Description
NPA is a classification used by financial institutions that refer to loans that are in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.
Research Journal of Social Sciences, 3: 4-12, 2008 © 2008, INSInet Publications
Are non - Performing Assets Gloomy or Greedy from Indian Perspective?
1
M. Karunakar, 2Mrs. K.Vasuki and 3Mr. S. Saravanan
Reader and Head, Department of Business Administration, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 2 Senior Lecturer in Commerce, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 3 Lecturer in Economics, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India.
Abstract: The economic reforms initiated by the then finance minister and present prime minister of India Dr. Manmohan Singh would have been remained incomplete without the overhaul of Indian banking sector. The important aspect of norms and guidelines for making the whole sector vibrant and competitive. The problem of losses and lower profitability of Non-Performing Assets (NPA) and liability mismatch in banks and financial sector depend on how various risks are managed in their business. An attempt is made in the paper that what is NPA? The factors contributing to NPA, the magnitude of NPA, reasons for high NPA and their impact on Indian banking operations. Besides capital to risk weightage assets ratio of public sector banks, management of credit risk and measures to control the menace of NPAs are also discussed. The lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. It is better to avoid NPAs at the market stage of credit consolidation by putting in place of rigourous and appropriate credit appraisal mechanisms. Key words: NPA, Factor contributing NPA, Magnitude and Consequences, Recovery methods, Capital adequacy ratio. INTRODUCTION The economic reforms initiated in 1991 by the then Finance minister and present Prime Minister Dr. M anmohan Singh would have been remained incomplete without the overhaul of the Indian banking sector. T he Narasimham committee report (First report) recommendations are the basis for initiation of the process, which is still continuing, though many of the sick banks are able to come out of the red after repeated doses of fund infusion. But a few of the banks are still in the red and efforts are on to resuscitate them. The bigger challenge at the moment is to deal with the worsening financial health of the banking sector. The important financial institutions like Industrial Finance Corporation of India (IFCI) and Industrial Development Bank of India (IDBI) are also not in the pink of health, which require government support for revitalizing themselves. The important aspect of the banking sector reforms is relating to liberalization of norms and guidelines for making the whole sector vibrant and competitive. This was a gradual process undertaken with utmost care and least it should disrupt the banking sector. Slowly the Reserve Bank of India (RBI) has freed the interest rate, but marginally increased now, both on the d e p o s it a n d le n d ing s pe c trum s a t p re se n t . Simultaneously it has relaxed the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) and also unlocking more and more funds in the financial markets. On the deposit side, the bank is free to offer any rate of interest depending upon their asset – liability position. But the RBI regulates the savings rate. Similarly the banks can charge the flexible rate on lending operations depending upon their risk perception. It is futile to say that there are no controls but they are much lesser as compared to the controls that was existed before the initiation of banking reforms. The other vibrant dimension of the banking sector is to reduce the Non – performing assets (NPA). During 1980 to 1996, there was a crisis in the banking sector W orld over. According to a study 73 percent of the member countries of the International Monetary Fund (IMF) have experienced serious banking problems but most of these member countries are developing nations only. One of the prominent reasons for the crisis is building up of Non Performing Assets in the banking and financial sector. India has also experienced the problem of raising NPA. Apart from compromise on object credit assessment of borrowers due to political economy considerations,
1
Corresponding Author: M. Karunakar, Reader and Head, Department of Business Administration, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 4
Res. J. Soc. Sci., 3: 4-12, 2008 laxities in legal system, accounting disclosure practices, recession and willful default have lead to the accumulation of NPA. Growth and Structural Changes in Banking Sector: In order to have proper understanding of NPA menace, it is necessary to have brief idea of growth and structural changes that have taken place in the banking sector. The growth of the banking business can be assessed in five phases. C Preliminary phase: Series of births and deaths of banks in the first five decades of twentieth Century. Business phase: Laying of solid and sound foundation for banking business which was taken place between 1949 and 1969 by enacting Banking Companies’ Regulation Act 1949. Branching out phase (1969 to 1985): W hen 19 major commercial banks were nationalized in two phases and these banks have reached larger mass of population through opening of branches and lead bank schemes. Consolidation phase: During this phase (1985 – 1991) weaknesses and defects of mass branching were identified and attended through various committees’ investigation. Reforms and strengthening stage (1991 to till date): Infact first dose of reforms started with Narasimham Committee report in 1991. Subsequently there were series of reforms in SLR, CRR, new norms of assets classification (NPA) and provisioning of capital adequacy norms, permission for entry of new generation of private banks and foreign banks regulation of interest rate, setting up of Debt Recovery Tribunals and passage of Securitization And Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) 2002. Banking Risks: The problem of losses or lower profitability of NPAs, assets and liability mismatch in banks and financial sector depend on how the following risks are managed in their businesses. (a) Credit risk (b) Interest rate risk (c) Exchange rate risk (d) Liquidity risk (e) Transfer risk (f) Operational risk (g) M arket risk (h) Settlement risk (i) Counter party risk and (j) Country risks. W hat is NPA?: Banking businesses is mainly that of borrowing from the public and lending it to the needy persons and business at a premium. Lending of money involves a credit risk. W hen the loans and advances made by banks or financial institutions turnout as non - productive, non-rewarding and non - remunerative then they will become Non – Performing Assets (NPA). According to SARFAESI 2002. NPA is an asset or account of a borrower, which is classified by a bank or financial institution as sub-standard asset, doubtful asset and loss asset .
C
C
C
C
Summary of the guidelines are given below: Loans and Advances Guidelines applicable From 31.3.2001 Term loan interest/ installment 180 days remains overdue for more than Overdraft / cash credit a/c Remains out of order (!) Bills purchased and discounted 180 days remains overdue for more than Agricultural loan interest / interest Two harvest seasons but not remains overdue for more than exceeding two and half year Other accounts – Any account to 180 days be received remains overdue for more than The NPA were to be reckoned on past due basis prior to 31.3.2001. As per the guidelines if the amount remained past due for more than two quarters it is treated as NPA. W hen the advance remains outstanding for 30 days beyond the due date it is past due as per RBI classification issued in December 1992. (!) Out of order means outstanding balance in the overdraft / cash credit account which remains continuously in excess of the sanctioned limit for 6 months. If the outstanding balance in principal
Guidelines applicable From 31.3.2002 90 days Remains out of order 90 days Two harvest seasons but not exceeding two and half years 90 days
Over draft and Cash credit is less than the sanctioned limit but there is no credit balance for 6 months or balance is not enough to cover interest debited for the period, then such account is also to be taken as out of order. Over the years the criteria for NPA regulations have become stricter. RBI reports said that these stricter guidelines are issued for improvements in the payment and settlement systems, recovery climate and up gradation of technology in the banking system.
5
Res. J. Soc. Sci., 3: 4-12, 2008 Factors Contributing NPAs: to NPAs are: C The factors contributing 2005 - 2006. The magnitude of gross NPAs and net NPAs have sliding down from 23.18% in 1992 –93 to 3.3% in 2005 – 2006whereas the net NPAs has gone down to 1.2% from 14.46% for the same period. It is to be treated as a serious crisis in view of its mounting NPAs in absolute terms. The high level of NPAs in banks is a matter of grave concern to the public as well as to government since the bank credit is a catalyst to the economic development of the country and any bottleneck in the smooth flow of credit due to the mounting NPAs is bound to create an adverse repercussion for the economy of the country however the magnitude of direction is in descending order which shows government and banks are taking corrective measures to contain NPAs. Indian B anking Industry Saddled with High NPAS – The Reasons: The liberalization policies launched in 1991 opened the doors to the entrepreneurs to setup industries and business, which are largely financed by loans from the Indian banking systems. There is a shakeout with many businesses are failing and loans have become bad. In the global economy prevailing today, the vulnerability of Indian businesses has increased. A culture change is crept in where repayment of bank loans is no longer assured. A constant follow up action and vigil are to be exercised by the operating staff. Diversion of funds and willful default has become more common. As per a study published in the RBI bulletin in July 1999, diversion of funds and willful default are found to be the major contributing factors for NPAs in public and private sector banks. Today, the situation looks optimistic with the industry succeeding in overcoming the hurdles faced earlier. The timely restructuring and rehabilitation measures have helped to overcome setbacks and hiccups without seriously jeopardizing their future. The greater transparency and stricter corporate governance methods have significantly raise the credibility of the corporate sector. The attrition rate in corporate sector has come down. The challenges before the banks in India today are the raising NPAs in the retail sector, propelled by high consumerism and lowering of moral standards. Impact of NPAs on Banking Operations: The efficiency of a bank is not reflected only by the size of its balance sheet but also the level of return on its assets. The NPAs do not generate interest income for banks but at the same time banks are required to provide provisions for NPAs from their current profits. The NPAs have deleterious impact on the return on assets in the following ways.
C
C
C C
C
C
C C C
C C
C C
D iversificatio n o f funds for expansion, modernization undertaking of new projects and also for helping associate concerns. This is coupled with recessionary trends and failure to tap required funds in the capital and debt market. Business (Product, marketing, financial) failure, inefficient management, strained labor relations, inappropriate technology, outmoded machinery, technical problems and product obsolescence. Recession, input and power shortage, price escalation, accidents, natural calamities, external problems in other countries leading to non – payment of over dues. Time and cost over run during project implementation stage. Government policies like changes in excise duties, pollution control, poor credit decisions, priority sector lending and outdated legal systems. W illful default, siphoning off funds, fraud and misappropriation by promoters and directors dispute. Deficiencies on the part of banks like delay in release of funds and delay in release of subsidies by government. Delay in finalization of rehabilitation package by the board of Industrial and Reconstruction (BIFR). Absence of written policies. The absence of portfolio concentration limits, poor industry analysis, cursory financial analysis of borrowers. Inadequate customers contract Excessive reliance on collateral, absence of follow up action by banks, poor control on loan documentation. Absence of asset classification and loan loss provisioning standards and The lack of co-ordination between the financial institutions and commercial banks, which provide long-term needs of industry that, enables the industry to misuse the funds.
M agnitude of NPAs in India: A glance through the statistics on the movement of NPAs of public sector banks will help to understand the extent to which they are standing with regard to NPAs is shown below The analysis of the above table gives a clear crystal picture about the NPAs in public sector banks. Since introduction of prudential norms in 1992 – 93, the gross NPAs are to the tune of Rs. 39253 crores in 1992 – 93 is increased to Rs. 51816 crores in 2005 -06. The net NPA has also moved up from Rs. 19691 crores in 93 – 94 to 18529 crores in
6
Res. J. Soc. Sci., 3: 4-12, 2008 C C The interest income of banks will fall and it is to be accounted only on receipt basis. Banks profitability is affected adversely because of the providing of doubtful debts and consequent to writing it off as bad debts. Return on investments (ROI) is reduced. The capital adequacy ratio is disturbed as NPAs are entering into its calculation. The cost of capital will go up. The assets and liability mismatch will widen. The economic value addition (EVA) by banks gets upset because EVA is equal to the net operating profit minus cost of capital and It limits recycling of the funds. Credit Risks of NPAs: The most of the public sector banks are incapable of visualizing the risk they are going to face in the emerging global economic scenario. The risk management machinery adopted requires a comprehensive overhaul of the system by the banks in this changing condition. The second consultative document on the New Basle capital accord on banking supervision has given a stress on the risk management aspect of the banks by introducing a more risk sensitive standardized approach towards capital adequacy. In spite of the stringent recommendations and RBIs apprehensions of the adequate preparedness of the banking sector in adopting instructions, it is quite clear about the willingness of the banks to vigorously pursue effective credit risk management mechanism by visualizing the magnitude of credit risk management to curtail the growth of mounting NPAs. The concept of recovering debts through Debt Recovery Tribunals has become a grand failure. The concept of establishing Asset Reconstruction Company (ARC) has greatly benefited the banks in containing the NPAs at a manageable level. The ARC is to take over the bad debts of the public sector banks. These banks have the option of either liquidating the assets of defaulting companies or writing off these bad debts altogether. The viable solution available to the public sector banks is to go for a better credit risk management scheme, which may be considered as difficult preposition. However a clear understanding of the concept of risk, availability of instruments to curtail risk and the strategies required to be adopted for implementing a risk management system are considered to be the call of the hour. Credit Risk Concept: The risk is inherent and absolutely unavoidable in banking sector. The risk is considered to be potential loss of an asset and portfolio is likely to suffer due to various reasons. It is around for centuries and thought to be the dominant financial risk today. The risk can be defined as the risk of erosion of value due to simple default and non-payment of the debt by the borrower. The degree of risk is reflected in the borrower’s credit rating, the premium it pays for funds and market price of the debts. M anagement of Credit Risk: The credit risk is one of the most significant risk classes for financial institutions and banks in India. There is no liquid market for trading the credit risk. In such a situation the financial institutions may increase their net market exposure sometimes at the expense of increasing the credit risk to certain parties. The credit derivatives allow financial institutions to change their exposure to a range of credit related risks. There are various structures that allow the transference of credit risk from one party to another. In some cases the bank can buy
C C C C C
C
It is due to above factors the public sector banks are faced with bulging NPAs which results in lower income and higher provisioning for doubtful debts and it will make a dent in their profit margin. In this context of crippling effect on banks operation the slew asset quality is placed as one of the most important parameters in the measurement of banks performance under the Camel’s supervisory rating system of RBI. Capital A dequacy Ratio of Public Sector Banks: The capital adequacy ratio reveals the health of a bank. The public sector banks are required to attain the stipulated eight percent capital adequacy ratios. The capital adequacy ratio is defined as the ratio between the total banks capital and its risk-weighted assets. As a part of the financial sector reforms the RBI has introduced the capital adequacy norms in April 1992 to encourage banks to be more risk sensitivity against both on and off balance sheet exposures. Under the prevailing system, except the government generated loans the most of the advances carry 100 percent risk weightages. According to the norms all claims on banks are assigned a risk weightage of 20 percent. W ith regard to off balance sheet items guarantees issued by the banks against the counter guarantee of other banks and discounting of documentary bills accepted by other banks are to the treated as claims on banks and carry a risk weight of 20 percent. But the commercial banks are striving for 8 percent capital adequacy ratio. It is observed from the table that 16 public sector banks have recorded capital to risk weightage asset ratio is above 10% at the end of March 1997 which is above the stipulated 9% margin. But is gradually increased to 26 public sector banks at the end of March 2006. More over 9 public sector banks recorded the ratio less than the 9% and gradually decreased to 1 public sector banks at the end of March 2006. The favourable development in this area is facilitated to considerable extent by large scale recapitalization of public sector banks after 1996 – 1997.
7
Res. J. Soc. Sci., 3: 4-12, 2008
Table 1: N PAs in Public Sector Banks Y ear Gross non-perform ing assets % Am ount in lakh Rupees N et non – perform ing assets % 1992 – 1993 39253 23.18 N il ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1993 -94 41041 24.78 19691 14.46 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1994 -95 38385 19.45 17566 10.67 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1995 -96 41661 18.01 18297 8.9 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1996 -97 47300 15.7 22340 8.1 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1997 – 98 50815 14.4 23761 7.3 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1998 – 99 58720 14.7 28020 7.6 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1999 – 00 60408 12.7 30073 6.8 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2000 – 01 63741 11.4 32461 6.2 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2001 – 02 70861 10.4 35554 5.5 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2002 – 03 68717 8.8 29692 4.0 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2003 – 04 61785 7.2 24396 2.8 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2004 - 05 58300 5.2 21441 2.6 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2005 - 06 51816 3.3 18529 1.2 Source: Report on Trend and Progress of Banking in India various issues Table 2: Capital To Risk W eightage Asset Ratio of Public Sector Banks Y ear Below 4% Below 4% to 9% Below 9% to 10% Above 10% Total 1996 – 97 2 0 9 16 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1997 –98 1 6 20 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1998 – 99 1 5 21 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1999- 00 1 4 22 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2000 – 01 1 1 2 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2001 – 02 1 1 2 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2002 – 03 4 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2003 – 04 1 26 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2004 – 05 1 26 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2005 – 06 1 26 27 Source: Report on Trend and Progress of Banking in India various issues Table 3: Recovery of N pas (Am ount in R S. Crore) Year Gross NPAs Net Recovery % Of recovery to gross NPAs 02 -03 68717 23183 33.74 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------03 - 04 64785 28004 43.37 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------04 – 05 59373 26940 45.37 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------05 – 06 51816 29087 56.14 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------06 -07 50552 27176 53.76 Source: D eccan Chronicle 27 Novem ber 2007
8
Res. J. Soc. Sci., 3: 4-12, 2008 protection in the form of default puts to transfer the credit risk to an insurance company or other financial investors. Moreover the bank may swap one credit for another credit of equal rating to reduce its exposure to one party. The credit risk management has two basic objectives C It manages the asset portfolio in a manner which ensures that the banks have adequate capital to hedge their risks and It matches the return to the risk. It is comprising of two basic steps viz., Credit Limited Notes (CLN): These are known as credit swaps in which buyer makes periodic payments of a fixed percentage of the reference asset to the seller over the life of the swap. Then the seller promises a payment in the case of credit default for the reasons viz., bankruptcy, delinquency and credit rating down grade. The payments may be either a pre - determined amount and also decrease in the market value of the reference obligation that may cause the credit event. The seller calls the structure away from the investor and delivers the defaulting notes against them on the happening of credit event. The CLN are like bonds in character and are acceptable to certain banks. They are not allowed to involve in credit default swap. Consequences of NPAs: The contaminated portfolio is definitely a bane for any bank. It puts severe dent on the liquidity and profitability of the bank where it is out of proportion. The NPAs in the public sector banks are well above the normal level. The consequences envisaged during the past several years are many. It has become a difficult task for the banks to reduce the lending rate due to the presence of large NPAs. Ultimately this is affecting the competitiveness of the Indian banks. W hen the bank does not enjoy the market competitiveness naturally the credit expansion would be slumped and when it happens, the profitability gets a set back. In this way the vicious circle will go on and on. Another important one is the reduction in the availability of funds for further expansion due to the unproductiveness of the existing portfolio. Sometimes it is found that the presence of large NPAs discourages banks to accept profitable but risky proposal loan from the customers. The NPAs also affect the risk taking ability of the banks. On the whole it affects the credibility of the bank and faces difficulty in raising fresh capital from the market for future requirements. M easures to Control NPAs M enace: It is proved beyond doubt that NPAs in bank ought to be kept at the lowest level. Two pronged approaches viz., 1. Preventive management and 2. Curative management would be necessary for controlling NPAs. Preventive M anagement: C r ed it A sse ssm e n t a n d R isk M a n a g e m e n t M echanism: A lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. The documentation of credit policy and credit audit immediately after the sanction is necessary to upgrade the quality of credit appraisal in banks. In a situation
C
Identification and Ascertainment of Credit Default Risk: In order to assess the credit default risk the concerned bank has to check the following five C’s from the borrower. C C C C C Cash flows reflecting the earning capacity of the borrower. Collateral - the tangible assets of the borrowers who intends to mortgage. Character – the management capabilities of the concerned party. Conditions - the loan covenants to safeguard the lenders interest and Capital - referring to the buffer to absorb earnings shocks.
Utilization of credit default protection measures and instruments: O nce the credit default is ascertained and quantified, credit default protection measures and instruments like credit default swaps, credit default options and credit linked notes can be utilized. Credit Default Swap: It is a bilateral financial contract in which buyer pays a periodic fee expressed in fixed basis points on the notional amount in return for a floating payment contingent on the default of a third party reference credit. The floating payment is designated to mirror the loss incurred by creditors of the reference credit in the event of its default. The credit event various from bank to bank and from transaction to transaction. The credit events are pre defined in the agreement, which includes 1. Bankruptcy 2. Insolvency 3. Rating, and downgrading below agreed threshold 4. Failure to adjust for new payment obligation and 5. Debt Rescheduling. The credit event triggers the obligation of the seller of default protection to the purchaser of the same. The investors who need to protect themselves against default but do not want to sell the at risk security for accounting, tax and regulatory reasons can buy a credit default swap.
9
Res. J. Soc. Sci., 3: 4-12, 2008 of liquidity overhang the enthusiasm of the banking system is to increase lending with compromise on asset quality, raising concern about adverse selection and potential danger of addition to the NPAs stock. It is necessary that the banking system is equipped with prudential norms to minimize if not completely avoid the problem of credit risk. Organisational Restructuring: W ith regard to internal factors leading to NPAs the onus for containing the same rest with the bank themselves. These will necessities organizational restructuring improvement in the managerial efficiency, skill up gradation for proper assessment of credit worthiness and a change in the attitude of the banks towards legal action, which is traditionally viewed as a measure of the last resort. Reduce Dependence on Interest: The Indian banks are largely depending upon lending and investments. The banks in the developed countries do not depend upon this income whereas 86 percent of income of Indian banks is accounted from interest and the rest of the income is fee based. T he banker can earn sufficient net margin by investing in safer securities though not at high rate of interest. It facilitates for limiting of high level of NPAs gradually. It is possible that average yield on loans and advances net default provisions and services costs do not exceed the average yield on safety securities because of the absence of risk and service cost. Potential and Borderline Npas under Check: The potential and borderline accounts require quick diagnosis and remedial measures so that they do not step into N PAs categories. The auditors of the banking companies must monitor all outstanding accounts in respect of accounts enjoying credit limits beyond cut – off points, so that new sub-standard assets can be kept under check. Curative M anagement: The curative measures are designed to maximize recoveries so that banks funds locked up in NPAs are released for recycling. The Central government and RBI have taken steps for arresting incidence of fresh NPAs and creating legal and regulatory environment to facilitate the recovery of existing NPAs of banks. They are: Debt Recovery Tribunals (DRT): In order to expedite speedy disposal of high value claims of banks Debt Recovery T ribunals were setup. T he Central Government has amended the recovery of debts due to banks and financial institutions Act in January 2000 for enhancing the effectiveness of DRTs. The provisions for placement of more than one recovery officer, power to attach dependents property before judgment, penal provision for disobedience of Tribunals order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in times to come. Lok Adalats: The Lok adalats institutions help banks to settle disputes involving accounts in doubtful and loss categories. These are proved to be an effective institution for settlement of dues in respect of smaller loans. The Lok adalats and Debt Recovery Tribunals have been empowered to organize Lok adalats to decide for NPAs of Rs. 10 lakhs and above. A sset Reconstruction C ompany (AR C ): T he Narasimham Committee on financial system (1991) has recommended for setting up of Asset Reconstruction Funds (ARF). The following concerns were expressed by the committee. C It was felt that centralized all India severely handicap in its recovery efforts widespread geographical reach which bank posses and. Given the large fiscal deficits, there problem of financing the ARF. fund will by lack of individual will be a
C
Subsequently, the Narasimham committee on banking sector reforms [5 ] has recommended for transfer of sticky assets of banks to the ARC. Thereafter the Varma committee on restructuring weak public sector banks has also viewed the separation of NPAs and its transfer thereafter to the ARF is an important element in a comprehensive restructuring strategy for weak banks. In recognition of the same ARC B ill was passed to regulate Securitization and Reconstruction of financial assets and enforcement of security interest. The ICICI BANK, State B ank of India and IDBI have promoted the country’s first Asset Reconstruction Company. The company is specialized in recovery and liquidation of assets. The NPAs can be assigned to ARC by banks at a discounted price. The objective of ARC is floating of bonds and making necessary steps for recovery of NPAs from the borrowers directly. This enables a one time clearing of balance sheet of banks by sticky loans. Corporate Debt Restructuring (CDR): The corporate debt restructuring is one of the methods suggested for the reduction of NPAs. Its objective is to ensure a timely and transparent mechanism for restructure of corporate debts of viable corporate entities affected by
10
Res. J. Soc. Sci., 3: 4-12, 2008 the contributing factors outside the purview of BIFR, DRT and other legal proceedings for the benefit of concerned. The CDR has three tier structure viz., a. CDR standing forum b. CDR empowered group and c. CDR cell. The M echanism of the CDR: It is a voluntary system based on debtors and creditors agreement. It will not apply to accounts involving one financial institution or one bank instead it covers multiple banking accounts, syndication, consortium accounts with outstanding exposure of Rs. 20 crores and above by banks and institutions. The CDR system is applicable to standard and sub – standard accounts with potential cases of NPAs getting a priority. In addition to the steps taken by the RBI and Government of India for arresting the incidence of new NPAs and creating legal and regulatory environment to facilitate for the recovery of existing NPAs of banks, the following measures were initiated for reduction of NPAs. Circulation of Information of Defaulters: The RBI has put in place a system for periodical circulation of details of willful defaulters of banks and financial institutions. The RBI also publishes a list of borrowers (with outstanding aggregate rupees one crore and above) against whom banks and financial institutions in recovery of funds have filed suits as on 31 st March every year. It will serve as a caution list while considering a request for new or additional credit limits from defaulting borrowing units and also from the directors, proprietors and partners of these entities. Recovery Action A gainst Large NPAs: The RBI has directed the PSBs to examine all cases of willful default of Rs. One crore and above and file criminal cases against willful defaulters. The board of directors are requested to review NPAs accounts of one crore and above with special reference to fix staff accountability in individually. It is observed from the above table that the gross NPAs of the banks is gradually declining from Rs. 68717 crores in 2002 - 03 to Rs. 50552 crores in 2006 – 07 whereas the net recovery of NPAs is increasing from Rs. 23183 crores in 2002 - 03 to Rs. 27176 crores in 2006 – 07. It shows that the banks have taken strenuous efforts to contain the NPAs. Moreover the percentage of recovery to gross NPAs is also in the increasing trend. Credit Information Bureau: The institutionalization of information sharing arrangement is now possible through the newly formed Credit Information Bureau of India Limited (CIBIL) It was set up in January 2001, by SBI, HDFC, and two foreign technology partners. This will prevent those who take advantage of lack of system of information sharing amongst leading institutions to borrow large amount against same assets and property, which has in no measures contributed to the incremental of NPAs of banks. Conclusion: It is needless to mention, that a lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. In a situation of liquidity overhang, the enthusiasm of the banking system to increase lending may compromise on asset quality, raising concern about their adverse selection and potential danger of addition to the stock of NPAs. It is necessary that the banking system is to be equipped with prudential norms to minimize if not completely to avoid the problem of NPAs. The onus for containing the factors leading to NPAs rests with banks themselves. This will necessitates organizational restructuring, improvement in the managerial efficiency and skill upgradation for proper assessment of credit worthiness It is better to avoid N PAs at the nascent stage of credit consideration by putting in place of rigorous and appropriate credit appraisal mechanisms. Having regard to strong possibilities of NPAs assuming high proportion of total assets, unless the authorities for preventing mounting NPAs thereby eroding the profitability and liquidity of the banks initiate serious corrective action. At the outset NPAs are considered to be gloomy as well as greedy to the Indian economy. REFERENCES 1. Deshpande, N.V., 2001. Indian Banking Emerging c h a l l e n g e s S tr a te g ie s a n d S o lu t i o n L e g a l Perspective, IBA Bulletin, March 2001. Muniappan, C.P., The NPA overhang, magnitude solutions, legal reforms, EconomicDevelopments in India, Vol. 52. Namboodri, T.C.G., NPA: Prevention is Better than Cure, V inimaya N ational Instituteof Bank Management, XXII(3): Oct-Dec2201. Study on preventing slippage of NPAs, Reserve Bank of India Report, 2002. Academic Foundation, monthly Bulletin on Banking and Finance, Vol: 35. Narasimham, M., 1998. Report of the committee on Banking Sector Reforms. Trend and Progress in Banking, 1996-97, Reserve Bank of India. Trend and Progress in Banking, 1997-98, Reserve Bank of India.
2.
3.
4.
5. 6. 7.
11
Res. J. Soc. Sci., 3: 4-12, 2008 8. 9. 10. 11. 12. 13. Trend and Progress in Banking, 1998-99, Bank of India. Trend and Progress in Banking, 1999-00, Bank of India. Trend and Progress in Banking, 2000-01, Bank of India. Trend and Progress in Banking, 2001-02, Bank of India. Trend and Progress in Banking, 2002- 03, Bank of India. Trend and Progress in Banking, 2003-04, Bank of India. Reserve Reserve Reserve Reserve Reserve Reserve 14. Trend and Progress in Banking, 2004-05, Reserve Bank of India. 15. Trend and Progress in Banking, 2005-06, Reserve Bank of India. 16. Trend and Progress in Banking, 2006-07, Reserve Bank of India. 17. Trivedi, I., 2007. Indian B anking in the New Millennium, 2000, RBSA publication, Jaipur 18. Deccan Chronicle 27 November 2007.
12
doc_530320632.pdf
NPA is a classification used by financial institutions that refer to loans that are in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.
Research Journal of Social Sciences, 3: 4-12, 2008 © 2008, INSInet Publications
Are non - Performing Assets Gloomy or Greedy from Indian Perspective?
1
M. Karunakar, 2Mrs. K.Vasuki and 3Mr. S. Saravanan
Reader and Head, Department of Business Administration, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 2 Senior Lecturer in Commerce, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 3 Lecturer in Economics, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India.
Abstract: The economic reforms initiated by the then finance minister and present prime minister of India Dr. Manmohan Singh would have been remained incomplete without the overhaul of Indian banking sector. The important aspect of norms and guidelines for making the whole sector vibrant and competitive. The problem of losses and lower profitability of Non-Performing Assets (NPA) and liability mismatch in banks and financial sector depend on how various risks are managed in their business. An attempt is made in the paper that what is NPA? The factors contributing to NPA, the magnitude of NPA, reasons for high NPA and their impact on Indian banking operations. Besides capital to risk weightage assets ratio of public sector banks, management of credit risk and measures to control the menace of NPAs are also discussed. The lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. It is better to avoid NPAs at the market stage of credit consolidation by putting in place of rigourous and appropriate credit appraisal mechanisms. Key words: NPA, Factor contributing NPA, Magnitude and Consequences, Recovery methods, Capital adequacy ratio. INTRODUCTION The economic reforms initiated in 1991 by the then Finance minister and present Prime Minister Dr. M anmohan Singh would have been remained incomplete without the overhaul of the Indian banking sector. T he Narasimham committee report (First report) recommendations are the basis for initiation of the process, which is still continuing, though many of the sick banks are able to come out of the red after repeated doses of fund infusion. But a few of the banks are still in the red and efforts are on to resuscitate them. The bigger challenge at the moment is to deal with the worsening financial health of the banking sector. The important financial institutions like Industrial Finance Corporation of India (IFCI) and Industrial Development Bank of India (IDBI) are also not in the pink of health, which require government support for revitalizing themselves. The important aspect of the banking sector reforms is relating to liberalization of norms and guidelines for making the whole sector vibrant and competitive. This was a gradual process undertaken with utmost care and least it should disrupt the banking sector. Slowly the Reserve Bank of India (RBI) has freed the interest rate, but marginally increased now, both on the d e p o s it a n d le n d ing s pe c trum s a t p re se n t . Simultaneously it has relaxed the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) and also unlocking more and more funds in the financial markets. On the deposit side, the bank is free to offer any rate of interest depending upon their asset – liability position. But the RBI regulates the savings rate. Similarly the banks can charge the flexible rate on lending operations depending upon their risk perception. It is futile to say that there are no controls but they are much lesser as compared to the controls that was existed before the initiation of banking reforms. The other vibrant dimension of the banking sector is to reduce the Non – performing assets (NPA). During 1980 to 1996, there was a crisis in the banking sector W orld over. According to a study 73 percent of the member countries of the International Monetary Fund (IMF) have experienced serious banking problems but most of these member countries are developing nations only. One of the prominent reasons for the crisis is building up of Non Performing Assets in the banking and financial sector. India has also experienced the problem of raising NPA. Apart from compromise on object credit assessment of borrowers due to political economy considerations,
1
Corresponding Author: M. Karunakar, Reader and Head, Department of Business Administration, Sir Theagaraya College, Chennai- 600 021, TamilNadu, India. 4
Res. J. Soc. Sci., 3: 4-12, 2008 laxities in legal system, accounting disclosure practices, recession and willful default have lead to the accumulation of NPA. Growth and Structural Changes in Banking Sector: In order to have proper understanding of NPA menace, it is necessary to have brief idea of growth and structural changes that have taken place in the banking sector. The growth of the banking business can be assessed in five phases. C Preliminary phase: Series of births and deaths of banks in the first five decades of twentieth Century. Business phase: Laying of solid and sound foundation for banking business which was taken place between 1949 and 1969 by enacting Banking Companies’ Regulation Act 1949. Branching out phase (1969 to 1985): W hen 19 major commercial banks were nationalized in two phases and these banks have reached larger mass of population through opening of branches and lead bank schemes. Consolidation phase: During this phase (1985 – 1991) weaknesses and defects of mass branching were identified and attended through various committees’ investigation. Reforms and strengthening stage (1991 to till date): Infact first dose of reforms started with Narasimham Committee report in 1991. Subsequently there were series of reforms in SLR, CRR, new norms of assets classification (NPA) and provisioning of capital adequacy norms, permission for entry of new generation of private banks and foreign banks regulation of interest rate, setting up of Debt Recovery Tribunals and passage of Securitization And Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) 2002. Banking Risks: The problem of losses or lower profitability of NPAs, assets and liability mismatch in banks and financial sector depend on how the following risks are managed in their businesses. (a) Credit risk (b) Interest rate risk (c) Exchange rate risk (d) Liquidity risk (e) Transfer risk (f) Operational risk (g) M arket risk (h) Settlement risk (i) Counter party risk and (j) Country risks. W hat is NPA?: Banking businesses is mainly that of borrowing from the public and lending it to the needy persons and business at a premium. Lending of money involves a credit risk. W hen the loans and advances made by banks or financial institutions turnout as non - productive, non-rewarding and non - remunerative then they will become Non – Performing Assets (NPA). According to SARFAESI 2002. NPA is an asset or account of a borrower, which is classified by a bank or financial institution as sub-standard asset, doubtful asset and loss asset .
C
C
C
C
Summary of the guidelines are given below: Loans and Advances Guidelines applicable From 31.3.2001 Term loan interest/ installment 180 days remains overdue for more than Overdraft / cash credit a/c Remains out of order (!) Bills purchased and discounted 180 days remains overdue for more than Agricultural loan interest / interest Two harvest seasons but not remains overdue for more than exceeding two and half year Other accounts – Any account to 180 days be received remains overdue for more than The NPA were to be reckoned on past due basis prior to 31.3.2001. As per the guidelines if the amount remained past due for more than two quarters it is treated as NPA. W hen the advance remains outstanding for 30 days beyond the due date it is past due as per RBI classification issued in December 1992. (!) Out of order means outstanding balance in the overdraft / cash credit account which remains continuously in excess of the sanctioned limit for 6 months. If the outstanding balance in principal
Guidelines applicable From 31.3.2002 90 days Remains out of order 90 days Two harvest seasons but not exceeding two and half years 90 days
Over draft and Cash credit is less than the sanctioned limit but there is no credit balance for 6 months or balance is not enough to cover interest debited for the period, then such account is also to be taken as out of order. Over the years the criteria for NPA regulations have become stricter. RBI reports said that these stricter guidelines are issued for improvements in the payment and settlement systems, recovery climate and up gradation of technology in the banking system.
5
Res. J. Soc. Sci., 3: 4-12, 2008 Factors Contributing NPAs: to NPAs are: C The factors contributing 2005 - 2006. The magnitude of gross NPAs and net NPAs have sliding down from 23.18% in 1992 –93 to 3.3% in 2005 – 2006whereas the net NPAs has gone down to 1.2% from 14.46% for the same period. It is to be treated as a serious crisis in view of its mounting NPAs in absolute terms. The high level of NPAs in banks is a matter of grave concern to the public as well as to government since the bank credit is a catalyst to the economic development of the country and any bottleneck in the smooth flow of credit due to the mounting NPAs is bound to create an adverse repercussion for the economy of the country however the magnitude of direction is in descending order which shows government and banks are taking corrective measures to contain NPAs. Indian B anking Industry Saddled with High NPAS – The Reasons: The liberalization policies launched in 1991 opened the doors to the entrepreneurs to setup industries and business, which are largely financed by loans from the Indian banking systems. There is a shakeout with many businesses are failing and loans have become bad. In the global economy prevailing today, the vulnerability of Indian businesses has increased. A culture change is crept in where repayment of bank loans is no longer assured. A constant follow up action and vigil are to be exercised by the operating staff. Diversion of funds and willful default has become more common. As per a study published in the RBI bulletin in July 1999, diversion of funds and willful default are found to be the major contributing factors for NPAs in public and private sector banks. Today, the situation looks optimistic with the industry succeeding in overcoming the hurdles faced earlier. The timely restructuring and rehabilitation measures have helped to overcome setbacks and hiccups without seriously jeopardizing their future. The greater transparency and stricter corporate governance methods have significantly raise the credibility of the corporate sector. The attrition rate in corporate sector has come down. The challenges before the banks in India today are the raising NPAs in the retail sector, propelled by high consumerism and lowering of moral standards. Impact of NPAs on Banking Operations: The efficiency of a bank is not reflected only by the size of its balance sheet but also the level of return on its assets. The NPAs do not generate interest income for banks but at the same time banks are required to provide provisions for NPAs from their current profits. The NPAs have deleterious impact on the return on assets in the following ways.
C
C
C C
C
C
C C C
C C
C C
D iversificatio n o f funds for expansion, modernization undertaking of new projects and also for helping associate concerns. This is coupled with recessionary trends and failure to tap required funds in the capital and debt market. Business (Product, marketing, financial) failure, inefficient management, strained labor relations, inappropriate technology, outmoded machinery, technical problems and product obsolescence. Recession, input and power shortage, price escalation, accidents, natural calamities, external problems in other countries leading to non – payment of over dues. Time and cost over run during project implementation stage. Government policies like changes in excise duties, pollution control, poor credit decisions, priority sector lending and outdated legal systems. W illful default, siphoning off funds, fraud and misappropriation by promoters and directors dispute. Deficiencies on the part of banks like delay in release of funds and delay in release of subsidies by government. Delay in finalization of rehabilitation package by the board of Industrial and Reconstruction (BIFR). Absence of written policies. The absence of portfolio concentration limits, poor industry analysis, cursory financial analysis of borrowers. Inadequate customers contract Excessive reliance on collateral, absence of follow up action by banks, poor control on loan documentation. Absence of asset classification and loan loss provisioning standards and The lack of co-ordination between the financial institutions and commercial banks, which provide long-term needs of industry that, enables the industry to misuse the funds.
M agnitude of NPAs in India: A glance through the statistics on the movement of NPAs of public sector banks will help to understand the extent to which they are standing with regard to NPAs is shown below The analysis of the above table gives a clear crystal picture about the NPAs in public sector banks. Since introduction of prudential norms in 1992 – 93, the gross NPAs are to the tune of Rs. 39253 crores in 1992 – 93 is increased to Rs. 51816 crores in 2005 -06. The net NPA has also moved up from Rs. 19691 crores in 93 – 94 to 18529 crores in
6
Res. J. Soc. Sci., 3: 4-12, 2008 C C The interest income of banks will fall and it is to be accounted only on receipt basis. Banks profitability is affected adversely because of the providing of doubtful debts and consequent to writing it off as bad debts. Return on investments (ROI) is reduced. The capital adequacy ratio is disturbed as NPAs are entering into its calculation. The cost of capital will go up. The assets and liability mismatch will widen. The economic value addition (EVA) by banks gets upset because EVA is equal to the net operating profit minus cost of capital and It limits recycling of the funds. Credit Risks of NPAs: The most of the public sector banks are incapable of visualizing the risk they are going to face in the emerging global economic scenario. The risk management machinery adopted requires a comprehensive overhaul of the system by the banks in this changing condition. The second consultative document on the New Basle capital accord on banking supervision has given a stress on the risk management aspect of the banks by introducing a more risk sensitive standardized approach towards capital adequacy. In spite of the stringent recommendations and RBIs apprehensions of the adequate preparedness of the banking sector in adopting instructions, it is quite clear about the willingness of the banks to vigorously pursue effective credit risk management mechanism by visualizing the magnitude of credit risk management to curtail the growth of mounting NPAs. The concept of recovering debts through Debt Recovery Tribunals has become a grand failure. The concept of establishing Asset Reconstruction Company (ARC) has greatly benefited the banks in containing the NPAs at a manageable level. The ARC is to take over the bad debts of the public sector banks. These banks have the option of either liquidating the assets of defaulting companies or writing off these bad debts altogether. The viable solution available to the public sector banks is to go for a better credit risk management scheme, which may be considered as difficult preposition. However a clear understanding of the concept of risk, availability of instruments to curtail risk and the strategies required to be adopted for implementing a risk management system are considered to be the call of the hour. Credit Risk Concept: The risk is inherent and absolutely unavoidable in banking sector. The risk is considered to be potential loss of an asset and portfolio is likely to suffer due to various reasons. It is around for centuries and thought to be the dominant financial risk today. The risk can be defined as the risk of erosion of value due to simple default and non-payment of the debt by the borrower. The degree of risk is reflected in the borrower’s credit rating, the premium it pays for funds and market price of the debts. M anagement of Credit Risk: The credit risk is one of the most significant risk classes for financial institutions and banks in India. There is no liquid market for trading the credit risk. In such a situation the financial institutions may increase their net market exposure sometimes at the expense of increasing the credit risk to certain parties. The credit derivatives allow financial institutions to change their exposure to a range of credit related risks. There are various structures that allow the transference of credit risk from one party to another. In some cases the bank can buy
C C C C C
C
It is due to above factors the public sector banks are faced with bulging NPAs which results in lower income and higher provisioning for doubtful debts and it will make a dent in their profit margin. In this context of crippling effect on banks operation the slew asset quality is placed as one of the most important parameters in the measurement of banks performance under the Camel’s supervisory rating system of RBI. Capital A dequacy Ratio of Public Sector Banks: The capital adequacy ratio reveals the health of a bank. The public sector banks are required to attain the stipulated eight percent capital adequacy ratios. The capital adequacy ratio is defined as the ratio between the total banks capital and its risk-weighted assets. As a part of the financial sector reforms the RBI has introduced the capital adequacy norms in April 1992 to encourage banks to be more risk sensitivity against both on and off balance sheet exposures. Under the prevailing system, except the government generated loans the most of the advances carry 100 percent risk weightages. According to the norms all claims on banks are assigned a risk weightage of 20 percent. W ith regard to off balance sheet items guarantees issued by the banks against the counter guarantee of other banks and discounting of documentary bills accepted by other banks are to the treated as claims on banks and carry a risk weight of 20 percent. But the commercial banks are striving for 8 percent capital adequacy ratio. It is observed from the table that 16 public sector banks have recorded capital to risk weightage asset ratio is above 10% at the end of March 1997 which is above the stipulated 9% margin. But is gradually increased to 26 public sector banks at the end of March 2006. More over 9 public sector banks recorded the ratio less than the 9% and gradually decreased to 1 public sector banks at the end of March 2006. The favourable development in this area is facilitated to considerable extent by large scale recapitalization of public sector banks after 1996 – 1997.
7
Res. J. Soc. Sci., 3: 4-12, 2008
Table 1: N PAs in Public Sector Banks Y ear Gross non-perform ing assets % Am ount in lakh Rupees N et non – perform ing assets % 1992 – 1993 39253 23.18 N il ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1993 -94 41041 24.78 19691 14.46 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1994 -95 38385 19.45 17566 10.67 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1995 -96 41661 18.01 18297 8.9 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1996 -97 47300 15.7 22340 8.1 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1997 – 98 50815 14.4 23761 7.3 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1998 – 99 58720 14.7 28020 7.6 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1999 – 00 60408 12.7 30073 6.8 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2000 – 01 63741 11.4 32461 6.2 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2001 – 02 70861 10.4 35554 5.5 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2002 – 03 68717 8.8 29692 4.0 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2003 – 04 61785 7.2 24396 2.8 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2004 - 05 58300 5.2 21441 2.6 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2005 - 06 51816 3.3 18529 1.2 Source: Report on Trend and Progress of Banking in India various issues Table 2: Capital To Risk W eightage Asset Ratio of Public Sector Banks Y ear Below 4% Below 4% to 9% Below 9% to 10% Above 10% Total 1996 – 97 2 0 9 16 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1997 –98 1 6 20 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1998 – 99 1 5 21 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------1999- 00 1 4 22 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2000 – 01 1 1 2 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2001 – 02 1 1 2 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2002 – 03 4 23 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2003 – 04 1 26 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2004 – 05 1 26 27 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------2005 – 06 1 26 27 Source: Report on Trend and Progress of Banking in India various issues Table 3: Recovery of N pas (Am ount in R S. Crore) Year Gross NPAs Net Recovery % Of recovery to gross NPAs 02 -03 68717 23183 33.74 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------03 - 04 64785 28004 43.37 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------04 – 05 59373 26940 45.37 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------05 – 06 51816 29087 56.14 ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------06 -07 50552 27176 53.76 Source: D eccan Chronicle 27 Novem ber 2007
8
Res. J. Soc. Sci., 3: 4-12, 2008 protection in the form of default puts to transfer the credit risk to an insurance company or other financial investors. Moreover the bank may swap one credit for another credit of equal rating to reduce its exposure to one party. The credit risk management has two basic objectives C It manages the asset portfolio in a manner which ensures that the banks have adequate capital to hedge their risks and It matches the return to the risk. It is comprising of two basic steps viz., Credit Limited Notes (CLN): These are known as credit swaps in which buyer makes periodic payments of a fixed percentage of the reference asset to the seller over the life of the swap. Then the seller promises a payment in the case of credit default for the reasons viz., bankruptcy, delinquency and credit rating down grade. The payments may be either a pre - determined amount and also decrease in the market value of the reference obligation that may cause the credit event. The seller calls the structure away from the investor and delivers the defaulting notes against them on the happening of credit event. The CLN are like bonds in character and are acceptable to certain banks. They are not allowed to involve in credit default swap. Consequences of NPAs: The contaminated portfolio is definitely a bane for any bank. It puts severe dent on the liquidity and profitability of the bank where it is out of proportion. The NPAs in the public sector banks are well above the normal level. The consequences envisaged during the past several years are many. It has become a difficult task for the banks to reduce the lending rate due to the presence of large NPAs. Ultimately this is affecting the competitiveness of the Indian banks. W hen the bank does not enjoy the market competitiveness naturally the credit expansion would be slumped and when it happens, the profitability gets a set back. In this way the vicious circle will go on and on. Another important one is the reduction in the availability of funds for further expansion due to the unproductiveness of the existing portfolio. Sometimes it is found that the presence of large NPAs discourages banks to accept profitable but risky proposal loan from the customers. The NPAs also affect the risk taking ability of the banks. On the whole it affects the credibility of the bank and faces difficulty in raising fresh capital from the market for future requirements. M easures to Control NPAs M enace: It is proved beyond doubt that NPAs in bank ought to be kept at the lowest level. Two pronged approaches viz., 1. Preventive management and 2. Curative management would be necessary for controlling NPAs. Preventive M anagement: C r ed it A sse ssm e n t a n d R isk M a n a g e m e n t M echanism: A lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. The documentation of credit policy and credit audit immediately after the sanction is necessary to upgrade the quality of credit appraisal in banks. In a situation
C
Identification and Ascertainment of Credit Default Risk: In order to assess the credit default risk the concerned bank has to check the following five C’s from the borrower. C C C C C Cash flows reflecting the earning capacity of the borrower. Collateral - the tangible assets of the borrowers who intends to mortgage. Character – the management capabilities of the concerned party. Conditions - the loan covenants to safeguard the lenders interest and Capital - referring to the buffer to absorb earnings shocks.
Utilization of credit default protection measures and instruments: O nce the credit default is ascertained and quantified, credit default protection measures and instruments like credit default swaps, credit default options and credit linked notes can be utilized. Credit Default Swap: It is a bilateral financial contract in which buyer pays a periodic fee expressed in fixed basis points on the notional amount in return for a floating payment contingent on the default of a third party reference credit. The floating payment is designated to mirror the loss incurred by creditors of the reference credit in the event of its default. The credit event various from bank to bank and from transaction to transaction. The credit events are pre defined in the agreement, which includes 1. Bankruptcy 2. Insolvency 3. Rating, and downgrading below agreed threshold 4. Failure to adjust for new payment obligation and 5. Debt Rescheduling. The credit event triggers the obligation of the seller of default protection to the purchaser of the same. The investors who need to protect themselves against default but do not want to sell the at risk security for accounting, tax and regulatory reasons can buy a credit default swap.
9
Res. J. Soc. Sci., 3: 4-12, 2008 of liquidity overhang the enthusiasm of the banking system is to increase lending with compromise on asset quality, raising concern about adverse selection and potential danger of addition to the NPAs stock. It is necessary that the banking system is equipped with prudential norms to minimize if not completely avoid the problem of credit risk. Organisational Restructuring: W ith regard to internal factors leading to NPAs the onus for containing the same rest with the bank themselves. These will necessities organizational restructuring improvement in the managerial efficiency, skill up gradation for proper assessment of credit worthiness and a change in the attitude of the banks towards legal action, which is traditionally viewed as a measure of the last resort. Reduce Dependence on Interest: The Indian banks are largely depending upon lending and investments. The banks in the developed countries do not depend upon this income whereas 86 percent of income of Indian banks is accounted from interest and the rest of the income is fee based. T he banker can earn sufficient net margin by investing in safer securities though not at high rate of interest. It facilitates for limiting of high level of NPAs gradually. It is possible that average yield on loans and advances net default provisions and services costs do not exceed the average yield on safety securities because of the absence of risk and service cost. Potential and Borderline Npas under Check: The potential and borderline accounts require quick diagnosis and remedial measures so that they do not step into N PAs categories. The auditors of the banking companies must monitor all outstanding accounts in respect of accounts enjoying credit limits beyond cut – off points, so that new sub-standard assets can be kept under check. Curative M anagement: The curative measures are designed to maximize recoveries so that banks funds locked up in NPAs are released for recycling. The Central government and RBI have taken steps for arresting incidence of fresh NPAs and creating legal and regulatory environment to facilitate the recovery of existing NPAs of banks. They are: Debt Recovery Tribunals (DRT): In order to expedite speedy disposal of high value claims of banks Debt Recovery T ribunals were setup. T he Central Government has amended the recovery of debts due to banks and financial institutions Act in January 2000 for enhancing the effectiveness of DRTs. The provisions for placement of more than one recovery officer, power to attach dependents property before judgment, penal provision for disobedience of Tribunals order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in times to come. Lok Adalats: The Lok adalats institutions help banks to settle disputes involving accounts in doubtful and loss categories. These are proved to be an effective institution for settlement of dues in respect of smaller loans. The Lok adalats and Debt Recovery Tribunals have been empowered to organize Lok adalats to decide for NPAs of Rs. 10 lakhs and above. A sset Reconstruction C ompany (AR C ): T he Narasimham Committee on financial system (1991) has recommended for setting up of Asset Reconstruction Funds (ARF). The following concerns were expressed by the committee. C It was felt that centralized all India severely handicap in its recovery efforts widespread geographical reach which bank posses and. Given the large fiscal deficits, there problem of financing the ARF. fund will by lack of individual will be a
C
Subsequently, the Narasimham committee on banking sector reforms [5 ] has recommended for transfer of sticky assets of banks to the ARC. Thereafter the Varma committee on restructuring weak public sector banks has also viewed the separation of NPAs and its transfer thereafter to the ARF is an important element in a comprehensive restructuring strategy for weak banks. In recognition of the same ARC B ill was passed to regulate Securitization and Reconstruction of financial assets and enforcement of security interest. The ICICI BANK, State B ank of India and IDBI have promoted the country’s first Asset Reconstruction Company. The company is specialized in recovery and liquidation of assets. The NPAs can be assigned to ARC by banks at a discounted price. The objective of ARC is floating of bonds and making necessary steps for recovery of NPAs from the borrowers directly. This enables a one time clearing of balance sheet of banks by sticky loans. Corporate Debt Restructuring (CDR): The corporate debt restructuring is one of the methods suggested for the reduction of NPAs. Its objective is to ensure a timely and transparent mechanism for restructure of corporate debts of viable corporate entities affected by
10
Res. J. Soc. Sci., 3: 4-12, 2008 the contributing factors outside the purview of BIFR, DRT and other legal proceedings for the benefit of concerned. The CDR has three tier structure viz., a. CDR standing forum b. CDR empowered group and c. CDR cell. The M echanism of the CDR: It is a voluntary system based on debtors and creditors agreement. It will not apply to accounts involving one financial institution or one bank instead it covers multiple banking accounts, syndication, consortium accounts with outstanding exposure of Rs. 20 crores and above by banks and institutions. The CDR system is applicable to standard and sub – standard accounts with potential cases of NPAs getting a priority. In addition to the steps taken by the RBI and Government of India for arresting the incidence of new NPAs and creating legal and regulatory environment to facilitate for the recovery of existing NPAs of banks, the following measures were initiated for reduction of NPAs. Circulation of Information of Defaulters: The RBI has put in place a system for periodical circulation of details of willful defaulters of banks and financial institutions. The RBI also publishes a list of borrowers (with outstanding aggregate rupees one crore and above) against whom banks and financial institutions in recovery of funds have filed suits as on 31 st March every year. It will serve as a caution list while considering a request for new or additional credit limits from defaulting borrowing units and also from the directors, proprietors and partners of these entities. Recovery Action A gainst Large NPAs: The RBI has directed the PSBs to examine all cases of willful default of Rs. One crore and above and file criminal cases against willful defaulters. The board of directors are requested to review NPAs accounts of one crore and above with special reference to fix staff accountability in individually. It is observed from the above table that the gross NPAs of the banks is gradually declining from Rs. 68717 crores in 2002 - 03 to Rs. 50552 crores in 2006 – 07 whereas the net recovery of NPAs is increasing from Rs. 23183 crores in 2002 - 03 to Rs. 27176 crores in 2006 – 07. It shows that the banks have taken strenuous efforts to contain the NPAs. Moreover the percentage of recovery to gross NPAs is also in the increasing trend. Credit Information Bureau: The institutionalization of information sharing arrangement is now possible through the newly formed Credit Information Bureau of India Limited (CIBIL) It was set up in January 2001, by SBI, HDFC, and two foreign technology partners. This will prevent those who take advantage of lack of system of information sharing amongst leading institutions to borrow large amount against same assets and property, which has in no measures contributed to the incremental of NPAs of banks. Conclusion: It is needless to mention, that a lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. In a situation of liquidity overhang, the enthusiasm of the banking system to increase lending may compromise on asset quality, raising concern about their adverse selection and potential danger of addition to the stock of NPAs. It is necessary that the banking system is to be equipped with prudential norms to minimize if not completely to avoid the problem of NPAs. The onus for containing the factors leading to NPAs rests with banks themselves. This will necessitates organizational restructuring, improvement in the managerial efficiency and skill upgradation for proper assessment of credit worthiness It is better to avoid N PAs at the nascent stage of credit consideration by putting in place of rigorous and appropriate credit appraisal mechanisms. Having regard to strong possibilities of NPAs assuming high proportion of total assets, unless the authorities for preventing mounting NPAs thereby eroding the profitability and liquidity of the banks initiate serious corrective action. At the outset NPAs are considered to be gloomy as well as greedy to the Indian economy. REFERENCES 1. Deshpande, N.V., 2001. Indian Banking Emerging c h a l l e n g e s S tr a te g ie s a n d S o lu t i o n L e g a l Perspective, IBA Bulletin, March 2001. Muniappan, C.P., The NPA overhang, magnitude solutions, legal reforms, EconomicDevelopments in India, Vol. 52. Namboodri, T.C.G., NPA: Prevention is Better than Cure, V inimaya N ational Instituteof Bank Management, XXII(3): Oct-Dec2201. Study on preventing slippage of NPAs, Reserve Bank of India Report, 2002. Academic Foundation, monthly Bulletin on Banking and Finance, Vol: 35. Narasimham, M., 1998. Report of the committee on Banking Sector Reforms. Trend and Progress in Banking, 1996-97, Reserve Bank of India. Trend and Progress in Banking, 1997-98, Reserve Bank of India.
2.
3.
4.
5. 6. 7.
11
Res. J. Soc. Sci., 3: 4-12, 2008 8. 9. 10. 11. 12. 13. Trend and Progress in Banking, 1998-99, Bank of India. Trend and Progress in Banking, 1999-00, Bank of India. Trend and Progress in Banking, 2000-01, Bank of India. Trend and Progress in Banking, 2001-02, Bank of India. Trend and Progress in Banking, 2002- 03, Bank of India. Trend and Progress in Banking, 2003-04, Bank of India. Reserve Reserve Reserve Reserve Reserve Reserve 14. Trend and Progress in Banking, 2004-05, Reserve Bank of India. 15. Trend and Progress in Banking, 2005-06, Reserve Bank of India. 16. Trend and Progress in Banking, 2006-07, Reserve Bank of India. 17. Trivedi, I., 2007. Indian B anking in the New Millennium, 2000, RBSA publication, Jaipur 18. Deccan Chronicle 27 November 2007.
12
doc_530320632.pdf