FINAL PROJECT REPORT ON

“NON PERFORMING ASSETS”

-----------------------------------------------------------------------------
-------------

UNDER THE GUIDANCE OF

MR. HARWINDER SINGH

SUBMITTED BY

AMRIK SINGH POTHIWAL

ROLL NO: 42

MASTER IN MANAGEMENT STUDIES

2009-2011

-----------------------------------------------------------------------------
-------------
 NPA MANAGEMENT

TO

THE UNIVERSITY OF MUMBAI

IN PARTIAL FULFILMENT OF TWO YEAR FULL TIME

DEGREE / DIPLOMA

OF

( MASTER OF MANAGEMENT STUDIES )

GURU NANAK INSTITUTE OF MANAGEMENT STUDIES

MATUNGA, MUMBAI 400 019.

2
 NPA MANAGEMENT

CERTIFICATE

This is to certify that the study presented by “Amrik singh pothiwal” to the University of
Mumbai in part completion of the two year full time degree/diploma of Masters of
management studies under the title of Non Performing Assets has been done under my
guidance.

To the best of my knowledge this project is in the nature of original work that has not been
submitted for any degree of this University or any other University.

Signature of the Candidate

_____________________

(Amrik singh pothiwal)

Forwarded through the Research Guide

Signature of the Guide

(Prof.Harwinder singh)

3
 NPA MANAGEMENT

ACKNOWLEDGEMENT

I take this opportunity to sincerely thanks and express my gratitude to my project guide
Prof.Harwinder singh for guiding me throughout my entire project.

The experience and the knowledge acquired over the interactions with the guide have been
invaluable to say the least and will help me a great deal in my future education and career.

My project was completed in a very supportive and interactive environment and has been
great learning experience. Last but not the least I would like to thanks my family and friends
for all the support they have provided me.

4
 NPA MANAGEMENT

ABSTRACT

This report deals with the problem of having non-performing assets, the reasons for
mounting of non-performing assets and the practices present in country for dealing with non-
performing assets.

“Banks are in the business of managing risk, not avoiding it……………………..”

Risk is the fundamental element that drives financial behavior. Without risk, the
financial system would be vastly simplified. However, risk is omnipresent in the real world.
Financial Institutions, therefore, should manage the risk efficiently to survive in this highly
uncertain world. The future of banking will undoubtedly rest on risk management dynamics.

Only those banks that have efficient risk management system will survive in the
market in the long run. The effective management of credit risk is a critical component of
comprehensive risk management essential for long-term success of a banking institution.
Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,
inherits. This has however, acquired a greater significance in the recent past for various
reasons. Foremost among them is the wind of economic liberalization that is blowing across
the globe. India is no exception to this swing towards market driven economy. Better credit
portfolio diversification enhances the prospects of the reduced concentration credit risk as
empirically evidenced by direct relationship between concentration credit risk profile and
NPAs of banks.

“……………………A bank’s success lies in its ability to assume and aggregate risk within
tolerable and manageable limits”.

5
 NPA MANAGEMENT

METHODOLOGY

Formulating the problem

Providing credit facility to the borrower is one of the important factors as far as the
banking sector is concerned. On the basis of the analyzed factor, I felt that the important issue
right now as far as the credit facilities are provided by bank is non performing assets. I started
knowing about the basics of the NPAs and decided to study on the NPAs.

Research Design

The research design for this study is basically analytical because it utilizes the large
number of data of the Public Sector Banks.

Type of the data

Primary data takes much time and are also expensive whereas the secondary data are easy to
search and are not expensive too. For my study I have utilized totally the secondary data.

Data Source

Bank of India

6
 NPA MANAGEMENT

OBJECTIVE OF THE STUDY

Primary objective:

The primary objective of the making report is:

 To know why NPAs are the great challenge to the Public Sector Banks.

Secondary objectives:

 To understand what is Non Performing Assets and what are the underlying reasons for
the emergence of the NPAs.
 To understand the impacts of NPAs on the operations of the Public Sector Banks.
 To know what steps are being taken by the Indian banking sector to reduce the NPAs

7
 NPA MANAGEMENT

INDEX

Sr. Topics Page

No. No.
1 History of Indian Banking 9
2 Scheduled banking structure in India 13
3 Bank of India- Introductory 16
4 What Is NPA? 22
5 Provisioning Norms & Asset Classification 34
6 Guidelines for Asset Classification 37
7 Write of Policy 39
8 Difficulties with NPA 41
9 Factors responsible for NPA 42
10 Reasons for NPA 44
11 Managing NPA 47
12 Measures to recover an NPA 48
13 Legal Resolutions for NPA 62
14 Findings and Recommendations 73
15 Conclusion 80
16 Limitations 84
17 Bibliography 85

HISTORY OF INDIAN BANKING

A bank is a financial institution that provides banking and ther financial services. By
the term bank is generally understood an institution that holds a Banking Licenses.
Banking licenses are granted by financial supervision authorities and provide rights to
conduct the most fundamental banking services such as accepting deposits and making loans.
There are also financial institutions that provide certain banking services without
meeting the legal definition of a bank, a so-called Non-bank. Banks are a subset of the
financial services industry.

The word bank is derived from the Italian banca, which is derived from German
and means bench. The terms bankrupt and "broke" are similarly derived from banca rotta,
which refers to an out of business bank, having its bench physically broken. Moneylenders in
8
 NPA MANAGEMENT

Northern Italy originally did business in open areas, or big open rooms, with each lender
working from his own bench or table.

Typically, a bank generates profits from transaction fees on financial services

or the interest spread on resources it holds in trust for clients while paying them
interest on the asset. Development of banking industry in India followed below stated steps.
1) Banking in India has its origin as early as the Vedic period. It is believed that
the transition from money lending to banking must have occurred even before
Manu, the great Hindu Jurist, who has devoted a section of his work to deposits and
advances and laid down rules relating to rates of interest.
2) Banking in India has an early origin where the indigenous bankers played a very
important role in lending money and financing foreign trade and commerce. During
the days of the East India Company, was the turn of the agency houses to
carry on the banking business. The General Bank of India was first Joint Stock
Bank to be established in the year 1786. The others which followed were the Bank
Hindustan and the Bengal Bank.

3) In the first half of the 19th century the East India Company established three
banks; the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of
Madras in 1843. These three banks also known as Presidency banks were
amalgamated in 1920 and a new bank, the Imperial Bank of India was established
in 1921. With the passing of the State Bank of India Act in 1955 the undertaking of
the Imperial Bank of India was taken by the newly constituted State Bank of India.

4) The Reserve Bank of India which is the Central Bank was created in 1935 by passing
Reserve Bank of India Act,1934 which was followed up with the Banking
Regulations in 1949.These acts bestowed Reserve Bank of India (RBI) with wide
ranging powers for licensing , supervision and control of banks. Considering the
proliferation of weak banks, RBI compulsorily merged many of them with stronger
banks in 1969.

5) The three decades after nationalization saw phenomenal expansion in the

geographical coverage and financial spread of the banking system in the country. As
certain rigidities and weaknesses were found to have developed in the system, during
9
 NPA MANAGEMENT

the late eighties the Government of India felt that these had to be
addressed to enable the financial system to play its role in ushering in a more
efficient and competitive economy. Accordingly, a high-level committee was set
up on 14 August 1991 to examine all aspects relating to the structure,
organization, functions and procedures of the financial system. Based on the
recommendations of the Committee (Chairman: Shri M. Narasimham), a
comprehensive reform of the banking system was introduced in 1992-93. The
objective of the reform measures was to ensure that the balance sheets of banks
reflected their actual financial health. One of the important measures related to
income recognition, asset classification and provisioning by banks, on the basis of
objective criteria was laid down by the Reserve Bank. The introduction of capital
adequacy norms in line with international standards has been another important
measure of the reforms process
.
• Comprises balance of expired loans, compensation and other bonds such as
National Rural Development Bonds and Capital Investment Bonds. Annuity
certificates are excluded.
• These represent mainly non – negotiable, non- interest bearing securities
issued to International Financial Institutions like International
Monetary Fund, International Bank for Reconstruction and Development
and Asian Development Bank.
• At book value.
• Comprises accruals under Small Savings Scheme, Provident Funds,
Special Deposits of Non- Government

6) In the post-nationalization era, no new private sector banks were allowed to be set up.
However, in 1993, in recognition of the need [Comparative analysis on NPA of
Private & Public sector Banks] to introduce greater competition which could
lead to higher productivity and efficiency of the banking system, new
private sector banks were allowed to be set up in the Indian banking system.
These new banks had to satisfy among others, the following minimum
requirements:

10
 NPA MANAGEMENT

• It should be registered as a public limited company;

• The minimum paid-up capital should be Rs 100 crore;
• The shares should be listed on the stock exchange;
• The headquarters of the bank should be preferably located in a centre which
does not have the headquarters of any other bank; and
• The bank will be subject to prudential norms in respect of banking operations,
accounting and other policies as laid down by the RBI. It will have to achieve
capital adequacy of eight per cent from the very beginning.

7) A high level Committee, under the Chairmanship of Shri M. Narasimham, was

constituted by the Government of India in December 1997 to review the
record of implementation of financial system reforms recommended by the CFS in
1991 and chart the reforms necessary in the years ahead to make the banking system
stronger and better equipped to compete effectively in international economic
environment. The Committee has submitted its report to the Government in April
1998. Some of the recommendations of the Committee, on prudential accounting
norms, particularly in the areas of Capital Adequacy Ratio, Classification of
Government guaranteed advances, provisioning requirements on standard
advances and more disclosures in the Balance Sheets of banks have been
accepted and implemented. The other recommendations are under consideration.

8) The banking industry in India is in a midst of transformation, thanks to the economic

liberalization of the country, which has changed business environment in the
country.During the pre-liberalization period, the industry was merely focusing on
deposit mobilization and branch expansion. But with liberalization, it found many of
its advances under the non-performing assets (NPA) list. More importantly,
the sector has become very competitive with the entry of many foreign and private
sector banks .The face of banking is changing rapidly. There is no doubt that
banking sector reforms have improved the profitability, productivity and efficiency

11
 NPA MANAGEMENT

of banks, but in the days ahead banks will have to prepare themselves to face new
challenges .

Scheduled banking structure in India

12
 NPA MANAGEMENT

HISTORY

Bank of India was founded on 7th September, 1906 by a group of eminent

businessmen from Mumbai. The Bank was under private ownership and control till July 1969
when it was nationalized along with 13 other banks.

Beginning with one office in Mumbai, with a paid-up capital of Rs.50 lakh and 50
employees, the Bank has made a rapid growth over the years and blossomed into a mighty
institution with a strong national presence and sizable international operations. In business
volume, the Bank occupies a premier position among the nationalised banks.

The Bank has 3021 branches in India spread over all states/ union territories including
136 specialized branches. These branches are controlled through 48 Zonal Offices. There are
28 branches/ offices (including three representative offices) abroad.

The Bank came out with its maiden public issue in 1997 and follow on Qualified
Institutions Placement in February 2008. . Total number of shareholders as on 31/03/2009 is
2, 35589.

While firmly adhering to a policy of prudence and caution, the Bank has been in the
forefront of introducing various innovative services and systems. Business has been
conducted with the successful blend of traditional values and ethics and the most modern
infrastructure. The Bank has been the first among the nationalized banks to establish a fully
computerised branch and ATM facility at the Mahalaxmi Branch at Mumbai way back in
1989. The Bank is also a Founder Member of SWIFT in India. It pioneered the introduction
of the Health Code System in 1982, for evaluating/ rating its credit portfolio.

The Bank's association with the capital market goes back to 1921 when it entered into
an agreement with the Bombay Stock Exchange (BSE) to manage the BSE Clearing House. It
is an association that has blossomed into a joint venture with BSE, called the BOI
Shareholding Ltd. to extend depository services to the stock broking community. Bank of
India was the first Indian Bank to open a branch outside the country, at London, in 1946, and
also the first to open a branch in Europe, Paris in 1974. The Bank has sizable presence

13
 NPA MANAGEMENT

abroad, with a network of 28 branches the international business accounts for around 17.82%
of Bank's total business.

14
 NPA MANAGEMENT

Mission & Vision

Mission
"to provide superior, proactive banking services to niche
markets globally, while providing cost-effective, responsive
services to others in our role as a development bank, and in so
doing, meet the requirements of our stakehoder
.

Vision
"to become the bank of choice for corporates, medium
businesses and upmarket retail customers and to provide cost
effective developmental banking for small business, mass
market and rural markets"

15
 NPA MANAGEMENT

BOARD MEMBERS OF BOI S.A.R.M.

Special Asset Recovery Management

Mumbai (Main) Branch

Asst. General
Shri L. Jayaraman
Manager
Shri M G.Lohani Chief Manager
Shri K.C. Ugrani Manager
Shri S.D. Tirmare Officer
Shri S.S. Pathak Officer
Miss. Vidya Deshpande Officer

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.
16
 NPA MANAGEMENT

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.

17
 NPA MANAGEMENT

THE EMERGENCE OF NPA IN INDIAN BANKING & FINANCIAL

INSTITUTIONS AND ITS DIMENSIONS

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 effected
under banking reforms by the Government of India and RBI in terms of the two Narasimhan
Committee Reports in this contemporary period have been neutralised 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.

NPA statistics is executed through the following ways.

• Failure to identify an NPA as per stipulated guidelines: There were instances of `sub-
standard' assets being classified as `standard';
• Wrong classification of an NPA: classifying a `loss' asset as a `doubtful' or `sub-
standard' asset; classifying a `doubtful' asset as a `sub-standard' asset.
• Classifying an account of a credit customer as `substandard' and other accounts of the
same credit customer as `standard', throwing prudential norms to the winds.

Essentially arising from the wrong classification of NPAs, there was a variation in the
level of loan loss provisioning actually held by the bank and the level required to be made.
This practice can be logically explained as a desperate attempt on the part of the bankers,
whenever adequate current earnings were not available to meet provisioning obligations.
Driven to desperation and impelled by the desire not to accept defeat, they have chosen to
mislead and claim compliance with the provisioning norms, without actually providing. This
only shows that the problem has swelled to graver dimensions.

The international rating agency Standard & Poor (S & P) conveys the gloomiest picture,
while estimating NPAs of the Indian banking sector between 35% to 70% of its total
outstanding credit. Much of this, up to 35% of the total banking assets, as per the rating
agency would be accounted as NPA if rescheduling and restructuring of loans to make them
18
 NPA MANAGEMENT

good assets in the book are not taken into account. However RBI has contested this dismal
assessment. But the fact remains that the infection if left unchecked will eventually lead to
what has been forecast by the rating agency. This invests an urgency to tackle this virus as a
fire fighting exercise.

Emergence of NPA as an Alarming Threat to Nationalised Banks

NPA is a brought forward legacy accumulated over the past three decades, when
prudent norms of banking were forsaken basking by the halo of security provided by
government ownership. It is not wrong to have pursued social goals, but this does not justify
relegating banking goals and fiscal discipline to the background. But despite this
extravagance the malaise remained invisible to the public eyes due to the practice of not
following transparent accounting standards, but keeping the balance sheets opaque. This
artificially conveyed picture of 'all is well' with PSBs suddenly came to an end when the lid
was open with the introduction of the prudential norms of banking in the year 1992-93,
bringing total transparency in disclosure norms and 'cleansing' the balance sheets of
commercial banks for the first time in the country.

19
 NPA MANAGEMENT

The Indian Banking System

India’s banking sector is growing at a fast pace. India has become one of the most
preferred banking destinations in the world. The reasons are numerous: the economy is
growing at a rate of 8%, Bank credit is growing at 30% per annum and there is an ever-
expanding middle class of between 250 and 300 million people (larger than the population of
the US) in need of financial services. All this enables double-digit returns on most asset
classes which is not so in a majority of other countries. Foreign banks in India achieving a
return on assets (ROA) of 3%, their keen interest in expanding their businesses is
understandable – even more so when compared with the measly 1% average ROA for the
Top 1000 banks in the world.

Indian markets provide growth opportunities, which are unlikely to be matched by the
mature banking markets around the world. Some of the high growth potential areas to be
looked at are: the market for consumer finance stands at about 2%-3% of GDP, compared
with 25% in some European markets, the real estate market in India is growing at 30%
annually and is projected to touch $ 50 billion by 2008, the retail credit is expected to cross
Rs 5,70,000 crore by 2010 from the current level of Rs 1,89,000 crore in 2004-05 and huge
SME sector which contributes significantly to India’s GDP.

20
 NPA MANAGEMENT

NON-PERFORMING ASSET 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 facility 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. Action for enforcement of security interest can be
initiated only if the secured asset is classified as Non Performing Asset. Non Performing
Asset means an asset or account of borrower, which has been classified by a bank or financial
institution as sub-standard, doubtful or loss asset, in accordance with the directions or
guidelines relating to asset classification issued by RBI.

21
 NPA MANAGEMENT

Indian economy and N.P.As:

Undoubtedly the world economy has slowed down, recession is at its peak, globally
stock markets have tumbled and business itself is getting hard to do. The Indian economy has
been much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal
system, cutting of exposures to emerging markets by FIIs, etc.

Further, international rating agencies like, Standard & Poor have lowered India's
credit rating to sub-investment grade. Such negative aspects have often outweighed positives
such as increasing forex reserves and a manageable inflation rate.

Under such a situation, it goes without saying that banks are no exception and are
bound to face the heat of a global downturn. Bankers have realized that unless the level of
N.P.As is reduced drastically, they will find it difficult to survive.

Global Developments and N.P.As:

The core banking business is of mobilizing the deposits and utilizing it for lending to
industry. Lending business is generally encouraged because it has the effect of funds being
transferred from the system to productive purposes, which results into economic growth.

However lending also carries credit risk, which arises from the failure of borrower to
fulfill its contractual obligations either during the course of a transaction or on a future
obligation.

A question that arises is how much risk can a bank afford to take? Recent happenings
in the business world - Enron, WorldCom, Xerox, Global Crossing do not give much
confidence to banks. In case after case, these giant corporates became bankrupt and failed to
provide investors with clearer and more complete information thereby introducing a degree of
risk that many investors could neither neither anticipate nor welcome. The history of financial
institutions also reveals the fact that the biggest banking failures were due to credit risk.

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.

22
 NPA MANAGEMENT

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.

The following are the primary causes for turning the accounts into NPA:

 Diversion of funds, mostly for the expansion/ diversification of business or for

promoting associate concern.
 Factors internal to business like product/ marketing failure, inefficient management,
inappropriate technology, labour unrest
 Changes in the Macro-environment like recession in the economy, infrastructural
bottlenecks etc.
 Inadequate control/ supervision, leading to time/cost over-runs during project
 Implementation.
 Changes in Government policies e.g. Import duties.
 Deficiencies like delay in the release of limits/ funds by banks/FIs

Secondary causes are as follows:-

 Selection of the project.

23
 NPA MANAGEMENT

 Implementation of the project- time over-run, cost over-run, under-financing

technology involved
 Intention of the borrower.
 Industrial/ Economic trend.
 Absence of the up gradation of the unit/ ploughing back of the profit.

24
 NPA MANAGEMENT

THE PROBLEM OF NON-PERFORMING ASSETS

Liberlization and Globalization ushered in by the government in the early 90s have
thrown open many challenges to the Indian financial sector. Banks, amongst other things,
were set on a path to align their accounting standards with the International standards and by
global players. They had to have a fresh look into their balance sheet and analyze them
critically in the light of the prudential norms of income recognition and provisioning that
were stipulated by the regulator, based on Narasimhan Committee recommendations.

Loans and Advances as assets of the bank play an important part in gross earnings and
net profits of banks. The share of advances in the total assets of the banks forms more than 60
percent7 and as such it is the backbone of banking structure. Bank lending is very crucial for
it make possible the financing of agricultural, industrial and commercial activities of the
country. The strength and soundness of the banking system primarily depends upon health of
the advances. In other words, improvement in assets quality is fundamental to strengthening
working of banks and improving their financial viability. Most domestic public sector banks
in the country are expected to completely wipeout their outstanding NPAs between 2006 and
2008.

NPAs are an inevitable burden on the banking industry. Hence the success of a bank
depends upon methods of managing NPAs and keeping them within tolerance level, of late,
several institutional mechanisms have been developed in India to deal with NPAs and there
has also been tightening of legal provisions. Perhaps more importantly, effective management
of NPAs requires an appropriate internal check and balances system in a bank.

In this background, this chapter is designed to give an outline of trends in NPAs in

Indian banking industry vis-à-vis other countries and highlight the importance of NPAs
management. NPA is an advance where payment of interest or repayment of installment of
principal (in case of Term loans) or both remains unpaid for a period of 90 days10

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 to functional
efficiency of financial intermediaries. From the early nineties till date, the regulators in India,

25
 NPA MANAGEMENT

under the general recommendations of the Narasimhan Committee Reports (1 & 2), Verma
Committee Report, Basle 1 & 2 and insights and findings of scholars, have continuously
provided guidelines and directives addressed at reducing NPAs. A perusal of the Reserve
Bank of India (RBI) circulars in this regard will give the reader a comprehensive idea about
the extent of detail in which norms and guidelines have been formulated to arrest the growth
in NPAs. It started off with introduction of prudential norms and has delved into adoption of
a risk based management system. The Indian financial sector has responded well and adopted
the directives given, and the overall health has shown considerable improvement.

Although NPAs are a balance sheet issue of individual banks and financial
institutions, it has wider macroeconomic implications and the literature, while discussing
financial sector reforms, has gone into a discussion on NPAs also. The reasons can be
observed from the following flow diagram.

26
 NPA MANAGEMENT

Presence of NPAs indicates asset quality of the balance sheet and hence future income
generating prospects. This also requires provisioning which has implications with respect to
capital adequacy. Declining capital adequacy adversely affects shareholder value and restricts
the ability of the bank/institution to access the capital market for additional equity to enhance
capital adequacy. If this happens for a large number of financial intermediaries, then, given
that there are large inter bank transactions, there could be a domino kind of effect. Low
capital adequacy will also severely affect the growth prospects of banks and institutions.

With weak growth outlook and low functional efficiency, the sector as a whole will
not be able to perform its role and will adversely affect the savings investment process. Once
we realize this, it is evident that a micro problem of a bank translates into a macro problem.

With weak growth outlook and low functional efficiency, the sector as a whole will
not be able to perform its role and will adversely affect the savings investment process. Once
we realize this, it is evident that a micro problem of a bank translates into a macro problem of
the economy. Capital market development takes a back seat and GDP growth rate weakens.
The adverse effects of fiscal deficit loom large and a balance of payments crisis also cannot
be ruled out. Banking crisis and foreign exchange crisis get interlinked.

27
 NPA MANAGEMENT

EVOLUTION OF NPAs

In the early Nineties PSBs were suffering from acute capital inadequacy and many of
them were depicting negative profitability. This is because the parameters set for their
functioning were deficient and they did not project the paramount need for these corporate
goals.

• Incorrect goal perception and identification led them to wrong destination

• Since the 70s, the SCBs of India functioned totally as captive capsule units cut off
from international banking and unable to participate in the structural transformations,
the sweeping changes, and the new type of lending products emerging in the global
banking Institutions.
• The personnel lacked desired training and knowledge resources required to compete
with international players. Such and other chaotic conditions in parts of the Indian
Banking industry had resulted in the accumulation of assets, which were termed as
non-productive in an unprecedented level
• "Audit and Inspections" remained as functions under the control of the executive
officers, which were not independent and were thus unable to correct the effect of
serious flaws in policies and directions of the higher ups.
• The quantum of credit extended by the PSBs increased by about 160 times in the
three decades after nationalization (from around Rs. 3000 crore in 1970 to Rs.
475113 Crore in 2004). The Banks were not developed in terms of skills and
expertise to regulate such stupendous growth in the volume and manage the diverse
risks that emerged in the process.
• The need for organizing an effective mechanism to gather and disseminate credit
information amongst the commercial banks was never felt or implemented. The
archaic laws of secrecy of customers-information that was binding Bankers in India,
disabled banks to publish names of defaulters for common knowledge of the other
Banks in the system.
• Lack of effective corporate management
28
 NPA MANAGEMENT

• Credit management on the part of the lenders to the borrowers to secure their genuine
and bonafide interests was not based on pragmatically calculated anticipated cash
flows of the borrower concern, while recovery of installments of Term Loans was not
out of profits and surplus generated but through recourse to the corpus of working
capital of the borrowing concerns. This eventually led to the failure of the project
financed leaving idle assets.
• Functional inefficiency was also caused due to over-staffing, manual processing of
over expanded operations and failure to computerize Banks in India, when elsewhere
throughout the world the system was to switch over to computerization of operations.

29
 NPA MANAGEMENT

Management of NPA

The table II&III shows that during initial sage the percentage of NPA was higher.
This was due to show ineffective recovery of bank credit, lacuna in credit recovery system,
inadequate legal provision etc. Various steps have been taken by the government to recover
and reduce NPAs. Some of them are. .

1 One time settlement/ Compromised Scheme. .

2. Lok adalats. .
3. Debt Recovery Tribunals .
4. Securitization and reconstruction of financial assets and enforcement of Security
Interest Act 2002
5.Corporate Reconstruction Companies .
6 credit information on defaulters and role of credit information bureaus

30
 NPA MANAGEMENT

NPA MANAGEMENT POLICY

Definition of an NPA:-

An asset becomes non-performing when it cease to generate income to the bank.

A non-performing asset (NPA) is defined as a credit facility in respect of which the
interest and/or instalments of principal has remained ‘overdue’ for a ‘specified period’
of time.

The concept of specified period is reduced in a phased manner. The shortening of the
period is from 4 quarters in 1993 when the concept of IRAC norms was first introduced in
India to present level of 90 days.

Action for enforcement of security interest can be initiated only if the secured asset is
classified as Non Performing Asset.

Non Performing Asset means an asset or account of borrower, which has been
classified by a bank or financial institution as sub-standard, doubtful or loss asset, in
accordance with the directions or guidelines relating to asset classification issued by RBI.

An amount due under any credit facility is treated as "past due" when it has not been paid
within 30 days from the due date. Due to the improvement in the payment and settlement
systems, recovery climate, upgradation of technology in the banking system, etc., it was
decided to dispense with 'past due' concept, with effect from March 31, 2001. Accordingly, as
from that date, a Non performing asset (NPA) shell be an advance where

i. interest and /or installment of principal remain overdue for a period of more than 180
days in respect of a Term Loan,
ii. the account remains 'out of order' for a period of more than 180 days, in respect of an
overdraft/ cash Credit(OD/CC),
iii. the bill remains overdue for a period of more than 180 days in the case of bills
purchased and discounted,
iv. 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 purpose, and
31
 NPA MANAGEMENT

v. any amount to be received remains overdue for a period of more than 180 days in
respect of other accounts.

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
NPAs, form the year ending March 31, 2004. Accordingly, with effect form March 31, 2004,
a non-performing asset (NPA) shell be a loan or an advance where;

i. interest and /or installment of principal remain overdue for a period of more than 90
days in respect of a Term Loan,
ii. the account remains 'out of order' for a period of more than 90 days, inrespect of an
overdraft/ cash Credit(OD/CC),
iii. the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,
iv. 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 purpose, and
v. any amount to be received remains overdue for a period of more than 90 days in
respect of other accounts.

'Out of order'

An account should be treated as 'out of order' if the outstanding balance remains

continuously in excess of the sanctioned limit/ drawing power. In case where the outstanding
balance in the principal operating account is less than the sanctioned limit/ drawing power,
but there are no credits continuously for six months as on the date of balance sheet or credits
are not enough to cover the interest debited during the same period, these account should be
treated as 'out of order'.

Overdue
Any amount due to the bank under any credit facility is 'overdue' if it is not paid on the
due date fixed by the bank.

32
 NPA MANAGEMENT

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 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.

33
 NPA MANAGEMENT

ASSET CLASSIFICATION

Classification of Assets:

While new private banks are careful about their asset quality and consequently have
low non-performing assets (N.P.As), public sector banks have large N.P.As due to wrong
lending policies followed earlier and also due to government regulations that require them to
lend to sectors where potential of default is high. Allaying the fears that bulk of the Non-
Performing Assets (N.P.As) was from priority sector, NPA from priority sector constituted
was lower at 46 per cent than that of the corporate sector at 48 per cent.

Loans and advances account for around 40 per cent of the assets of SCBs. However,
delay/default in payment of interest and/or repayment of principal has rendered a significant
proportion of the loan assets non-performing. As per RBI’s prudential norms, a Non-
Performing Asset (NPA) is a credit facility in respect of which interest/installment has
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 is loans on which the dues are not received for two quarters. N.P.As
consist of assets fewer than 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.

34
 NPA MANAGEMENT

Sub-standard Asset:

An asset which remains as NPA for a period exceeding 24 months, where the current
net worth of the borrower, guarantor or the current market value of the security charged to the
bank is not enough to ensure recovery of the debt due to the bank in full.

Doubtful Assets:

An NPA, which continued to be so for a period exceeding two years (18 months, with effect
from March, 2001, as recommended by Narsimham Committee II, 1998).

Loss Assets:

An asset identified by the bank or internal/ external auditors or RBI inspection as loss asset,
but the amount has not yet been written off wholly or partly.

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".

Asset Classification Provision requirements

Standard assets 0.25%
Substandard assets 20%(irrespective of value of security)
Doubtful assets 20% - 50% of the secured portion depending on the
age of NPA, and 100% of the unsecured portion.
Loss assets 100%

Guidelines for the classification of assets

35
 NPA MANAGEMENT

1) Classification of assets into above categories should be done taking into account the degree
of well defined credit weaknesses and the extent of dependencies on collateral security for the
realization of dues.

2.) Banks should establish appropriate internal systems to eliminate the tendency to delay or
postpone the identification of NPA’s especially in respect of high value of accounts .

3.) Account with temporary Deficiencies:

The classification of an asset as NPA should be based on the record of recovery .Bank should
not classify an advance account as NPA merely due to the existence of some deficiencies,
which are temporary in nature as such as non – availability of adequate drawing power based
on latest stock.

4.) Asset classification to be borrower – wise and not facility-wise:

It is difficult to envisage a situation when only one facility to a borrower becomes a problem
credit and not others. Therefore, all the facilities granted by a bank to a borrower will have to
be treated as NPA and not the particular facility or a part thereof, which has become irregular.

5.) Advances under consortium arrangements:

Asset classified of accounts under consortium should be based on the record of recovery of
the individual member banks and other aspects having bearing on the recoverability of the
advances.

6.) Accounts where there is erosion in the value of security can be reckoned as significant
when the realizable value of the security is less than 50percent of the value assessed by the
bank or accepted by RBI at the time of last inspection, as the case may be. Such NPAs may
be straightway classified under doubtful category and provisioning should be made as
applicable to doubtful assets.

7.) Agricultural Advances

(a.) In respect of advances granted for agricultural purpose purpose where interest and / or
installment of principal remains unpaid after it has become past due for two harvest seasons
but for a period not exceeding two half years , such an advance should be treated as NPA.
36
 NPA MANAGEMENT

(b.) Where the natural calamities impair the repaying capacity of agricultural borrowers,
banks may decide on their own as a relief measure-conversion of the short –term production
loan into a term or re-schedulement of the repayment period.

(c.) In such cases of conversation or re-schedulement, the term loan as well as fresh short-
term loan may be treated as current dues and need not be classified as NPA.

8.) Restructuring /Rescheduling of loans:

A standard asset where the terms of the loan arrangement regarding interest and principal
have been renegotiated or rescheduled after the commencement of production should be as
sub-standard and should remain in such category for at least one year of satisfactory
performance under the renegotiated or restructured terms. In case of substandard and doubtful
assets also, rescheduling does not entitle a bank to upgrade the quality of advances
automatically unless there is satisfactory performance under the rescheduled –renegotiated
terms.

9.) Exceptions :As trading involves only buying and selling of commodities and the problems
associated with manufacturing units.

Write Off Policy

37
 NPA MANAGEMENT

Write Off is resorted to in the borrowal accounts when the bank has exhausted. all
possible avenues of recovery and there are no more chances for effecting the recovery.

Write Off is of two kinds- Prudential write off and Regular Write of. The basic difference
between prudential and Regular write off is that in prudential write off there is possibility of
recovery at a distant future even after write off while in Regular write off is no/little
possibility of recovery.

 Regular Write off

General conditions:-

A Regular write off will be considered on the happening of 1 and 2 and any of the 3 to 4
below:-

1. Account is classified as loss Asset.

2. 100% provision is held in such accounts as at the end of previous accounting year.
3. Prior approval for waiver of legal action including where account is already time
barred/termination of suit proceedings/waiver of appeal, etc.
4. All efforts for recovery have been taken to their conclusion, by means of action under
SRFEASI Act, legal action, execution of decree, etc. and there is absolutely no
prospect for any further recovery
5. In exceptional cases, where the borrower has or have expired or their whereabouts can
not be traced in spite of all efforts, and there is no security which can be realized.
6. Cases where all efforts of recovery have been adopted and the remaining balance and
circumstances are such that any further effort is considered cost-ineffective.

7. As a result of a negotiated settlement in any account, where any proportion of the

outstanding balance, unrealized interest and/or uncharged interest/ charges is agreed
to be written off or waived, this write off shall be effected after receipt of full
compromise amount plus interest if any, as per terms of OTS approved . No specific
approval is required for this since the write off is part of compromise settlement duly
approved by competent authority.

38
 NPA MANAGEMENT

Difficulties with the Non performing Assets

1.) Owners do not receive a market return on their capital. In the worst case, if the bank fails,
owners lose their assets. In modern times, this may affect a broad pool of shareholders.

39
 NPA MANAGEMENT

2.) Depositors do not receive a market return on savings. In the worst case if the bank fails,
depositors lose their assets or uninsured balance. Banks also redistribute losses to other
borrowers by charging higher interest rates .Lower deposit rates and higher lending rates
repress savings and financial markets, which hampers economic growth.

3.) Non performing loans represent bad investments. NPA misallocate credit from good
projects, which do not receive funding, to failed projects. Bad investment ends up in
misallocation of capital and, by extension, labour and natural resources. The economy
performs below its production potential.

4.) Non performing loans may spill over the banking system and contract the money stock
,which may lead to economic contraction .

This spillover effect can channelize through illiquidity or bank insolvency;

(a) When many borrowers fail to pay interest, banks may experience liquidity shortages
.These shortages can jam payments across the country.

(c) Undercapitalized banks exceeds the bank’s capital base.

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.
40
 NPA MANAGEMENT

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

Internal Factors:

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

helping or promoting sister concerns.Time/Cost overruns while implementing the projects.

Business failure like product failing to capture market, inefficient management,

strike/strained labour relations, wrong technology, technical problems, product obsolescence,
etc.

External factors:

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

adverse exchange rate, etc.

Government policies like excise, import duty changes, deregulation, pollution control
orders, etc. Willful default, siphoning of funds, fraud, misappropriation, and
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

41
 NPA MANAGEMENT

rules in this regard in consultation with the banks, FII and IBA and circulated the same
among banks and financial institution for implementation.

Susceptibility of the sanctioning authorities to external pressure, failings of CEOs and

the ineffectiveness of the board to check his ways also contributed in no small measures to
the unusual build up of N.P.As in some of the banks. One of the most prominent causes for
N.P.As, as often observed by RBI Inspectors, is the slackness on the part of the credit
management staff in their follow up to detect and prevent diversion of funds in the post
disbursement stage.

REASONS FOR AN ASSET TURNING NPA

The various reasons, either singly or jointly, behind an asset turning NPA can be classified as
follows

 Reasons from the economy side

42
 NPA MANAGEMENT

 Reasons from the industry side

 Reasons from the borrower’s side
 Reasons from the banking system side
 Reasons from the loan structuring side
 Reasons from the security side – collateral vs cash flow
 Reasons from the regulatory side

From the above, it may be surprising to many that only the borrower is not always at fault. At
times, systemic faults can also adversely affect the profitability of financial intermediaries.
The following discussion will clarify our position.

 Reasons from the economy side

A) Political – mindset regarding paradigm, proactive, fiscally responsible (national

income accounts)

b) Economic – growth, distribution, efficient allocation of resources c)

Social – acceptability, mobility, education

0 d). Technological – advances in use of IT

1 e) Legal – Enforceability of loan contracts
2 f) Environmental – liberalization & globalization

If loan contracts are not easily enforceable, there will naturally be a tendency to default.
Opening up of the economy can render companies uncompetitive. Lack of adaptation of IT
will make data processing difficult and information dissemination will be impossible.
Objective analysis of risk would be difficult and appraisal would remain a subjective matter.
Similarly, directed programs of lending can be counterproductive.

 Reasons from the industry side

43
 NPA MANAGEMENT

a. Global competition

b. Cyclical downswing

1 c. Sunset industry
2 d. Frequent changes in regulatory norms
3
 Reasons from the borrower’s side

a. Misconceived project

b. Poor governance

c. Product failure

d. Inefficient management

e. Diversion of funds

f. Dormant capital market

g. Regulatory changes

 Reasons from the banking system side

a. Parameters set for their functioning were deficient: incorrect goal perception and
identification – lazy banking

1 b. Directed banking and lack of freedom to choose products and pricing

2 c. Being unexposed to international marketing methods and products, people lacked
training and knowledge resources
3 d. Ownership and management were not distinguished – composition of Board of
Directors
4 e. Lack of systems and procedures – audit and inspections
44
 NPA MANAGEMENT

5 f. Banks lacked the ability to handle enormous growth in liabilities and assets
6 g. Lack of a mechanism of credit information dissemination
7 h. Lack of an effective judicial system for recovery from defaulters
8 i. Collateral based lending leading to idle assets
9 j. Fixing of price and quantum of loans
10 k. Lack of an effective IT system and MIS
11

 Reasons from the loan structuring side

a. High debt equity ratio

b. Timing of raising equity

c. Discrepancy between the rate of interest charged and the realistic rate of return

d. Inconsistency between revenue generation and the loan repayment schedule

e. Lack of binding penal clauses and performance guarantees

 Reasons from the security side – collateral vs cash flow

There is a tendency among banks and institutions to depend excessively on collateral for
advancing of loans. While this is important, it presumes from the very beginning that the
borrower would default and the security would need to be encashed for recovery of the loan.
Clearly, this logic is unacceptable. Emphasis should then be on cash generation and a charge
on this should be built into the loan contract through some escrow mechanism.

 Reasons from the regulatory side

Frequent regulatory changes can turn assets non-performing. Accounting reason like
reduction in income recognition norms from 180 days to 90 days could be one such reason.
Pollution related issues could be the other reason. Distance between two sugar mills could be
a third.

45
 NPA MANAGEMENT

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.

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.

46
 NPA MANAGEMENT

Measures to Recover N.P.As

Over the last few years Indian banking in its attempt to integrate itself with the global
banking has been facing lots of hurdles in its way due to its inherent weaknesses, despite its
high sounding claims and lofty achievements. One of the major hurdles, the Indian banking is
facing today, is its ever-growing size of non-performing assets over which the top
management of almost each bank is baffled. On account of the intricacies involved in
handling the N.P.As the ticklish task of assets management of the bank has become a tight
rope walk affair for the controlling heads, because a little wavering ‘this or that side’ may
land the concern bank in trouble. The growing N.P.As is a potent source of worry for the
finance minister as well, because in a developing country like ours, banking is seen as an
important instrument of development, while with the backbreaking N.P.As banks have
become helpless burden on the economy.

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

In case of doubtful and loss assets, through the modified schemes, the banks have
been directed to follow up a settlement formula under which the minimum amount to be
recovered, amounts to be entire outstanding running ledger balances as on the date the
account was identified as NPA i.e. the date from which the interest was not charged to the
running ledger, an analysis of the given formula shows that RBI has been very much
generous in granting huge relaxation to the borrowers who were not coming forward for
setting their overdue loans due to one or other reason. The scheme is of high practical value
as it protects the borrowers who were having genuine problems in clearing their dues because
the interest component constituted a multiplied amount of principal outstanding. On the other
hand, the concerned banks were also finding in difficult to sacrifice the entire interest
component, but outstanding in the dummy ledger. Now as per the provision to the scheme,
they will be ready to grant such relaxation in favour of the borrowers. These guidelines have
come as a windfall for borrowers who after a lot of negotiations were almost ready to repay
47
 NPA MANAGEMENT

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.

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
48
 NPA MANAGEMENT

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.

49
 NPA MANAGEMENT

IMPACT ON PROFITABILITY

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 PSBs. In
turn PSBs are seen as poor performers and unable to approach the market for raising
additional capital. Equity issues of nationalised banks that have already tapped the market are
now quoted at a discount in the secondary market. Other banks hesitate to approach the
market to raise new issues. This has alternatively forced PSBs 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 Recapitalisation.

NPA is not merely non-remunerative. 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. 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 no 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 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 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 bank 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.

50
 NPA MANAGEMENT

Impact of NPAs on Development Financial Institutions Health:

The efficiency of any Development Financial Institutions 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 any
income for DFIs but at the same time DFIs are required to make provisions for such NPAs
from their current profits.

Following are the deleterious effect on the return on assets in several ways:

1 They erode current profits through provisioning requirements

2 They result in reduced interest income

3 They require high provisioning requirements affecting profits

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

51
 NPA MANAGEMENT

KEY STRUCTURAL CHANGES

Phasing out of statutory pre-emption - The SLR requirement have been brought down
from 38.5% to 25% and CRR requirement from 7.50% to 5.75%. (Presently 4.5%)

• Deregulation of interest rates - All lending rates except for lending to small borrowers and
a part of export finance has been de-regulated. Interest on all deposits is determined by banks
except on savings deposits.

• Capital adequacy - CAR of 9 % prescribed with effect from March 31, 2000.

• Other prudential norms - Income recognition, asset classification and provisioning norms
has been made applicable. The provisioning norms are more prudent, objective, transparent,
and uniform and designed to avoid subjectivity.

• Entry of new private sector banks - 9 new private sector banks have been set up with a
view to induce greater competition and for improving operational efficiency of the banking
system.

Competition has been introduced in a controlled manner and today we have nine new private
sector banks and 36 foreign banks in India competing with the public sector banks both in
retail and corporate banking

• Functional autonomy - The minimum prescribed Government equity was brought to

51%. Nine nationalised banks raised Rs.2855 crores from the market during 1994-2001.
Banks Boards have been given more powers in operational matters such as rationalization
of branches, credit delivery and recruitment of staff.

• Debt Recovery Tribunals - 22 DRTs and 5 DRATs have already been set up and 7 more
DRTs will be set up during the current financial year. Comprehensive amendment in the Act
have been made to make the provisions for adjudication, enforcement and recovery more
effective.

52
 NPA MANAGEMENT

• Transparency in financial statements - Banks have been advised to disclose certain key
parameters such as CAR, percentage of NPAs, provisions for NPAs, net value of investment,
Return on Assets, profit per employee and interest income as percentage to working funds.

53
 NPA MANAGEMENT

REPORTING FORMAT FOR NPAs

CHART FOR ASSESSING CORRECTIVE STEPS IN DIFFERENT

CIRCUMSTANCES:

54
 NPA MANAGEMENT

55
 NPA MANAGEMENT

Different Approaches to Valuation of N.P.As:

N.P.As are by-product of most financial systems and the level of N.P.As is an
indicator of the health of the financial system of an economy. Valuation techniques should
present the situation, which maximize the overall interest of all the concerned parties.

The broad objectives of the valuation framework are essentially:

 To set a sound basis for the selling bank/institution to finalize the sale of assets,
 To provide a basis for the fair market value of the assets,
 To promote transparency of the valuation processes and,
 To comply with internationally accepted practices.

The valuation of an asset or the pool of assets is a precursor to any restructuring exercise.
Any valuation exercise shall attempt to address the following issues:

 The fair market value of the asset should represent the price at which market
participants would undertake a restructuring.
 The transaction value should reflect the potential for income generation and return of
principal, balanced against the applicable risk profile and market lending margins.
 The valuation framework should allow for valuation of specific assets as well as a
portfolio of assets (i.e. portfolio of loans to be acquired from a bank.) In most cases, a
single value will apply to each loan required. For larger loans, however, an element of
risk/return sharing with the selling bank may be considered.

There are various methodologies used to value the companies or their debt. Typically, cash
flows, assets or replacement values, or a combination of these, are considered when
determining the value of the company or its debt. The matrix shows the risk profile of the
NPA based on its cash flows and collateral. As shown, stronger the cash flows and collateral,
lower the risk profile of the asset. Some of the widely used approaches towards valuation of
an NPA by the valuation firms are detailed as under:

56
 NPA MANAGEMENT

 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 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
57
 NPA MANAGEMENT

place, the value of the assets further fall down, as it is more or less equal to forced sale of the
assets. As a result of this forced sale, the seller has to accept a discount on the fair market
value of such assets. In most cases, such a realization is not able to cover even the secured
debt fully and hence the valuation of the debt would be limited by this realized value. This
approach has been widely used in countries like Thailand where a significant number of loans
were secured by real estate and other marketable securities of various kinds.

 Earning Model -

In performing companies, the P/E ration of the industry or other similar companies
may be used as a tool for determining the market value of the assets of company. If the debt
of the company is more than its assets, then a proportionate discount may be applied to the
debt. The above approach, however, cannot be used for most of the N.P.As, as they would
have negative EPS. In such cases, the cash earning per share of the company and cash P/E
ratio of the similar companies may be used to arrive at a market value of the NPA debt.

 Case Specific Valuation Model –

Depending on case to case, various models have been evolved and used for specific
requirements. I shall discuss here one of such models to provide an insight as to how provide
varied models can be from the conventional approaches.

Segmentation into buckets:

For a huge portfolio of small loans, different kind of approach may be used for arriving at the
realistic valuation. One of them is categorizing 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. For arriving at the
appropriate valuation, they had followed the following methodology:

58
 NPA MANAGEMENT

 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.

Basis of Non – Performing Assets:

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

59
 NPA MANAGEMENT

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.

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

DEBT RECOVERY TRIBUNAL

60
 NPA MANAGEMENT

Any person aggrieved by any measure taken by secured creditor or his authorised
officer may file an appeal to Debts Recovery Tribunal, within 45 days from date on which
such measure was taken. i.e. action of taking possession of asset, takeover of management of
business of borrower, appointing person to manage secured asset etc. is taken by the creditor.
When a borrower files an appeal, the appeal cannot be entertained unless; the borrower
deposits 75% of the amount claimed in the notice by secured creditor. The DRT can waive or
reduce the amount required to be deposited. The amount is not required to be deposited at the
time of filing appeal, but appeal will not be heard till the amount is deposited. The borrower
while filing the appeal should also file an application requesting the Debt Recovery Tribunal
to admit the appeal without deposit of any amount. It the DRT orders partial deposit of the
amount and the same is not deposited, appeal can be dismissed. The 75% deposit is only
required if the appeal is filed by the borrower. If some other aggrieved person (e.g. guarantor,
shareholder) files it the deposit is not required.

DEBT RECOVERY APPELATE TRIBUNAL

If a person is aggrieved by the order of the DRT, it can file an appeal to the Appellate
Tribunal within 30 days from date of receipt of the DRT order. If the DRT or Appellate
Tribunal holds that possession of assets by the secured creditor was wrongful and directs the
secured creditor to return asset to concerned borrower, the borrower shall be entitled to
compensation and costs as may be determined by DRT or Appellate tribunal. The Tribunal
can also direct return of asset, if the secured creditor had already sold or transferred the asset
to a third party. In liberalizing economy banking and financial sector get high priority. Indian
banking sector of having a serious problem due non performing. The earning capacity and
profitability of the bank are highly affected due to this NPA is defined as an advance for

61
 NPA MANAGEMENT

which interest or repayment of principal or both remain outstanding for a period of more than
two quarters. The level of NPA act as an indicator showing the bankers credit risks and
efficiency of allocation of resource.

In liberalizing economy banking and financial sector get high priority. Indian banking sector
of having a serious problem due non performing. The financial reforms have helped largely
to clean NPA was around Rs. 52,000 crores in the year 2004. The earning capacity and
profitability of the bank are highly affected due to this

NPA is defined as an advance for which interest or repayment of principal or both remain out
standing for a period of more than two quarters. The level of NPA act as an indicator
showing the bankers credit risks and efficiency of allocation of resource.

Reasons:

Various studies have been conducted to analysis the reasons for NPA. What ever may be
complete elimination of NPA is impossible. The reasons may be widely classified in two.
:

(1) Over hang component .

(2) Incremental component .
Over hang component is due to the environment reasons, business cycle etc.
Incremental component may be due to internal bank management, credit policy, terms of
credit etc.
62
 NPA MANAGEMENT

Steps to be taken under DRT route :-

(a) Procedure Before Filing the case before DRT:-

 Sell pledge goods after sending reasonable notice to the borrower.

 Ensure that documents/securities are enforceable against
borrowers/guarantors.

(b) Procedure while filing the case in DRT:-

 Recovery application should contain description of all relevant documents and

securities charged to the bank.
 Original documents should be retained with the Branch till DRT requires the
same.

(c) After filing the case before DRT:-

 If the recovery application filed is complete in all respects, DRT gives a serial
number; issues summons to borrowers/guarantors called defendants.

(d) Execution of Recovery Certificates:-

 Recovery Officer of DRT executes Recovery Certificates (RCs) issued by

Presiding Officer of DRT.
 Branch/Zone should supply the Asset details within one month of the issuance
of the RC.

Designation of Registrar:-

Government of Nepal has to designate one officer level employee of the gazette third class of
Nepal Judicial Service to act as the Registrar of the tribunal or appellate tribunal, in order to
carry out functions relating to general administration of the tribunal or appellate tribunal,
subject to general direction and control of such tribunal and appellate tribunal.

63
 NPA MANAGEMENT

Functions, duties and powers of Registrar:-

In addition to the functions, duties and powers mentioned elsewhere in this regulation, the
functions, duties and powers of the Registrar shall be as follows.

 To examine and verify documents including petitions, notes of defense and

memoranda of appeals to be filed with the tribunal or appellate tribunal and register
them if they meet requirements or endorse them with reasons if they cannot be
registered,
 To verify duplicate copies submitted in a case with the originals and certify them if
they appear in order, and if the originals appear to have some defects, to mention such
defects and get the concerned party to sign to that effect,
 To verify whether documents submitted along with petitions, memoranda of appeal
and notes of defense are correct or not,
 To issue summons and get it served,
 To appoint days for appearance in cases, indicating reasonable reasons pursuant to
law,
 To obtain power of attorney and get a case assumed pursuant to prevailing law,
 To promptly execute, or cause to be executed, actions as referred to in the order made
by the Bench,
 To have security or guarantee as per the order made by the Bench,
 To maintain, or cause to be maintained, updated records including registration books,
 To maintain personal records of employees,
 To safely retain orders and directions in a serial order.

What is the power of Debt Recovery Officer?

The order issued by the Debt Recovery Officer shall deemed to be the order issued by the
Tribunal. If any person disobeys any order given by the Debt Recovery Officer, the Tribunal
may institute contempt proceedings against that person under the provision of the Act.

In recovering the principal and interest of a loan, the Debt Recovery Officer, may follow the
following procedures:

64
 NPA MANAGEMENT

In consistent with the decision of the Tribunal the Debt Recovery Officer may follow the
following procedures, subject to the prevailing law.

 To take possession of, or auction, the borrower's other movable or immovable

property whether furnished as security or not,
 To take possession of, or auction, the guarantor's movable or immovable property,
 Where any individual is a borrower or guarantor, to arrest such individual and detain
him pursuant to the prevailing law.

Presiding officer:-

 He is the Head of the department.

 He has judicial power to execute the case.

LOKADALATS

The institution of Lokadalat constituted under the Legal Services Authorities Act,
1987 helps in resolving disputes between the parties by conciliation, mediation, compromise
or amicable settlement. It is known for effecting mediation and counseling between the
parties and to reduce burden on the court, especially for small loans. Cases involving suit
claims up to Rs. l million can be brought before the Lokadalat and every award of the
65
 NPA MANAGEMENT

Lokadalat shall be deemed to be a decree of a Civil Court and no appeal can lie to any court
against the award made by the Lokadalat. Several people of particular localities/ various
social organizations are approaching Lokadalats which are generally presided over by two or
three senior persons including retired senior civil servants, defense personnel and judicial
officers. They take up cases which are suitable for settlement of debt for certain
consideration. Parties are heard and they explain their legal position. They are advised to
reach to some settlement due to social pressure of senior bureaucrats or judicial officers or
social workers. If the compromise is arrived at, the parties to the litigation sign a statement in
presence of Lokadalats which is expected to be filed in court to obtain a consent decree.
Normally, if such settlement contains a clause that if the compromise is not adhered to by the
parties, the suits pending in the court will proceed in accordance with the law and parties will
have a right to get the decree from the court. In general, it is observed that banks do not get
the full advantage of the Lokadalats. It is difficult to collect the concerned borrowers willing
to go in for compromise on the day when the Lokadalat meets. In any case, we should
continue our efforts to seek the help of the Lokadalat.

ENACTMENT OF SRFAESI ACT

66
 NPA MANAGEMENT

The "The Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest Act" (SRFAESI) provides the formal legal basis and regulatory framework
for setting up Asset Reconstruction Companies (ARCs) in India. In addition to asset
reconstruction and ARCs, the Act deals with the following largely aspects,

 Securitization and Securitization Companies

 Enforcement of Security Interest
 Creation of a central registry in which all securitization and asset reconstruction
transactions as well as any creation of security interests has to be filed.

The Reserve Bank of India (RBI), the designated regulatory authority for ARCS has
issued Directions, Guidance Notes, Application Form and Guidelines to Banks in April 2003
for regulating functioning of the proposed ARCS and these Directions/ Guidance Notes cover
various aspects relating to registration, operations and funding of ARCS and resolution of
NPAs by ARCS. The RBI has also issued guidelines to banks and financial institutions on
issues relating to transfer of assets to ARCS, consideration for the same and valuation of
instruments issued by the ARCS. Additionally, the Central Government has issued the
security enforcement rules ("Enforcement Rules"), which lays down the procedure to be
followed by a secured creditor while enforcing its security interest pursuant to the Act. The
Act permits the secured creditors (if 75% of the secured creditors agree) to enforce their
security interest in relation to the underlying security without reference to the Court after
giving a 60 day notice to the defaulting borrower upon classification of the corresponding
financial assistance as a non-performing asset.

The Act permits the secured creditors to take any of the following measures:

 Take over possession of the secured assets of the borrower including right
to transfer by way of lease, assignment or sale;
 Take over the management of the secured assets including the right to
transfer by way of lease, assignment or sale;

67
 NPA MANAGEMENT

 Appoint any person as a manager of the secured asset (such person could be
the ARC if they do not accept any pecuniary liability); and
 Recover receivables of the borrower in respect of any secured asset which
has been transferred.

After taking over possession of the secured assets, the secured creditors are required to obtain
valuation of the assets. These secured assets may be sold by using any of the following routes
to obtain maximum value.

 By obtaining quotations from persons dealing in such assets or otherwise

interested in buying the assets;
 By inviting tenders from the public;
 By holding public auctions; or
 By private treaty.


Lenders have seized collateral in some cases and while it has not yet been possible to
recover value from most such seizures due to certain legal hurdles, lenders are now clearly in
a much better bargaining position vis-a-vis defaulting borrowers than they were before the
enactment of SRFAESI Act. When the legal hurdles are removed, the bargaining power of
lenders is likely to improve further and one would expect to see a large number of NPAs
being resolved in quick time, either through security enforcement or through settlements.

Under the SRFAESI Act ARCS can be set up under the Companies Act, 1956. The
Act designates any person holding not less than 10% of the paid-up equity capital of the ARC
as a sponsor and prohibits any sponsor from holding a controlling interest in, being the
holding company of or being in control of the ARC. The SRFAESI and SRFAESI Rules/
Guidelines require ARCS to have a minimum net-owned fund of not less than Rs.
20,000,000. Further, the Directions require that an ARC should maintain, on an ongoing
basis, a minimum capital adequacy ratio of 15% of its risk weighted assets. ARCS have been

68
 NPA MANAGEMENT

granted a maximum realization time frame of five years from the date of acquisition of the
assets.

The Act stipulates several measures that can be undertaken by ARCs for asset
reconstruction. These include:

 Enforcement of security interest;

 Taking over or changing the management of the business of the
borrower;
 The sale or lease of the business of the borrower;
 Settlement of the borrowers' dues; and
 Restructuring or rescheduling of debt.

ARCS are also permitted to act as a manager of collateral assets taken over by the lenders
under security enforcement rights available to them or as a recovery agent for any bank or
financial institution and to receive a fee for the discharge of these functions. They can also be
appointed to act as a receiver, if appointed by any Court or DRT.

69
 NPA MANAGEMENT

INSTITUTION OF CDR MECHANISM

The RBI has instituted the Corporate Debt Restructuring (CDR) mechanism for resolution
of NPAs of viable entities facing financial difficulties. The CDR mechanism instituted in

70
 NPA MANAGEMENT

India is broadly along the lines of similar systems in the UK, Thailand, Korea and Malaysia.
The objective of the CDR mechanism has been to ensure timely and transparent restructuring
of corporate debt outside the purview of the Board for Industrial and Financial
Reconstruction (BIFR), DRTs or other legal proceedings. The framework is intended to
preserve viable corporate affected by certain internal/external factors and minimize losses to
creditors/other stakeholders through an orderly and coordinated restructuring programme.
RBI has issued revised guidelines in February 2003 with respect to the CDR mechanism.
Corporate borrowers with borrowings from the banking system of Rs. 20crores and above
under multiple banking arrangement are eligible under the CDR mechanism. Accounts falling
under standard, sub-standard or doubtful categories can be considered for restructuring. CDR
is a non-statutory mechanism based on debtor-creditor agreement and inter-creditor
agreement. Restructuring helps in aligning repayment obligations for bankers with the cash
flow projections as reassessed at the time of restructuring. Therefore it is critical to prepare a
restructuring plan on the lines of the expected business plan along with projected cash flows.

The CDR process is being stabilized. Certain revisions are envisaged with respect to
the eligibility criteria (amount of borrowings) and time frame for restructuring. Foreign
banks are not members of the CDR forum, and it is expected that they would be signing
the agreements shortly. However they attend meetings. The first ARC to be operational in
India- Asset Reconstruction Company of India (ARGIL) is a member of the CDR forum.
Lenders in India prefer to resort to CDR mechanism to avoid unnecessary delays in
multiple lender arrangements and to increase transparency in the process. While in the RBI
guidelines it has been recommended to involve independent consultants, banks are so far
resorting to their internal teams for recommending restructuring programs.

71
 NPA MANAGEMENT

Compromise Settlement Schemes

 One Time Settlement Schemes:-

NPAs in all sectors, which have become doubtful or loss as on 31st March 2000.
The scheme also covers NPAs classified as sub-standard as on 31st March 2000,
which have subsequently become doubtful or loss. All cases on which the banks have
initiated action under the SRFAESI Act and also cases pending before
Courts/DRTs/BIFR, subject to consent decree being obtained from the
Courts/DRTs/BIFR are covered. However cases of willful default, fraud and
malfeasance are not covered. As per the OTS scheme, for NPAs up to Rs. 10crores,
the minimum amount that should be recovered should be 100% of the outstanding
balance in the account.

 Negotiated Settlement Schemes

The RBI/Government has been encouraging banks to design and implement

policies for negotiated settlements, particularly for old and unresolved NPAs. The
broad framework for such settlements was put in place in July 1995. Specific
guidelines were issued in May 1999 to public sector banks for one-time settlements of
NPAs of small scale sector. This scheme was valid until September 2000 and enabled
banks to recover Rs 6.7 billion from various accounts. Revised guidelines were issued
in July 2000 for recovery of NPAs of Rs. 50 million and less. These guidelines were
effective until June 2001 and helped banks recover Rs. 26 billion.

72
 NPA MANAGEMENT

RECOMMENDATIONS

 Studies have shown that management of N.P.As rather than elimination is prudent.
India’s growth rate and bank spreads are higher than western nations. As a result we
can support a non-zero levels of N.P.As, which balances the risk vis-à-vis return
appropriate to the Indian context.
 Concerns have been raised about the relevance to India. A significant percentage of
the N.P.As of the PSBs are in the priority sectors. Loans in rural areas are difficult to
collect and banks by virtue of their sheet reach are better placed to recover these
loans. Lok Adalats and debt recovery tribunals are other effective mechanism to
handle this risk. ARCs should focus on borrowers. Further, there is a need for private
sector and foreign participation in the ARC. Private parties will look for active
resolution of the problem and not merely regard it as a book transaction. Moving
N.P.As to an Arc doesn’t get rid of the problem. In china, potential investors are still
worried about the risks of non-enforcement of ownership rights of the assets they
purchase from the ARCs. Actions and measures have to be taken to build investors
confidence.
 Numerous papers have stressed the criticality of a well-developed capital market in
the restructuring process. A capital market brings liquidity and mechanism for write
off loans. Without this a bank may postpone the NPA problem for fear pf capital
adequacy problems and resort to tactics like ever greening. Monitoring by
bondholders is better as they have no motive to sustain uneconomic activity. Further
the banks can manage credit risk better as it is easier to sell or securities loans and
negotiate credit derivatives. Indian debt markets is relatively under developed and
attention should be focused on building liquidity and volumes.

Regulations must incorporate a contextual perspective (like temporary cash flow problems)
and clients should be handled in a manner, which reflects true value of their assets and future

73
 NPA MANAGEMENT

potential to pay. The top management should delegate authority and back decision of this
kind taken by middle level managers.

This has been extensive in China, Japan, and Korea and has attracted international
participants due to lower liquidity risks. The resolution trust corporation has helped develop
the securitisation market in Asia and has taken over around $ 460 bn as bad debts from 750
failed banks. Its highly standardized products appeal a broad investor base. Securitisation in
India is still in a nascent stage but the potential in the areas of Mortgage Backed Securities.

 There is a fear that disposal through the provision of excessive reserves may result in
a deflationary spiral. A through provision of reserves will have no negative impact on
the long-term dividends paid to the shareholders. Firstly, it helps restore credibility in
the financial systems. Further, an adjustments mechanism can be created by which the
capital gains and future profits that will result from the disposal of 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.

The various resolution strategies for recovery from NPAs include financial restructuring,
change in management, one time settlement, merger, sale to an asset reconstruction company,
securitisation of receivables and filing of legal suit. Under each option there are options,

74
 NPA MANAGEMENT

which can be exercised either singly or jointly. The details under each strategy are given in
the following.

 Early recognition of the problem

 Early Alert System – determine threshold for proactive intervention before account
becomes a NPA
 Identify borrowers with genuine intent
 Restructuring should be attempted only after an objective assessment of the viability
and the promoter’s intent. Banks should be convinced of a turnaround within a
scheduled timeframe
 Timeliness and adequacy of response
 Focus on Cash flows
 Management Effectiveness
 Consortium / Multiple Financing

75
 NPA MANAGEMENT

FINANCIAL RESTRUCTURING

 Reschedulement of the principal repayment

 Reduction in the rate of interest
 Funding of past due interest into loan or instruments (debt or equity or quasi equity)
 Funding of future interest
 Waiver of past simple interest, compound interest or liquidated damages
 Conversion of loan into equity or quasi-equity
 Reduction in equity
 Debt write-off
 Funds infusion by way of equity or debt for project completion
 Funds infusion for working capital purposes
 Escrowing of receivables – Trust & Retention Account
 Under this strategy, the company is in operation, but requires some relief. However,
along with reliefs, some additional fund infusion by the promoter should be a must.

CHANGE IN MANAGEMENT

 Change in the promoters

 Induction of professionals

ONE TIME SETTLEMENT (OTS)

76
 NPA MANAGEMENT

 Full principal with all past interest and future interest with prepayment premium
 Full principal with all past interest
 Full principal with part interest
 Full principal with full or part interest converted to equity or quasi equity instrument
 Part principal with the remaining part converted to some equity or quasi equity
instrument
 Part principal and remaining part written off

MERGER WITH ANOTHER COMPANY

 Nature of the industry – sunrise or sunset

 Synergy issues
 Valuation
 Share swap ratio
 Tax implications

77
 NPA MANAGEMENT

RECOMMENDATIONS OF THE STUDY

Through RBI has introduced number of measures to reduce the problem of increasing NPAs
of the banks such as CDR mechanism. One time settlement schemes, enactment of SRFAESI
act, etc. A lot of measures are desired in terms of effectiveness of these measures. What we
would like to suggest for reducing the evolutions of the NPAs of Public Sector Banks are as
under.

(1) Each bank should have its own independent credit rating agency which should evaluate
the financial capacity of the borrower before than credit facility.

(2) The credit rating agency should regularly evaluate the financial condition of the clients.

(3) Special accounts should be made of the clients where monthly loan concentration
reports should be made.

(4) It is also wise for the banks to carryout special investigative audit of all financial and
business transactions and books of accounts of the borrower company when there is
possibility of the diversion of the funds and mismanagement.

(5) The banks before providing the credit facilities to the borrower company should
analyze the major heads of the income and expenditure based on the financial performance
of the comparable companies in the industry to identify significant variances and seek
explanation for the same from the company management. They should also analyze the
current financial position of the major assets and liabilities.

78
 NPA MANAGEMENT

(6) Banks should evaluate the SWOT analysis of the borrowing companies i.e. how they
would face the environmental threats and opportunities with the use of their strength and
weakness, and what will be their possible future growth in concerned to financial and
operational performance.

(7) Independent settlement procedure should be more strict and faster and the decision
made by the settlement committee should be binding both borrowers and lenders and any
one of them failing to follow the decision of the settlement committee should be punished
severely

(8) There should be proper monitoring of the restructured accounts because there is every
possibility of the loans slipping into NPAs category again.

(9) Proper training is important to the staff of the banks at the appropriate level with
ongoing process. That how they should deal the problem of NPAs, and what continues
steps they should take to reduce the NPAs.

(10) Willful Default of Bank loans should be made a Criminal Offence.

(11) No loan is to be given to a Group whose one or the other undertaking has become a
Defaulter.

79
 NPA MANAGEMENT

CONCLUSION OF THE STUDY

Asset quality is one of the important parameters based on which the performance of a
bank is assessed by the regulation and the public. Some of the areas where the Indian banks
identified to for better NPA management like credit risk management, special investigative
audit, negotiated settlement, internal checks & systems for early indication of NPAs etc

The response to Basel Accord II reforms world over is not uniform and spontaneous.
Basel-II is known for complicated risk management models and complex data requirements.
Big international banks, as those in the US, prefer this new version, as they perceive that their
superior technology and systems would make them Basel compliant and provide an edge in
the competitive environment, in the form of lower regulatory capital.

Indian banks do not perceive any immediate value in the new norms as they are
globally insignificant players with simple and straight forward balance-sheet structures. This
is clearly vindicated by the sample study according to which 57 per cent of the executives of
public sector banks are sceptical about Basel Accord II norms, particularly in respect of
investment cost and the complexity of proposed internal rating system. As against this, the
private sector banks with supposedly more investment in technology related infrastructure are
in favour of the proposals under New Basel Capital Accord as vindicated by the sample study
according to which 67 percent of executives of private sector banks are in-favour for New
Basel Capital Accord.

However, putting Basel II in place is going to be far more challenging than Basel I.
The adoption of Basel II will boost good Risk Management practices and good corporate

80
 NPA MANAGEMENT

governance in banks. However, the cost of putting in place robust system today is viewed in
an increasingly number of countries as a price worth paying to prevent such crisis. Assuming
that the banks can get over the technological and operational hurdles, switching over to Basel
II norms can no doubt turn the Indian banks, mainly the public sector banks, more efficient
and competitive globally. This, in turn, will help strengthen the financial sector to undertake
further reforms including capital account convertibility more confidently.

It is realized that if a resolution strategy for recovery of dues from NPAs is not put in
place quickly and efficiently, these assets would deteriorate in value over time and little value
would be realized at the end, except may be its scrap value. That is why; asset securitisation
has gained popularity among financial sector players. The literature, however, has not
specifically discussed about the various resolution strategies that could be put in place for
recovery from NPAs, and in particular, in which situation which strategy should be adopted.
The purpose of this paper is to indicate the various considerations that one has to bear in
mind before zeroing on a resolution strategy. The details of the strategy would follow after
that.

It is important to note that it is difficult to get data from banks and institutions
regarding the decision process that leads to a specific resolution strategy for a particular
NPA. This is so as there is no fixed formula on the basis of which a recovery strategy for a
NPA is undertaken. Broad parametric guidelines can be given like vintage of plant and
machinery and current market value, future revenue generating potential of the assets, extent
of provisioning in the books of the lender, asset classification as per prudential norms, the
nature of the industry etc. But to arrive a specific figure for a one time settlement or sale of a
second hand asset or financial restructuring involves subjective elements in bargaining, the
extent to which the borrower is conscious of his/her social status, financial strength of the
incumbent promoter etc. For example it is difficult to substantiate as to why a bank, for a
particular company, went it for settlement for 50% of the principal amount waiving all other
dues. Two NPAs of the same vintage in the same industry may be resolved in two ways. This
is why, although Reserve Bank of India (RBI) has given some guidelines in this regard, it has
left it to the discretion of the Board of Directors of a bank/institution to take decisions outside
the guidelines of RBI.

81
 NPA MANAGEMENT

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.

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.

1. The NPA is one of the biggest problems that the Public Sector Banks are facing today is
the problem of nonperforming assets. If the proper management of the NPAs is not
undertaken it would hamper the business of the banks.

2. In absolute terms, the last three years have seen an increase in the net NPAs of 25
public sector banks by 24 per cent. According to the numbers, the last year it saw a 17
percent rise in the sticky assets.

3. The largest public sector lender, SBI, has seen an increase in the net NPAs by a whopping
41 percent in 2007-08.

4. As the global slowdown has crept into the economy, bankers feel that in more loans are
going to turn bad in the coming quarters and therefore they want RBI to relax the deadline for
loan reconstruction.

5. Due to Recession & slowdown in the Indian economy would result in emerging
NPA‘s for the public sector banks from textiles, real estate, retail, exports and auto sectors.

6. The RBI has also been trying to take number of measures but the ratio of NPAs is not
decreasing of the banks. The banks must find out the measures to reduce the evolving
problem of the NPAs.

82
 NPA MANAGEMENT

7. The reduction of the NPAs would help the banks to boost up their profits, smooth
recycling of funds in the nation. This would help the nation to develop more banking
branches and developing the economy by providing the better financial services to the nation.

8. If the concept of NPAs is taken very lightly it would be dangerous for the Indian banking
sector. The NPAs would destroy the current profit, interest income due to large provisions of
the NPAs, and would affect the smooth functioning of the recycling of the funds.

9. As a result of the NPA’s owners do not receive a market return on their capital. In the
worst case, if the bank fails, owners lose their assets & this may affect a broad pool of
shareholders & act as a rain on Profitability.

10. Banks also redistribute losses to other borrowers by charging higher interest rates .Lower
deposit rates and higher lending rates repress savings and financial markets, which hampers
economic growth.

12. When many borrowers fail to pay interest, banks may experience liquidity shortages
.These shortages can jam payments across the country and as a result non performing loans
may spill over the banking system and contract the money stock, which may lead to
economic contraction.

13. Banks need to create capital reserve to write off the mounting NPA’s burden.

14. “A Man without money is like a bird without wings”, the Rumanian proverb insists the
importance of the money. A bank is an establishment, which deals with money. The basic
functions of Commercial banks are the accepting of all kinds of deposits and lending of
money. In general there are several challenges confronting the commercial banks in its day to
day operations. The main challenge facing the commercial banks is the disbursement of funds
in quality assets (Loans and Advances) or otherwise it leads to Non-performing assets.”

83
 NPA MANAGEMENT

LIMITATIONS OF THE STUDY

The limitations that we felt in our study are:

 It was critical for us 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.

Every bank submitting suit file /NPA Data to RBI under:

1. Quarterly RBI format

2. Comprehensive statement

a) Sharing recovery in suit filed A/c

b) Age wise classification of A/c
c) Sector wise i.e. C&IC, Agriculture and SSI etc.

 Since our study is based on the secondary data, the practical operations as related to
the NPAs are adopted by the banks are not exercised.

 Since there is mass banking as far as amount as well as no. of branches are so wide
Even Bank of India is having more than 3000 branches so it was not possible for
us to cover all the banks of the Indian banking sector.

84
 NPA MANAGEMENT

 Provision for the classification of the Assets / NPA’s are differs as per guidelines of
controlling banks i.e. RBI 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.

BIBLIOGRAPHY

Websites:

 http://www.equitymaster.com/stockquotes/mystocks.asp
 http://moneyterms.co.uk/interest_spread/
 http://economictimes.indiatimes.com/Features/The_Sunda
y_ET/Economy/Private_banks_struggle_to_manage_their_non-
performing_assets/articleshow/3049718.cms#write
 www.123eng.com
 http://www.rupeetimes.com/experts/joseph_samson_5.htm
l
 http://www.rupeetimes.com/news/personal_loan/banks_as
k_rbi_to_relax_npa_norms_for_real_estate_sector_1919.html
 http//:www.rbi.org.com
 http//:www.money.radiff.com
 http//:www.economictimes.indiatimes.com

85
 NPA MANAGEMENT

86