 days overdue norm for identification of NPA, from the year
ending March 31, 2004. Accordingly, with effect from March 31, 2004, a non-performing asset
(NPA)is a loan or an advance where;

Interest and/or installment of principal remain overdue for a period of more than 91 days
in respect of a term loan,

The account remains out of order for a period of more than 90 days, in respect of
an Overdraft/Cash Credit (OD/CC),

The bill remains overdue for a period of more than 90 days in the case of bills purchased
and discounted,

Interest and/or installment of principal remains overdue for two harvest seasons but for a
period not exceeding two half years in the case of an advance granted for agricultural
purposes, and

Any amount to be received remains overdue for a period of more than 90 days in respect
of other accounts.

Non submission of Stock Statements for 3 Continuous Quarters in case of Cash Credit
Facility.
4

No active transactions in the account (Cash Credit/Over Draft/EPC/PCFC) for more than
91days

sify non-performing assets further into the following three categories based on the period for
which the asset has remained non-performing and the realisability of the dues:
1. Sub-standard assets: a sub standard asset is one which has been classified as NPA for a
period not exceeding 12 months.
2. Doubtful Assets: a doubtful asset is one which has remained NPA for a period exceeding
12 months.
3. Loss assets: where loss has been identified by the bank, internal or external auditor or
central bank inspectors. But the amount has not been written off, wholly or partly.
Sub-standard asset is the asset in which bank have to maintain 15% of its reserves. All those
assets which are considered as non-performing for period of more than 12 months are called as
Doubtful Assets. All those assets which cannot be recovered are called as Loss Assets.

ABOUT THE REPORT

Title of the study: - The present study is titled as A

PROJECT
REPORT
ON
NPA
MANAGEMENT
IN
BANK(SBI).

Objective of the study:- The following are the objective of

the study
To study the position of non performing assets in SBI.
To know the impact on NPA on strategic banking variable.
To know the reason for an asset becoming NPA.

Period of the study:-The period of the present study is

FEB 2016.

Limitations of the Study:-The present study has got all

the limitations of explanatory study method.
6

 Data and Methodology:-For the purpose of the present

study I had referred internet, books, newspaper to collect
information.

CHAPTER 2
PROFILE
STATE BANK OF INDIA

SBI is the largest bank in India with deposits of Rs 3, 67,000 crore as on March 31, 2005. It
dominates the Indian banking sector with a market share of around 20% in terms of total banking
sector deposits. The increasing focus on upgrading the technology back-bone of the bank will
enable it to leverage its reach better, improve service levels, provide new delivery platforms, and
improve operating efficiency to counter the threat of competition effectively. Once the core
banking solution (CBS) is fully implemented, it will cover over 10,000 branches and ATMs of
the State Bank group, and emerge as the strongest technology enabled distribution network in
India.
The increasing integration of SBI with its associate banks (associates) and subsidiaries will
further strengthen its dominant position in the banking sector and position it as the countrys
largest universal bank.

Resource-raising capabilities
SBIs funding profile is strong, underpinned by its strong retail deposit base. The bank is facing
increasing competition in its metropolitan and urban franchise. SBIs strong franchise gives it
access to a steady source of stable retail funds, which constitute around 59% of the total
resources as on March 31, 2005 (56% as at March 31, 2004).
7

Savings deposits have shown a strong three-year growth of 19%. Thus, despite a reduction in the
proportion of current account deposits, low-cost deposits have continued to constitute over 40%
of total deposits as at March 31, 2005. The banks cost of deposits (excluding IMD) has
significantly reduced to 4.70% for the 2004-05 (refers to financial year from April 1 to March
31), compared with 5.48% in 2003-04. The banks liquidity position is very strong due to healthy
accretion to deposits, large limits in the call market, and significant surplus SLR investments.
SBI will maintain its strong funding profile and a low cost resource position in view of its strong
retail base and wide geographical reach.

Earnings profile to remain good

SBI will maintain a good earnings profile in the medium term despite high pressure on yields due
to the increasing competition in the banking sector. SBIs earning profile is characterised by
consistency in the return on assets (PAT/Average Assets), at around 1% per annum for the past
three years, and diverse income streams. To maintain yields and pursue credit growth, the bank is
aggressively targeting retail finance and small and medium enterprises (SMEs). The banks core
fee income of 1% of average funds deployed bolsters its revenue profile. However, with the
opening of government business like tax collection to other banks and increased competition, the
growth in fee income is expected to slow down. The banks operating expense at 2.44% of
average funds deployed in 2004-05 is in line with other public sector banks. The banks cost
structure is rigid as fixed employee cost accounted for 74% of the operating expenditure in 200405. Thus, despite good asset growth and technology efficiency gains, the banks operating costs
will remain high in the medium term. To be able to reap the full benefits of technology
implementation, the bank will have to reduce or redeploy work force; since this is a sensitive
issue, it is expected to happen gradually.
The banks fund based and fee income earnings are diversified across industries, regions, asset
classes, and customer segments.
Strong diversification in income streams will ensure that the banks earnings remain relatively
stable, despite the decline in profitability in some segments.

Comfortable capital position

SBI is adequately capitalized with a tier I capital adequacy ratio of 8.04% and a large capital
base of Rs 240.72 billion as at March 31, 2005. The bank has considerably improved its net
worth coverage for net NPAs to 4.4 times as at March 31, 2005 due to lower slippages reflecting
an improving asset quality, witnessed across the entire banking sector. The capitalization levels
of SBI are adequate to address the asset side risks and support the business growth in the
medium term.

Management strategies
In retail finance, the bank has leveraged its corporate relationships, pursued business growth
selectively, and has not competed based on interest rate. The bank has taken initiatives like online tax returns filing and faster transfer of funds to protect its dominant position in the
government business. The bank also has a clear technology strategy that will enable it to compete
with the new generation private sector banks in customer service and operational efficiency.

Asset quality to remain at average levels

The bank continues to have a high level of gross NPAs at 5.95% of gross advances as at March
31, 2005, compared with 4.9% for all scheduled commercial banks (SCBs) taken together. The
bank is facing challenges to improve the quality of assets originated, as can be seen in the
consistently higher levels of slippages (additions to NPAs) at 2.71% in 2004-05.
To contain NPAs and ensure credit growth, the bank has decided to focus on financing the retail
(personal) segment as well as SMEs. The share of retail advances has increased to 24.73% (Rs
522.08 billion) of total advances as at September 30 2005. In the retail loan segment, SBI is
targeting primarily the housing loans segment, which constitutes Rs. 283.41 billion (54.3%) of
total retail loans. The NPAs in retail finance are low currently; however they are steadily
increasing (especially in the housing finance portfolio) and have started showing signs of stress.
SBIs retail portfolio has grown at over 37% CAGR in the last two years and hence a significant
portion of the portfolio is largely unseasoned. The housing finance portfolio has a 12-month,
lagged gross NPA of 4.34% as at March 31, 2005.The bank will face significant challenges in the
9

medium term to develop effective credit appraisal and collection systems in order to contain
NPAs in retail finance. SBIs asset quality is expected to remain at average levels, as the banks
large and diverse asset portfolio reflects of the asset quality of the banking system.

Business description
SBI along with its associate banks offer a wide range of banking products and services across its
different client markets. The bank has entered the market of term lending to corporates and
infrastructure financing, traditionally the domain of the financial institutions. It has increased its
thrust in retail assets in the last two years, and has built a strong market position in housing
loans.
SBI, through its non-banking subsidiaries, offers a host of financial services, viz., merchant
banking, fund management, factoring, primary dealership, broking, investment banking and
credit cards. SBI has commenced its life insurance business by setting up a subsidiary, SBI Life
Insurance Company Limited, which is a joint venture with Cardiff S.A., one of the largest
insurance companies in France. SBI currently holds 74% equity in the joint venture.

Industry prospects
To leverage benefits such as access to low cost resources and the facility to provide a larger
gamut of services, a number of finance companies such as Kotak Mahindra Finance Limited and
HDFC Limited have promoted banks. Simultaneously, yet another emerging trend is that of
foreign banks promoting NBFCs to benefit from regulatory flexibility available to such entities
in areas like absence of statutory liquidity ratio and cash reserve ratio requirements, priority
sector requirements, and corporate exposure limits.

New private sector banks capture market share

With technological edge and a strong marketing thrust, private sector banks have been stealing
market share in retail deposits and the corporate fee business from public sector banks. Together
10

with some foreign banks, these private banks have also aggressively entered the retail asset
financing space, hitherto the domain of non-banking finance companies.
Given their focus on cross selling and optimizing their customer base, they now offer the entire
range of products and services on the asset and liability side to retail and wholesale customers

Asset quality to improve

Banks have not yet fully resolved the stress in the asset quality of their legacy corporate loan
portfolios, however. Though slippages to NPAs and provisioning were high for some banks in
FY2004, as they moved to the 90-day norm for recognising and provisioning for NPAs, the
treasury gains enabled significant provisioning to be made with the result that net NPAs for most
public sector banks are now less than 3%.
Going forward, steady growth in gross domestic product should help improve the banks asset
quality and increase corporate lending. The securitization and reconstruction of financial assets
and enforcement of security interest (Sarfaesi) Act should also help banks in limiting slippages
and improving NPA recoveries.

Better Capitalization levels

Banks have demonstrated a fair amount of flexibility in raising fresh equity capital through
public issues in recent years, thereby improving their capitalization levels. The steady accruals to
net worth and falling non-performing asset levels have resulted in an improvement in the
capitalization position of banks in recent years.

Challenges ahead
Competition from new private sector and foreign banks remains a key challenge for public sector
banks. They need to reorient their staff and effectively utilize technology platforms to retain
customers and reduce costs. They also need to fortify their credit risk management systems to
mitigate the risks arising from small-ticket lending to the retail, small and medium enterprises,
and services segments.
11

Consolidation and emergence of universal banking groups

The cap on foreign ownership of banks has already been raised from 49% to 74%. The
competition in the sector could get further intensified if the 10% cap on voting rights is also
relaxed. New private sector banks are expanding their geographical coverage and making inroads
into government business. The new private and foreign banks will continue to gain market share
from public sector banks because of their efficient cost structures, technological edge, focused
marketing approach and operational freedom. However, the emergence of newer players would
be restricted if the private ownership of banks is capped at low levels. Mergers among PSBs
would create banks with even larger balance sheets and customer base. However, the integration
process in such mergers is expected to be complex and time long drawn.
These would also be driven by GoI due to provisions of Banking Companies (Acquisition and
Transfer of Undertakings) Act 1969, and hence political scenario will impact the timing and
permutations possible. Strategic alliances between banks and other financial sector players such
as insurance companies and mutual funds are also likely as banks attempt to enhance their
product range, leverage on economies of scale and reduce costs.

12

CHAPTER 3
THEORETICAL VIEW
CLASSIFICATION OF NPA
Banks are required to classify NPAs further into the following three categories based on the
period for which the asset has remained non-performing and the reliability of the dues:
i.

Sub-standard Assets: A sub-standard asset is one which has remained NPA for a period
less than or equal to 18 months. In such cases, the current net worth of the borrower, or
the current market value of the security charged is not enough to ensure recovery of the
dues to the banks in full. Such assets will have well defined credit weakness that
jeopardize the liquidation of the debt and are characterized by the distinct possibility that
the bank will sustain a loss.

ii.

Doubtful Assets: A Doubtful Asset which has remained NPA for a period exceeding 18
months. It has all the weaknesses inherent to a sub-standard asset with the added
characteristic that the collection or liquidation in full on the basis of currently known
facts is highly questionable and improbable.

iii.

Loss Assets: A loss asset is one where a loss has been identified by the bank or, internal
or external auditors but the amount has not been written off wholly.

13

GUIDELINES FOR CLASSIFICATION OF NPAS

Broadly speaking, classification should be done taking into account the degree of well defined
credit weaknesses and the extent of dependence on collateral security for realization of dues.
Banks should establish appropriate internal systems to eliminate the tendency to delay or
postpone the identification of NPAs, especially in respect of high value accounts.

Accounts with temporary deficiencies: These should be classified based on the past recovery
records.

Accounts regularize near about the balance sheet date: These accounts should be handled
with care and without scope for subjectivity. Where the account indicates inherent weakness
based on available data, it should be deemed as an NPA.

Asset classification should be borrower-wise and not facility-wise: If a single facility to a

borrower is classified as NPA, others should also be classified the same way, as it is difficult
to envisage only a solitary facility becoming a problem credit and not others.

Advances under consortium arrangements: Classification here should be based on the

recovery record of the individual member banks.

Accounts where there is erosion in the value of the security: If there is a significant (i.e. the
realizable value of the security is less than 50% of that assessed by the bank during
acceptance) the account may be classified as NPA.

14

NPA SOME ASPECTS AND ISSUES

1.

The NPAs of banks in India are considered to be at higher levels than those in other
countries. This issue has attracted attention of public as also of international financial
institutions and has gained further prominence in the wake of transparency and disclosure
measures initiated by RBI during recent years.

2.

The NPA Management Policy document of SBI lays down to contain net NPAs to less
than 5% of bank's total loan assets in confirmity with the international standard. It is,
therefore necessary that as per guidelines provided in NPA Management Policy
document, every effort be made at all levels to cut down the NPAs. All this requires
greater efforts and teamwork.

3.

It is essential to keep a constant watch over the non-performing assets not just to keep it
performing but also that once they become non-performing, effective measures are
initiated to get full recovery and where this is not possible, the various means are to be
initiated to get rid off the NPAs from the branch books.

4.

NPAs adversely affect the wealth condition of the branch advances as also the
profitability of the branch. Some of the reasons for this are as under:

5.

(a)

Interest cannot be applied on the loan accounts classified as NPAs.

(b)

The Branch 'has to pay interest to central office on outstanding classified as NPA.

(c)

The Branch has to incur cost in supervision and follow up of such advances.

(d)

Provision has to be made on NPAs at Bank level.

Under Income Recognition, Assets Classification and provisioning, NPA may be Sub
standard, Doubtful or loss assets.

6.

Once the assets are classified as NPA, the Branch Manager has to take all the necessary
steps to get the dues recovered there-under to maintain the good health of advances and
the higher profitability at the-Branch. This requires management of NPAs in such a
15

Planned and scientific manner that the percentage of NPAs to the total advances will be
minimum.

16

RECOGNITION OF INCOME ON NON-PERFORMING LOANS (NPLS)

Stricter regulations have been laid down by supervisory authorities in many countries with
regard to income recognition on Non-Performing

Loans (NPLs). The suspension of interest

payments is required on loans that are classified as 'non-performing' ['substandard', 'doubtful' and
'loss'].
Any uncollected interest payments on NPLs are considered non-accrued interest. Previously
accrued, but uncollected interest is reversed out of income. Failure to do so would overstate
income. Uncollected interest is normally put in a memorandum account. NPLs are restored on an
accrual basis only after full settlement has been made on all delinquent principal and interest. It
would, therefore, be useful, if the accounts carry a footnote, explaining the accounting policies
followed with regard to recognition of income on NPLs.

17

REASONS FOR RISE IN NPAs

FACTORS FOR RISE IN NPAs The banking sector has been facing the serious problems of the
rising NPAs. But the problem of NPAs is more in public sector banks when compared to private
sector banks and foreign banks. The NPAs in PSB are growing due to external as well as internal
factors.
EXTERNAL FACTORS
Ineffective recovery tribunal
The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and
advances. Due to their negligence and ineffectiveness in their work the bank suffers the
consequence of non-recover, their by reducing their profitability and liquidity.
Wilful Defaults
There are borrowers who are able to payback loans but are intentionally withdrawing it. These
groups of people should be identified and proper measures should be taken in order to get back
the money extended to them as advances and loans.
Natural calamities
This is the measure factor, which is creating alarming rise in NPAs of the PSBs. every now and
then India is hit by major natural calamities thus making the borrowers unable to pay back there
loans. Thus the bank has to make large amount of provisions in order to compensate those loans,
hence end up the fiscal with a reduced profit. Mainly ours farmers depends on rain fall for
cropping. Due to irregularities of rain fall the farmers are not to achieve the production level thus
they are not repaying the loans
Industrial sickness
Improper project handling , ineffective management , lack of adequate resources , lack of
advance technology , day to day changing govt. Policies give birth to industrial sickness. Hence
the banks that finance those industries ultimately end up with a low recovery of their loans
reducing their profit and liquidity.
18

 Lack of demand
Entrepreneurs in India could not foresee their product demand and starts production which
ultimately piles up their product thus making them unable to pay back the money they borrow to
operate these activities. The banks recover the amount by selling of their assets, which covers a
minimum label. Thus the banks record the nonrecovered part as NPAs and has to make provision
for it.
Change on Govt. policies
With every new govt. banking sector gets new policies for its operation. Thus it has to cope with
the changing principles and policies for the regulation of the rising of NPAs. eg. The fallout of
handloom sector is continuing as most of the weavers Co-operative societies have become
defunct largely due to withdrawal of state patronage. The rehabilitation plan worked out by the
Central govt to revive the handloom sector has not yet been implemented. So the over dues due
to the handloom sectors are becoming NPAs.

INTERNAL FACTORS
Defective Lending process
There are three cardinal principles of bank lending that have been followed by the commercial
banks since long. i. Principles of safety ii. Principle of liquidity iii. Principles of profitability
i. Principles of safety By safety it means that the borrower is in a position to repay the loan both
principal and interest. The repayment of loan depends upon the borrowers:
a. Capacity to pay
b. Willingness to pay
Capacity to pay depends upon: 1. Tangible assets 2. Success in business Willingness to pay
depends on: 1. Character 2. Honest 3. Reputation of borrower The banker should, there fore take
utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one

19

and the borrower is capable of carrying it out successfully .he should be a person of integrity and
good character.
Inappropriate technology
Due to inappropriate technology and management information system, market driven decisions
on real time basis can not be taken. Proper MIS and financial accounting system is not
implemented in the banks, which leads to poor credit collection, thus NPA. All the branches of
the bank should be computerised.
Improper swot analysis
The improper strength, weakness, opportunity and threat analysis is another reason for rise in
NPAs. While providing unsecured advances the banks depend more on the honesty, integrity, and
financial soundness and credit worthiness of the borrower. Banks should consider the
borrowers own capital investment. it should collect credit information of the borrowers from a.
From bankers b. Enquiry from market/segment of trade, industry, business. c. From external
credit rating agencies. Analyse the balance sheet True picture of business will be revealed on
analysis of profit/loss a/c and balance sheet. Purpose of the loan When bankers give loan, he
should analyse the purpose of the loan. To ensure safety and liquidity, banks should grant loan
for productive purpose only. Bank should analyse the profitability, viability, long term
acceptability of the project while financing.
Poor credit appraisal system
Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the bank
gives advances to those who are not able to repay it back. They should use good credit appraisal
to decrease the NPAs.
Managerial deficiencies
The banker should always select the borrower very carefully and should take tangible assets as
security to safe guard its interests. When accepting securities banks should consider the 1.
Marketability 2. Acceptability 3. Safety 4. Transferability.

20

The banker should follow the principle of diversification of risk based on the famous maxim do
not keep all the eggs in one basket; it means that the banker should not grant advances to a few
big farms only or to concentrate them in few industries or in a few cities. If a new big customer
meets misfortune or certain traders or industries affected adversely, the overall position of the
bank will not be affected. Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand
loom industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), and the handloom
sector Orissa hand loom WCS ltd (2439.60lakhs).
Absence of regular industrial visit
The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank
officials to the customer point decreases the collection of interest and principals on the loan. The
NPAs due to wilful defaulters can be collected by regular visits.
Re loaning process
Non remittance of recoveries to higher financing agencies and re loaning of the same have
already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters and
CCBs and PACs, the NPAs of OSCB is increasing day by day.

21

IMPACT OF NPAS ON BANKS:In portion of the interest income is absorbed in servicing NPA.NPA is not merely nonremunerative. It is also cost absorbing and profit eroding.
In the context of severe competition in the banking industry, the weak banks are at disadvantage
for leveraging the rate of interest in the deregulated market and securing remunerative business
growth. The options for these banks are lost. "The spread is the bread for the banks". This is the
margin between the cost of resources employed and the return therefrom." This is the margin
between the cost of resources employed and the return thereform. In other words it is gap
between the return on funds deployed (Interest earned on credit and investments) and cost of
funds employed (Interest paid on deposits).
When the interest rates were directed by RBI, as heretofore, there was not option for banks. But
today in the deregulated market the banks decide their lending rates and borrowing rates. In the
competitive money and capital Markets, inability to offer competitive market rates adds to the
disadvantage of marketing and building new NPA has affected the profitability, liquidity and
competitive functioning of banks and finally the psychology of the bankers in respect of their
disposition towards credit delivery and credit expansion.

1.

Impact on Profitability

"The efficiency of banks is not always reflected only by the size of its balance sheet but by
the level of return on its assets. NPAS do not generate interest income for the banks, but at the
same time banks are required to make provisions for such NPAS from their current profits.
NPAS have a deleterious effect on the return on assets in several ways:

They erode current profits through provisioning requirements.

They result in reduced interest income.

They require higher provisioning requirements affecting profits and accretion to

capital funds and capacity to increase good quality risk assets in future, and
22

They limit recycling of funds, set in asset-liability mismatches, etc.

There is at times a tendency among some of the banks to understate the level of NPAs in order to
reduce the provisioning and boost up bottom lines. It would only postpone the process.
In the context of crippling effect on a bank's operations in all spheres, asset quality has been
placed as one of the most important parameters in the measurement of a bank's performance
under the CAMELS supervisory rating system of RBI.
Between 01.04.93 to 31.03.2001, SBI Group incurred a total amount of Rs. 31251 Crores
towards provisioning NPA. This has brought Net NPA to Rs. 32632 Crores or 6.2% of net
advances. To this extent the problem is contained but a what cost?
This costly remedy is made at the sacrifice of building healthy reserves for future capital
adequacy.
The enormous provisioning of NPA together with the holding cost of such non-productive assets
over the years has acted as a severe drain on the profitability of the SBI Group. In turn SBI
Group are seen as poor performers and unable to approach the market for raising additional
capital. Equity issues of nationalized banks that have already tapped the market are now quoted
at a discount in the secondary market. Other bans hesitate to approach the market to rise new
issues. This has alternatively forced SBI Group to borrow heavily from the debt market to build
Tier II Capital to meet capital adequacy norms putting severe pressure on their profit margins;
else they are to seek the bounty of the Central Government for repeated Recapitalization.
Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of funds at
6% plus 1% service charge) the net NPA of Rs. 32632 Croces absorbs a recurring holding ost of
Rs. 2300 Crores annually. Considering the average provisions made for the last 8 years which
works out to average of Rs. 3300 crores from annum, a sizeab business.

In the face of the deregulated banking industry, an ideal competitive working is reached, when
the banks are able to earn adequate amount of non-interest income to cover their entire operating

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expenses i.e. a positive burden. In that event the spread factor i.e. the difference between the
gross interest income and interest cost will constitute its operating profits.
Theoretically even if the banks keeps 0% spread, it will still break even in terms of operating
profit and not return an operating loss. The net profit is the amount of the operating profit minus
the amount of provisions to be made including for taxation. On account of the burden of heavy
NPA, many nationalised banks have little option and they are unable to lower lending rates
competitively, as a wider spread is necessitated to cover cost of NPA in the face of lower income
from off balance sheet business yielding non-interest income.

The following working results of SBI Group an identified well manged nationalised banks for
the last two years and for the first nine months of the current financial year, will be revealing to
prove this statement.
Non-interest income fully absorbs the operating expenses of this banks in the current financial
year for the first 9 months. In the last two financial years, though such income has substantially
covered the operating expenses (between 80 to 90%) there is still a deficit left.
The strength of SBI Group is indentified by the following positive feature:
1.

It's sizeable earnings under of non-interest income substantially/totally meets its noninterest expenses.

2.

Its obligation for provisioning requirements is within bounds. (Net NPA/Net

Advances is 1.92%)

It is worthwhile to compare the aggregate figures of the 19 Nationalised banks for the year ended
March, 2001, as published by RBI in its Report on trends and progress of banking in India.
Interest on Recapitalization Bonds is a income earned form the Government, who had issued the
Recapitalization Bonds to the weak banks to sustain their capital adequacy under a bailout
package. The statistics above show the other weaknesses of the nationalised banks in addition to
the heavy burden they have to bear for servicing NPA by way of provisioning and holding cost as
under:
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Their operating expenses are higher due to surplus manpower employed. Wage costs total
assets is much higher to PSBs compared to new private banks or foreign banks.

Their earnings from sources other than interest income are meagre. This is due to failure
to develop off balance sheet business through innovative banking products.

2.

Impact on Liquidity of the SBI Group

Though SBI Group are able to meet norms of Capital Adequacy, as per RBI guidelines, the facts
that their net NPA in the average is as much as 7% is a potential threat for them. RBI has
indicated the ideal position as Zero percent Net NPA. Even
granting 3% net NPA within limits of tolerance the SBI Group are holding an uncomfortable
burden at 7.1% as at March 2001. They have not been able to build additional capital needed for
business expansion through internal generations or by tapping the equity market, but have
resorted to II-Tier capital in the debt market or looking to recapitalistion by Government of
India.
3.

Impact on Outlook of Bankers towards Credit Delivery.

The fear of NPA permeates the psychology of bank managers in the SBI Group in entertaining
new projects for credit expansion. In the world of banking the concepts of business and risks are
inseparable. Business is an exercise of balancing between risk and reward. Accept justifiable
risks and implements de-risking steps. Without accepting risk, there can be no reward. The
psychology of the banks today is to insulate themselves with zero percent risk and turn lukewarm
to fresh credit. This has affected adversely credit growth compared to growth of deposits,
resulting in a low C/D Ratio around 50 to 54% for the industry.
The fear psychosis also leads to excessive security-consiousness in the approach towards lending
to the small and medium sized credit customers. There is insistence on provision of collateral
security, sometimes up to 200% value of the advance, and consequently due to a feeling of
assumed protection on account of holding adequate security (albeit over-confidence). a tendency
towards laxity in the standards of credit appraisal comes to the fore. It is well know that the
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existence of collateral security at best may convert the credit extended to productive sectors into
an investment against real estate, but will not prevent the account turning into NPA. Further
blocked assets and real estate represent the most illiquid security and NPA in such advances has
the tendency to persist for a long duration.
SBI Group have reached a dead-end of the tunnel and their future prosperity depends on an
urgent solution for handling this hovering threat.
4.

Impact on Productivity:

High level of NPAs effect the productivity of the banks by increasing the cost of funds and by
reducing the efficiency of banks employees. Cost of funds is increased because due to nonavailability of sufficient internal sources they have to rely on external sources to fulfill their
future financial requirements. Productivity of employees is also reduced because it keeps staff
busy with the task of recovery of overdue. Instead of devoting time for planning for development
through more credit and mobilization of resources the branch staff would primarily be engaged
in preparing a large value of returns and statements relating to sub-standard, doubtful and loss
assets, preparing proposal for filing of suits, waivement of legal action, compromise, write off or
in preparing DICGC claim papers etc.
5.

Impact on other Variables:

High level of NPAs also leads to squeezing of interest spread, when asset becomes an NPA for
the first time it adversely affects the spread by not contributing to the interest income and from
the second year onwards it will have its impact on the bottom line of the balance sheet because of
provisioning to be made for it and not have incremental effect on the spread.
Now a days Govt. does not encourage liberal capital support to be given to banks. Banks are
required to bring their own capital by issuing share to the public, whereas high level of NPAs
leads to lower profits hence less or no profits available for equity shareholders hence lower EPS
and fall in the value of share. During the year 2001-02 share of 12 public sector banks were
traded on the NSE out of which share value of three PSBs have decreased. Low market value of
shares has also forced the banks to borrow heavily debt market to build Tier II capital to meet
capital adequacy norms, putting severe pressure on their profit margins.
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6.

Qualitative aspects of the Micro Level Impact of NPAs:

High incidence of loan defaults shakes the confidence of general public in the soundness of
banking setup and indirectly effects the capacity of the banking system to mop up the deposits. It
is a blot on the credibility of the banking system. It also leads to loss of trust of foreign suppliers.
Reputed foreign suppliers do not accept letter of credit opened bi Indian banks or confine their
transaction to top Indian banks only. Moreover, it puts negative effect on granting of autonomy
to PSBs whreas it is must for banks in this competitive environment. Banks having positive net
profits for the last three years, Net NPA level below 9%, owned funds of Rs. 100 Crore, CAR of
> 8% are the 4 condition to be fulfilled to get autonomous status, which becomes difficult in the
situation of huge level of NPAs
.
Inadequate recovery also inhibits the banks to draw refinance from higher level agency.
The eligibility of a bank to draw refinance from NABARD is linked to the %age of recovery to
demand in respect of direct, medium and long term loans for agriculture and allied activities. It
implies that refinance facility would be progressively reduced depending on the position of NPAs
and also on the No. of years in which a banks branch remains in a particular category of default.
Due to fear of NPAa banks are being taken away from the basic function for which these were
established it is becoming more & more risky and less remunerative. They are floating their
subsidiaries to manage mutual funds, factoring, insurance business, Good money is spent to
recover bad money. Deterioration in the quality of loan assets and inability to come with new
products makes the Indian banks uncompetitive globally. Due to high cost, they cannot reduce
lending rate to meet the economy's demand of low lending rate. It is also biggest threat for
capital account convertibility.
7.

Some areas of Macro-Economic Impact:

It is not only the banks which are affected higher level of NPAs but it is the economy as a whole
which pays for it. Banks are not putting enough resource in lending due to fear of default. Once
the credit to various sectors of the economy slow down, the economy is badly hit. There is
slowdown in growth in GDP, industrial output and fall in the profit margins of the corporate and

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consequent depression in the market. Further high level of NPAs can result in adding to the
inflationary potential in the economy and eroding the viability of the credit system as a whole.
Not only this, burden of NPAs is to be borne by the society as a whole. When capital support is
given to PSB on A/c of losses booked and/ or erosion of capital due to NPAs, it comes out of
either Govt. budgetary resources or from the public as per
Liberalization policy, whether this money is from tax revenues or from the hard earned saving of
the investing public, in fact, the society is bearing the cost of these
NPAs. Moreover, Govt. holds majority of shares in PSBs in some banks 100% capital is in its
hand. Any dividend declared would have gone to the Govt. and which can be spent on the
welfare and development program.

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RECOMMENDATION

Credit administration:

A banks have to strengthen their credit administrative

machinery and put in place effective credit risk management systems to reduce the fresh
incidence of NPAs.

Better Inspection:

We shall keep a close watch on the manner in which NPA

reduction is taking place.

Cash Recovery:

We should also insist that cash recoveries should more than offset

the fresh write-offs in NPAs.

Perception:

The mindset of the borrowers needs to change so that a culture of proper

utilization of credit facilities and timely repayment is developed.

Financial System:

As you are aware, one of the main reason for corporate default is

on account of diversion of funds and corporate entities should come forward of avoid this
practice in the interest of strong and sound financial system.

Coordinator: Extending credit involves lenders and borrowers and both should realize
their role and responsibilities. They should appreciate the difficulties of each other and
should endeavor to work contributing to a healthy financial system.

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CHAPTER 4
CONCLUSION
CONCLUSION
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 NPA 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 prescriptions of 40% of net bank credit to priority
sectors have led to higher NPAs, due to credit to these sectors becoming stickly 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, mangers should make it
amply clear to potential borrowers that banks resources are scare 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 and
use of funds and timely recovery f loans is absolutely necessary pre conditions for preventing
of minimizing the incidence of new NPAs.

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BIBILOGRAPHY
BOOKS : INDIAN FINANCIAL SYSTEM
AUTHOR : KHAN.
PUBLISHER : TATA MCGRAW HILL.

www.sbi.com
www.wikipedia.com
www.scribd.com

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