Professional Documents
Culture Documents
There are many reasons as to why a loan goes bad. For a business, it could be
because it fails to take off.
Such a situation may arise because of sudden health expenditure or job loss or
death. Often, as in the US today, it can be because of over-leveraging, when
consumers borrow against most of their assets and, maybe, have unsecured loans
too.
In such a case, any hit on income can jeopardize all repayments. They, however,
can file for bankruptcy under Chapters 7, 11 and 13 of the United States
Bankruptcy Code. Indians don’t have such an option.
In India, the situation has worsened due to banks aggressively pushing loans,
even unsecured ones, to individuals to prevent idle assets on their books.
President and founder of International Consumer Rights Protection Council, an
NGO, says most customers in India are not financially educated and banks are
luring them to take more and more loans, often without checking their financial
position
Definitions:_-An asset, including a leased asset, becomes non-performing when
it ceases to generate income for the bank.
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, from the year ending March 31, 2004. Accordingly, with
effect from March 31, 2004, a non-performing asset (NPA) shall be a loan or an
advance where;
> The account remains 'out of order' for a period of more than 90 days, in
respect of an Overdraft/Cash Credit (OD/CC),
> The bill remains overdue for a period of more than 90 days in the case of
bills purchased and discounted,
> Interest and/or installment of principal remains overdue for two harvest
seasons but for a period not exceeding two half years in the case of an
advance granted for agricultural purposes, and
Any amount to be received remains overdue for a period of more than 90
days in respect of other accounts.
1. 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.
The installments, which has become overdue for a period of more than twelve
months.
2) Net NPA
Net NPAs are those type of NPAs in which the bank has deducted the
provision regarding NPAs. Net NPA shows the actual burden of banks.
Since in India, bank balance sheets contain a huge amount of NPAs and the
process of recovery and write off of loans is very time consuming, the
provisions the banks have to make against the NPAs according to the
central bank guidelines, are quite significant. That is why the difference
between gross and net NPA is quite high.
Banks should classify their assets into the following broad groups, viz.
1. Standard Assets
2. Sub-standard Assets 3.Doubtful Assets
4. Loss Assets
1. Standard Assets
Standard Asset is one which does not disclose any problems and which does
not carry more than normal risk attached to the business. Such an asset
should not be an NPA.
2. Sub-standard Assets
(I) with effect from March 31, 2005 an asset would be classified as Sub-
standard if it remained NPA for a period less than or equal to 12 months. In such
cases, the current net worth of the borrowers/ guarantors or the current market
value of the security charged is not enough to ensure recovery of the dues to the
banks in full. In other words, such assets will have well defined credit
weaknesses that jeopardize the liquidation of the debt and are characterized by
the distinct possibility that the banks will sustain some loss, if deficiencies are
not corrected.
(ii) An asset where the terms of the loan agreement regarding interest and
principal have been re-negotiated or rescheduled after commencement of
production, should be classified as substandard and should remain in such
category for at least 12 months of satisfactory performance under the re-
negotiated or rescheduled terms. In other words, the classification of an asset
should not be upgraded merely as a result of rescheduling, unless there is
satisfactory compliance of this condition.
With effect from March 31, 2005, an asset is required to be classifieds doubtful,
if it has remained NPA for more than 12 months. For Tier I banks, the 12-
month period of classification of a substandard asset in doubtful category is
effective from April 1, 2009. As in the case of sub-standard assets, rescheduling
does not entitle the bank to upgrade the quality of an advance automatically. A
loan classified as doubtful has all the weaknesses inherent as that classified as
sub-standard, with the added characteristic that the weaknesses Make collection
or liquidation in full, on the basis of currently known facts, conditions and
values, highly questionable and improbable.
Note: Consequent to change in asset classification norms w.e.f. March 31, 2005
banks are permitted to phase the consequent additional provisioning over a five
year period commencing from the year ended March 31, 2005, with a minimum
of 10 % of the required provision in each of the first two years and the balance
in equal installments over the subsequent three years.
4) Loss Assets A loss asset is one where loss has been identified by the bank or
internal or external auditors or by the Co-operation Department or by the
Reserve Bank of India inspection but the amount has not been written off,
wholly or partly. In other words, such an asset is considered un-collectible and
of such little value that its continuance as a bankable asset is not warranted
although there may be some salvage or recovery value.
Basic Considerations
(I) broadly speaking, classification of assets into above categories should be
done taking into account the degree of well defined credit weaknesses and extent
of dependence on collateral security for realization of dues.
(ii) Responsibility and validation levels for ensuring proper asset classification
may be fixed by the bank.
(iii) The system should ensure that doubts in asset classification due to any
reason are settled through specified internal channels within one month from the
date on which the account would have been classified as NPA as per extant
guidelines.
(iv) RBI would continue to identify the divergences arising due to non-
compliance, for fixing accountability. Where there is willful non-compliance by
the official responsible for classification and is well documented, RBI would
initiate deterrent action including imposition of monetary penalties.
INCOME RECOGNITION
As and when an asset is classified as an NPA, the bank has to further sub-
classify it into sub-standard, loss and doubtful assets. Based on this classification,
bank makes the necessary provision against these assets.
Reserve Bank of India (RBI) has issued guidelines on provisioning requirements
of bank advances where the recovery is doubtful. Banks are also required to
comply with such guidelines in making adequate provision to the satisfaction of
its auditors before declaring any dividends on its shares.
In case of loss assets, guidelines specifically require that full provision (100%)
for the amount outstanding should be made by the concerned bank. This is
justified on the grounds that such an asset is considered uncollectible and cannot
be classified as bankable asset.
For instance, for NPAs which are up to 1-year old, provision should be made of
20% of secured portion, in case of 1-3 year old NPAs up to 30% of the secured
portion and finally in case of more than 3 year old NPAs up to 50% of secured
portion should be made by the concerned bank.
Reserve Bank of India (RBI) has merely laid down the minimum provisioning
requirement that should be complied with by the concerned bank on a mandatory
basis. However, where there is a substantial uncertainty to recovery, higher
provisioning should be made by the bank concerned.
Disclosure Norms:
Banks should disclose in balance sheets maturity pattern of advances, deposits,
investments and borrowings. Apart from this, banks are also required to give
details of their exposure to foreign currency assets and liabilities and movement
of bad loans. These disclosures were to be made for the year ending March 2000
In fact, the banks must be forced to make public the nature of N.P.As being
written off. This should be done to ensure that the taxpayer’s money given to the
banks, as capital is not used to write off private loans without adequate efforts
and punishment of defaulters. # A Close look: For the future, the banks will
have to tighten their credit evaluation process to prevent this scale of sub-
standard and loss assets. The present evaluation process in several banks is
burdened with a bureaucratic exercise, sometimes involving up to 18 different
officials, most of whom do not add any value (information or judgment) to the
evaluation. But whether this government and its successors will continue to play
with bank funds remains to be seen. Perhaps even the loan waivers and loan
"melas" which are often decried by bankers form only a small portion of the
total N.P.As. As mentioned above, much more stringent disclosure norms are
the only way to increase the accountability of bank management to the
taxpayers. A lot therefore depends upon the seriousness with which a new
regime of regulation is pursued by RBI and the newly formed Board for
Financial Supervision.
(i) In respect of a borrower having more than one facility with a bank, all the
facilities granted by the bank will have to be treated as NPA and not the
particular facility or part thereof which has become irregular.
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 corporate
became bankrupt and failed to provide investors with clearer and more complete
information thereby introducing a degree of risk that many investors could
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.
Why such huge levels of NPAs exist in the Indian banking system
(IBS)?
The origin of the problem of burgeoning NPAs lies in the quality of managing
credit risk by the banks concerned. What is needed is having adequate preventive
measures in place namely, fixing pre-sanctioning appraisal responsibility and
having an effective post-disbursement supervision. Banks concerned should
continuously monitor loans to identify accounts that have potential to become
non-performing.
Also, with increasing deposits made by the public in the banking system, the
banking industry cannot afford defaults by borrower s since NPAs 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.
a) internal factors
b)external factors
INTERNAL FACTORS
There are three cardinal principles of bank lending that have been followed by
the commercial banks since long
Principles of safety
Principle of liquidity
Principles of profitability
Principles of safety:-
By safety it means that the borrower is in a position to repay
the loan both principal and interest. The repayment of loan
depends upon the borrowers:
a. Capacity to pay
b. Willingness to pay
When bankers give loan, he should analyze the purpose of the loan. To ensure
safety and liquidity, banks should grant loan for productive purpose only. Bank
should analyze the profitability, viability, long term acceptability of the project
while financing 4. Poor credit appraisal system--Poor credit appraisal is
another factor for the rise in NPAs. Due to poor credit appraisal the bank gives
advances to those who are not able to repay it back. They should use good credit
appraisal to decrease the NPAs
5. Managerial deficiencies
The banker should always select the borrower very carefully and
should take tangible assets as security to safe guard its interests. When
accepting securities banks should consider the_
1. Marketability
2. Acceptability
3. Safety
4. Transferability.
The banker should follow the principle of diversification of risk based on the
famous maxim "do not keep all the eggs in one basket"; it means that the banker
should not grant advances to a few big farms only or to concentrate them in few
industries or in a few cities. If a new big customer meets misfortune or certain
traders or industries affected adversely, the overall position of the bank will not
be affected.
Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom
industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), And the
handloom sector Orissa hand loom WCS ltd (2439.60lakhs).
EXTERNAL FACTORS
2. Willful Defaults
There are borrowers who are able to payback loans but are intentionally
withdrawing it. These groups of people should be identified and proper measures
should be taken in order to get back the money extended to them as advances
and loans.
3. Natural calamities
This is the measure factor, which is creating alarming rise in NPAs of the PSBs.
every now and then India is hit by major natural calamities thus making the
borrowers unable to pay back there loans. Thus the bank has to make large
amount of provisions in order to compensate those loans, hence end up the fiscal
with a reduced profit.
Mainly ours farmers depends on rain fall for cropping. Due to irregularities of
rain fall the farmers are not to achieve the production level thus they are not
repaying the loans.
4. Industrial sickness
5. Lack of demand
Entrepreneurs in India could not foresee their product demand and starts
production which ultimately piles up their product thus making them unable to
pay back the money they borrow to operate these activities. The banks recover
the amount by selling of their assets, which covers a minimum label. Thus the
banks record the non recovered part as NPAs and has to make provision for it.
6. Change on Govt, policies
With every new govt, banking sector gets new policies for its operation. Thus it
has to cope with the changing principles and policies for the regulation of the
rising of NPAs.
1. Owners do not receive a market return on there capital .in the worst case, if
the banks fails, owners loose their assets. In modern times this may affect a
broad pool of shareholders.
IMPACT OF NPA
1. Profitability: -
NPA means booking of money in terms of bad asset, which occurred due to
wrong choice of client. Because of the money getting blocked the prodigality of
bank decreases not only by the amount of NPA but NPA lead to opportunity cost
also as that much of profit invested in some return earning project/asset. So NPA
doesn't affect current profit but also future stream of profit, which may lead to
loss of some long-term beneficial opportunity. Another impact of reduction in
profitability is low ROI (return on investment), which adversely affect current
earning of bank.
2. Liquidity:-
Money is getting blocked, decreased profit lead to lack of enough cash at hand
which lead to borrowing money for shot\rtes period of time which lead to
additional cost to the Company. Difficulty in operating the functions of bank is
another cause of NPA due to lack of money. Routine payments and dues.
3. Involvement of management:-
Time and efforts of management is another indirect cost which bank has to bear
due to NPA. Time and efforts of management in handling and managing NPA
would have diverted to some fruitful activities, which would have given good
returns. Now day's banks have special employees to deal and handle NPAs,
which is additional cost to the bank.
4. Credit loss:-
Bank is facing problem of NPA then it adversely affect the value of bank in
terms of market credit. It will lose its goodwill and brand image and credit
which have negative impact to the people who are putting their money in the
banks.
Preventive measures of NPAs
Invariably, by the time banks start their efforts to get involved in a revival
process, it's too late to retrieve the situation- both in terms of rehabilitation of
the project and recovery of bank's dues. Identification of weakness in the very
beginning that is: When the account starts showing first signs of weakness
regardless of the fact that it may not have become NPA, is imperative.
Assessment of the potential of revival may be done on the basis of a techno-
economic viability study. Restructuring should be attempted where, after an
objective assessment of the promoter's intention, banks are convinced of a
turnaround within a scheduled timeframe. In respect of totally unviable units as
decided by the bank, it is better to facilitate winding up/ selling of the unit
earlier, so as to recover whatever is possible through legal means before the
security position becomes worse.
Identifying borrowers with genuine intent from those who are non- serious with
no commitment or stake in revival is a challenge confronting bankers. Here the
role of frontline officials at the branch level is paramount as they are the ones
who have intelligent inputs with regard to promoters' sincerity, and capability to
achieve turnaround. Bases don this objective assessment, banks should decide as
quickly as possible whether it would be worthwhile to commit additional
finance.
Longer the delay in response, grater the injury to the account and the asset. Time
is a crucial element in any restructuring or rehabilitation activity. The response
decided on the basis of techno-economic study and promoter's commitment, has
to be adequate in terms of extend of additional funding and relaxations etc.
under the restructuring exercise. The package of assistance may be flexible and
bank may look at the exit option.
5. Management Effectiveness:-
The general perception among borrower is that it is lack of finance that leads to
sickness and NPAs. But this may not be the case all the time. Management
effectiveness in tackling adverse business conditions is a very important aspect
that affects a borrowing unit's fortunes. A bank may commit additional finance
to an align unit only after basic viability of the enterprise also in the context of
quality of management is examined and confirmed. Where the default is due to
deeper malady, viability study or investigative audit should be done - it will be
useful to have consultant appointed as early as possible to examine this aspect.
A proper techno- economic viability study must thus become the basis on which
any future action can be considered.
6. Multiple Financing
b). In some default cases, where the unit is still working, the bank should
make sure
that it captures the cash flows (there is a tendency on part of the borrowers
to
switch bankers once they default, for fear of getting their cash flows
forfeited),
and ensure that such cash flows are used for working capital purposes.
Toward
this end, there should be regular flow of information among consortium
members. A bank, which is not part of the consortium, may not be allowed
to
Offer credit facilities to such defaulting clients. Current account facilities
may also be denied at non-consortium banks to such clients and violation
may attract penal action. The Credit Information Bureau of India Ltd.
(CIBIL) may be very useful for meaningful information exchange on
defaulting borrowers once the setup becomes fully operational.
C) In a forum of lenders, the priority of each lender will be different. While one
set of
lenders may be willing to wait for a longer time to recover its dues, another
lender may have a much shorter timeframe in mind. So it is possible that the
letter categories of lenders may be willing to exit, even a t a cost - by a
discounted settlement of the exposure. Therefore, any plan for
restructuring/rehabilitation may take this aspect into account.
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.
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. Some of
the widely used approaches towards valuation of an NPA by the valuation firms
are detailed as under:
1. 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/ NPAs.
3. Earning Model
The legal basis for the mechanism is provided by the Inter-Creditor Agreement
(ICA). All participants in the CDR mechanism must enter the ICA with
necessary enforcement and penal clauses.
3.DRT ACT: -
The banks and FIs can enforce their securities by initiating recovery proceeding
under the Recovery if Debts due to Banks and FI act, 1993 (DRT Act) by filing
an application for recovery of dues before the Debt Recovery Tribunal
constituted under the Act. On adjudication, a recovery certificate is issued and
the sale is carried out by an auctioneer or a receiver.
DRT has powers to grant injunctions against the disposal, transfer or creation of
third party interest by debtors in the properties charged to creditor and to pass
attachment orders in respect of charged properties. In case of non-realization of
the decreed amount by way of sale of the charged properties, the personal
properties if the guarantors can also be attached and sold. However, realization
is usually time-consuming. Steps have been taken to create additional benches.
For claims below Rs.10 lacks, the banks and FIs can initiate proceedings under
the Code of Civil Procedure of 1908, as amended, in a civil court.
The courts are empowered to pass injunction orders restraining the debtor
through itself or through its directors, representatives, etc from disposing of,
parting with or dealing in any manner with the subject property.
Courts are also empowered to pass attachment and sales orders for subject
property before judgment, in case necessary.
The sale of subject property is normally carried out by way of open public
auction subject to confirmation of the court. The foreclosure proceedings, where
the DRT Act is not applicable, can be initiated under the Transfer of Property
Act of 1882 by filing a mortgage suit where the procedure is same as laid down
under the CPC.
BIFR has been given the power to consider revival and rehabilitation of
companies under the Sick Industrial Companies (Special Provisions) Act of
1985 (SICA), which has been repealed by passing of the Sick Industrial
Companies (Special Provisions) Repeal Bill of 2001.
The board of Directors shall make a reference to BIFR within sixty days from
the date of finalization of the duly audited accounts for the financial year at the
end of which the company becomes sick. The company making reference to
BIFR to prepare a scheme for its revival and rehabilitation and submit the same
to BIFR the procedure is same as laid down under the CPC.The shelter of BIFR
misused by defaulting and dishonest borrowers It is a time consuming process.
In December 2002, the Indian Parliament passed the Companies Act of 2002
(Second Amendment) to restructure the Companies Act, 1956 leading to a new
regime of tackling corporate rescue and insolvency and setting up of NCLT.
NCLT will abolish SICA; have the jurisdiction and power relating to winding up
of companies presently vested in the High Court and jurisdiction and power
exercised by Company Law Board
However, the quality and skills of judges, newly appointed or existing, will need
to be reinforced and no provision has been made for appropriate procedures to
evaluate the performance of judges based on the standards
Writing off of NPAs
1. In terms of Section 43(D) of the Income Tax Act 1961, income by way of
interest in relation to such categories of bad and doubtful debts as may be
prescribed having regard to the guidelines issued by the RBI in relation to
such debts, shall be chargeable to tax in the previous year in which it is
credited to the bank’s profit and loss account or received, whichever is
earlier.
2. This stipulation is not applicable to provisioning required to be made as
indicated above. In other words, amounts set aside for making provision for
NPAs as above are not eligible for tax deductions.
3. Therefore, the banks should either make full provision as per the
guidelines or write-off such advances and claim such tax benefits as are
applicable, by evolving appropriate methodology in consultation with their
auditors/tax consultants. Recoveries made in such accounts should be
offered for tax purposes as per the rules.
The main purpose of this notice is to inform the borrower that either the sum due
to the bank or financial institution is paid by the borrower or else the former will
take action by way of taking over the possession of assets. Besides assets, banks
can also takeover the management of the company.
Thus the bankers under the aforementioned Act will have the much needed
authority to either sell the assets of the defaulting companies or change their
management.
But the protection under the said Act only provides a partial solution. What
banks should ensure is that they should move with speed and charged with
momentum in disposing off the assets. This is because as uncertainty increases
with the passage of time, there is all possibility that the recoverable value of asset
also reduces and it cannot fetch good price. If faced with such a situation than the
very purpose of getting protection under the Securitization Act, 2002 would be
defeated and the hope of seeing a must have growing banking sector can easily
vanish.
Reporting of NPAs to RBI
1) Banks are required to furnish a Report on NPAs as on 31st March each year
after completion of audit. The NPAs would relate to the banks’ global portfolio,
including the advances at the foreign branches. The Report should be furnished
as per the prescribed format given in the Annex I.
2) While reporting NPA figures to RBI, the amount held in interest suspense
account, should be shown as a deduction from gross NPAs as well as gross
advances while arriving at the net NPAs and net advances. Banks which do not
maintain Interest Suspense Account for parking interest due on non-performing
advance accounts, may furnish the amount of interest receivable on NPAs as a
foot note to the Report.
3) Whenever NPAs are reported to RBI, the amount of technical write off, if
any, should be reduced from the outstanding gross advances and gross NPAs to
eliminate any distortion in the quantum of NPAs being reported.