CHAPTER 1 INTRODUCTION

INTRODUCTION

An asset becomes NPA when it ceases to generate income for the bank. This would mean that interest, which is debited to borrowers account, has to be realised by the bank to count it as income. An account has to be classified as NPA on the basis of record of recovery rather than security charged in favour of the bank in respect of such account. Thus, an account of a borrower may become NPA if interest charged to that particular borrower is not realised despite the account being fully secured. Prudential norms on income recognition, asset classification and provisioning thereon have been

implemented from the financial year 1992-93,as per the recommendations of the committee on the Financial Systems(Narasimham Committee I). These norms have brought in qualifications and objectivity into the assessment and provisioning of NPAs under the prudential norms laid down by RBI,income should not be recognised on NPAs on accrual basis but should be booked only when it is actually received in respect of such account. An asset is considered as non-performing if interest or instalments of principal due remain unpaid for more than 90 days. Any NPA could migrate from sub-standard to doubtful category after 12 months; it would get classified as loss asset, if it is irrecoverable or only marginally recoverable.Banks should make full provision of doubtful assets plus 20 to 25 per cent of the secured portion (depending on the period for which the account is doubtful), and a general 10 per cent of the outstanding balance in respect of sub-standard assets.

The efficiency of a bank is not always reflected only by size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for banks, but the same time banks are required to make provision for such NPAs from their current profits. In the context of crippling effect on a banks operations in all spheres, asset quality has been placed as one of the most important parameters in the measurement of banks performance under the CAMELS supervisory rating system of RBI. NPAs have a deleterious effect on the return on assets in several ways: i) They erode current profits through provisioning requirements ii) They result in reduced interest income iii) They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future iv) They limit recycling of funds, set in asset-liability mismatch. Thus, three letters NPAs strike terror in the banking circles today. The high level of NPAs in banks has been a matter of grave concern to the public at large as bank credit is the catalyst to the economic growth of the country. Any bottleneck in the smooth flow of credit, one cause for which the mounting NPAs, is bound to create adverse repercussions in the economy. NPAs are not anymore lenders problem alone, but equally that of borrowers and shareholders too. All should be equally concerned about NPAs.

1.2 OBJECTIVES OF THE STUDY

The study is based on the following objectives. 1. To study of the concept of Non-Performing Asset in Indian perspective 2. To study the impact of NPAs 3. To evaluate the efficiency in managing Non Performing Asset of different types of banks (Public, Private & Foreign banks) by comparing NPA with profits.

4. To check the proportion of NPA of different types of banks in different categories.

1.3 SCOPE OF THE STUDY

Study about the non-performing assets of Indian commercial banks was made by taking into account the secondary data available from the RBI web site and other RBI publications. The scope of the study is limited to the group wise analysis and the NPAs of individual banks is not taken into account. Furthermore, the scope of the study is limited to a limited period. Qualitative aspects regarding the NPAs were not taken into account for evaluating the impact of NPAs.

1.4 METHODOLOGY
This research has been done using secondary data. The data about NPAs & its composition, classification of loan assets, profits & advances of different banks is taken from Reserve Bank of India website. For the study, banks in India have been classified into three groups namely, public sector banks, private

sector banks, and foreign banks. The data gathered were analysed with percentages, averages and ratios.

1.5 LIMITATIONS OF THE STUDY

The limitations felt in the study are: It was critical to gather the financial information pertaining to NPA of all banks so proper comparison was not possible. There are some data which are available for just 3 years while the same data for its counterparts were available for 9 years. So exact comparison was not possible. The study is primarily based on secondary data gathered from RBI. No first-hand information regarding NPAs were used in this study. Hence it was not possible to identify the exact reasons for NPAs and its consequences.

CHAPTER 2 THEORITICAL REVIEW

2.1 REVIEW OF LITERATURE

A considered view is that banks lending policy could have crucial influence on non-performing loans (Reddy, 2004).Reddy (2004) critically examined various issues pertaining to terms of credit of Indian banks. In this context, it was viewed that the element of power has no bearing on the illegal activity. A default is not entirely an irrational decision. Rather a defaulter takes into account probabilistic assessment of various costs and benefits of his decision. In the seminal study on credit policy, systems, and culture, Reddy (2004) raised various critical issues pertaining to credit delivery mechanism of the Indian banking sector. The study focused on the terms of credit such as interest rate charged to various productive activities and borrowers, the

approach to risk management, and portfolio management in general. There are three pillars on which Indias credit system was based in the past; fixing of prices of credit or interest rate as well as quantum of credit linked with purpose; insisting on collateral; and prescribing the end-use of credit. Interest rate prescription and fixing quantum has, however, been significantly reduced in the recent period. In the context of NPAs on account of priority sector lending, it was pointed out that the statistics may or may not confirm this. There may be only a marginal difference in the NPAs of banks lending to priority sector and the bankslending to private corporate sector. Against this background, the study suggested that given the deficiencies in these areas, it is imperative that

banks need to be guided by fairness based on economic and financial decisions rather than system of conventions.

Sergio (1996) in a study of non-performing loans in Italy found evidence that, an increase in the riskiness of loan assets is rooted in a banks lending policy adducing to relatively unselective and inadequate assessment of sectorial prospects. Interestingly, this study refuted that business cycle could be a primary reason for banks NPLs.The study emphasised that increase in bad debts as a consequence of recession alone is not empirically demonstrated. It was viewed that the bank-firm relationship will thus; prove effective not so much because it overcomes informational asymmetry but because it recoups certain canons of appraisal.

In a study of loan losses of US banks, McGoven (1993) argued that character has historically been a paramount factor of credit and a major determinant in the decision to lend money. Banks have suffered loan losses through relaxed lending standards. It was suggested that bankers should make a fairly accurate personality-morale profile assessment of prospective and current borrowers and guarantors. Besides considering personal interaction, the banker should (i) try to draw some conclusions about staff morale and loyalty, (ii) study the persons personal credit report, (iii) do trade-credit reference checking, (iv) check references from present and former bankers, and (v) determine how the borrower handles stress. In addition, banks can minimise

risks by securing the borrowers guarantee, using Government guaranteed loan programs, and requiring conservative loan-to-value ratios. Bloem and Gorter (2001) suggested that a more or less predictable level of non-performing loans, though it may vary slightly from year to year, is caused by an inevitable number of wrong economic decisions by individuals and plain bad luck (inclement weather, unexpected price changes for certain products, etc.). Under such circumstances, the holders of loans can make an allowance for a normal share of non-performance in the form of bad loan provisions, or they may spread the risk by taking out insurance. Enterprises may well be able to pass a large portion of these costs to customers in the form of higher prices. For instance, the interest margin applied by financial institutions will include a premium for the risk of non-performance on granted loans. At this time, banks non-performing loans increase, profits decline and substantial losses to capital may become apparent. Eventually, the economy reaches a trough and turns towards a new expansionary phase, as a result the risk of future losses reaches a low point, even though banks may still appear relatively unhealthy at this stage in the cycle.

Guptas study (1983) on a sample of Indian companies financed by ICICI concludes that certain cash flows coverage ratios are better indicators of corporate sickness.

2.2 TYPES OF NPA: Gross NPA::

Gross NPAs are the sum total of all loan assets that are classified as NPAs as per RBI guidelines as on Balance Sheet date. Gross NPA reflects the quality of the loans made by banks. It consists of all the nonstandard assets like as sub-standard, doubtful, and loss assets. It can be calculated with the help of following ratio: Gross NPAs Ratio = Gross NPAs Gross Advances

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. It can be calculated by following:

Net NPAs =

Gross NPAs Provisions Gross Advances Provisions

2.3 ASSET CLASSIFICATION: Assets are classified into following four categories:: Standard Assets Sub-standard Assets

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 Doubtful Assets Loss Assets Standard Assets:: Standard assets are the ones in which the bank is receiving interest as well as the principal amount of the loan regularly from the customer. Here it is also very important that in this case the arrears of interest and the principal amount of loan do not exceed 90 days at the end of financial year. If asset fails to be in category of standard asset that is amount due more than 90 days then it is NPA and NPAs are further need to classify in sub categories

Sub-standard Assets:: With effect from 31 March 2005, a substandard asset would be one, which has remained NPA for a period less than or equal to 12 month. The following features are exhibited by substandard assets: the current net worth of the borrowers guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full; and the asset has 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. Doubtful Assets:: A loan classified as doubtful has all the weaknesses inherent in assets that were 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. With
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effect from March 31, 2005, an asset would be classified as doubtful if it remained in the sub-standard category for 12 months. Loss Assets:: A loss asset is one which considered uncollectible and of such little value that its continuance as a bankable asset is not warranted- although there may be some salvage or recovery value. Also, these assets would have been identified as loss assets by the bank or internal or external auditors or the RBI inspection but the amount would not have been written-off wholly.

2.4 IMPACT OF NPA:

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 doesnt 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. Liquidity Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for shortest period of time which lead to

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additional cost to the company. Difficulty in operating the functions of bank is another cause of NPA due to lack of money.

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 days banks have special employees to deal and handle NPAs, which is additional cost to the bank. 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. Drain of profit The profits of the banks are considerably reduced by the provisions made for non-performing assets.

Affects the goodwill Higher NPA ratios affect the goodwill of the banking institution. This has a bad effect on the equity value of the banks.

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2.5 PREVENTIVE MEASUREMENT FOR NPA: Early Recognition of the Problem

Invariably, by the time banks start their efforts to get involved in a revival process, its too late to retrieve the situation- both in terms of rehabilitation of the project and recovery of banks 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 promoters 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

Identifying borrowers with genuine intent from those who are nonserious 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. Based on this objective assessment, banks should decide as quickly as possible whether it would be worthwhile to commit additional finance. In this regard banks may consider having Special Investigation of all financial transaction or business

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transaction, books of account in order to ascertain real factors that contributed to sickness of the borrower. Banks may have penal of technical experts with proven expertise and track record of preparing techno-economic study of the project of the borrowers. Borrowers having genuine problems due to temporary mismatch in fund flow or sudden requirement of additional fund may be entertained at branch level, and for this purpose a special limit to such type of cases should be decided. This will obviate the need to route the additional funding through the controlling offices in deserving cases, and help avert many accounts slipping into NPA category.

Timeliness and Adequacy of response

Longer the delay in response, grater will be 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 promoters 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.

Focus on Cash Flows

While financing, at the time of restructuring the banks may not be guided by the conventional fund flow analysis only, which could yield a potentially misleading picture. Appraisal for fresh credit requirements may be done by analysing funds flow in conjunction with the Cash Flow rather than only on the basis of Funds Flow.

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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 units fortunes. A bank may commit additional finance to an 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.

Multiple Financing

1. During the exercise for assessment of viability and restructuring, a Pragmatic and unified approach by all the lending banks/ FIs as also sharing of all relevant information on the borrower would go a long way toward overall success of rehabilitation exercise, given the probability of success/failure.

2. 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
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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 nonconsortium 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.

3. 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.

4. Corporate Debt Restructuring mechanism has been institutionalized in

2001 to provide a timely and transparent system for restructuring of the corporate debt of Rs. 20 crore and above with the banks and FIs on a voluntary basis and outside the legal framework. Under this system, banks may greatly benefit in terms of restructuring of large standard accounts (potential NPAs) and viable sub-standard accounts with consortium/multiple banking arrangements.

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2.6 PROCEDURES FOR RESOLUTION IN INDIA:

NPA

IDENTIFICATION

AND

1. Internal Checks and Control

Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance. Though most banks have Early Warning Systems (EWS) for identification of potential NPAs, the actual processes followed, however, differ from bank to bank. The EWS enable a bank to identify the borrower accounts which show signs of credit deterioration and initiate remedial action. Many banks have evolved and adopted an elaborate EWS, which allows them to identify potential distress signals and plan their options beforehand, accordingly. The early warning signals, indicative of potential problems in the accounts, viz. persistent irregularity in accounts, delays in servicing of interest, frequent devolvement of L/Cs, units financial problems, market related problems, etc. are captured by the system. In addition, some of these banks are reviewing their exposure to borrower accounts every quarter based on published data which also serves as an important additional warning system. These early warning signals used by banks are generally independent of risk rating systems and asset classification norms prescribed by RBI. The major

components/processes of a EWS followed by banks in India as brought out by a study conducted by Reserve Bank of India at the instance of the Board of Financial Supervision are as follows:

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 Designating Relationship Manager/ Credit Officer for monitoring account/s Preparation of `know your client profile Credit rating system Identification of watch-list/special mention category accounts Monitoring of early warning signals

Relationship Manager/Credit Officer The Relationship Manager/Credit Officer is an official who is expected to have complete knowledge of borrower, his business, his future plans, etc. The Relationship Manager has to keep in constant touch with the borrower and report all developments impacting the borrowable account. As a part of this contact he is also expected to conduct scrutiny and activity inspections. In the credit monitoring process, the responsibility of monitoring a corporate account is vested with Relationship Manager/Credit Officer. Know your client profile (KYC) Most banks in India have a system of preparing `know your client (KYC) profile/credit report. As a part of `KYC system, visits are made on clients and their places of business/units. The frequency of such visits depends on the nature and needs of relationship. Credit Rating System The credit rating system is essentially one point indicator of an individual credit exposure and is used to identify measure and monitor the credit risk of individual proposal. At the whole bank level, credit rating system

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enables tracking the health of banks entire credit portfolio. Most banks in India have put in place the system of internal credit rating. While most of the banks have developed their own models, a few banks have adopted credit rating models designed by rating agencies. Credit rating models take into account various types of risks viz. financial, industry and management, etc. associated with a borrowable unit. The exercise is generally done at the time of sanction of new borrowable account and at the time of review renewal of existing credit facilities. Watch-list/Special Mention Category The grading of the banks risk assets is an important internal control tool. It serves the need of the Management to identify and monitor potential risks of a loan asset. The purpose of identification of potential NPAs is to ensure that appropriate preventive / corrective steps could be initiated by the bank to protect against the loan asset becoming non-performing. Most of the banks have a system to put certain borrowable accounts under watch list or special mention category if performing advances operating under adverse business or economic conditions are exhibiting certain distress signals. These accounts generally exhibit weaknesses which are correctable but warrant banks closer attention. The categorization of such accounts in watch list or special mention category provides early warning signals enabling Relationship Manager or Credit Officer to anticipate credit deterioration and take necessary preventive steps to avoid their slippage into non performing advances. Early Warning Signals It is important in any early warning system, to be sensitive to signals of credit

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deterioration. A host of early warning signals are used by different banks for identification of potential NPAs. Most banks in India have laid down a series of operational, financial, transactional indicators that could serve to identify emerging problems in credit exposures at an early stage. Further, it is revealed that the indicators which may trigger early warning system depend not only on default in payment of installment and interest but also other factors such as deterioration in operating and financial performance of the borrower, weakening industry characteristics, regulatory changes, general economic conditions, etc. Early warning signals can be classified into five broad categories viz. a) Financial b) Operational c) Banking d) Management and e) External factors. Financial related warning signals generally emanate from the borrowers balance sheet, income expenditure statement, statement of cash flows, statement of receivables etc. Following common warning signals are captured by some of the banks having relatively developed EWS. Financial warning signals Persistent irregularity in the account Default in repayment obligation

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 Devolvement of LC/invocation of guarantees Deterioration in liquidity/working capital position Substantial increase in long term debts in relation to equity Declining sales Operating losses/net losses Rising sales and falling profits Disproportionate increase in overheads relative to sales Rising level of bad debt losses Operational warning signals Low activity level in plant Disorderly diversification/frequent changes in plan Non-payment of wages/power bills Loss of critical customer/s Frequent labour problems Evidence of aged inventory/large level of inventory Management related warning signals Lack of co-operation from key personnel Change in management, ownership, or key personnel Desire to take undue risks Family disputes Poor financial controls Fudging of financial statements Diversion of funds

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Banking related signals Declining bank balances/declining operations in the account Opening of account with other bank Return of outward bills/dishonoured cheques Sales transactions not routed through the account Frequent requests for loan Frequent delays in submitting stock statements, financial data, etc.

Signals relating to external factors Economic recession Emergence of new competition Emergence of new technology Changes in government / regulatory policies Natural calamities

1. Management/Resolution of NPAs A reduction in the total gross and net NPAs in the Indian financial system indicates a significant improvement in management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past which include the SRFAESI Act, one time settlement schemes, setting up of the CDR mechanism, strengthening of DRTs. From the data available of Public Sector Banks as on March 31, 2003, there were 1,522 numbers of NPAs as on March 31, 2003 which had gross value greater than Rs. 50 million in all the public sector banks in India. The total gross value of these NPAs amounted to Rs. 215
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billion. The total number of resolution approaches (including cases where action is to be initiated) is greater than the number of NPAs, indicating some double counting. As can be seen, suit filed and BIFR are the two most common approaches to resolution of NPAs in public sector banks. Rehabilitation has been considered/ adopted in only about 13% of the cases. Settlement has been considered only in 9% of the cases. It is likely to have been adopted in even fewer cases. Data available on resolution strategies adopted by public sector banks suggest that Compromise settlement schemes with borrowers are found to be more effective than legal measures. Many banks have come out with their own restructuring schemes for settlement of NPA accounts. State Bank of India, HDFC Limited, M/s. Dun and Bradstreet Information Services (India) Pvt.Ltd And M/s. Trans Union to serve as a mechanism for exchange of information between banks and FIs for curbing the growth of NPAs incorporated credit Information Bureau (India) Limited (CIBIL) in January 2001. Pending the enactment of CIB Regulation Bill, the RBI constituted a working group to examine the role of CIBs. As per the recommendations of the working group, Banks and FIs are now required to submit the list of suit-filed cases of Rs. 10 million and above and suit filed cases of wilful defaulters of Rs. 2.5 million and above to RBI as well as CIBIL. CIBIL will share this information with commercial banks and FIs so as to help them minimize adverse selection at appraisal stage. The CIBIL is in the process of getting operationalized.

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2. Wilful Defaulters RBI has issued revised guidelines in respect of detection of wilful default and diversion and siphoning of funds. As per these guidelines a wilful default occurs when a borrower defaults in meeting its obligations to the lender when it has capacity to honour the obligations or when funds have been utilized for purposes other than those for which finance was granted. The list of wilful defaulters is required to be submitted to SEBI and RBI to prevent their access to capital markets. Sharing of information of this nature helps banks in their due diligence exercise and helps in avoiding financing unscrupulous elements. RBI has advised lenders to initiate legal measures including criminal actions, wherever required, and undertake a proactive approach in change in management, where appropriate. 3. Legal and Regulatory Regime Debt Recovery Tribunals DRTs were set up under the Recovery of Debts due to Banks and Financial Institutions Act, 1993. Under the Act, two types of Tribunals were set up i.e. Debt Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT). The DRTs are vested with competence to entertain cases referred to them, by the banks and FIs for recovery of debts due to the same. The order passed by a DRT is appealable to the Appellate Tribunal but no appeal shall be entertained by the DRAT unless the applicant deposits 75% of the amount due from him as determined by it. However, the Affiliate Tribunal may, for reasons to be received in writing, waive or reduce the amount of such deposit. Advances

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of Rs. 1 million and above can be settled through DRT process. An important power conferred on the Tribunal is that of making an interim order (whether by way of injunction or stay) against the defendant to debar him from transferring, alienating or otherwise dealing with or disposing of any property and the assets belonging to him within prior permission of the Tribunal. This order can be passed even while the claim is pending. DRTs are criticized in respect of recovery made considering the size of NPAs in the Country. In general, it is observed that the defendants approach the High Country challenging the verdict of the Appellate Tribunal which leads to further delays in recovery. Validity of the Act is often challenged in the court which hinders the progress of the DRTs. Lastly, many needs to be done for making the DRTs stronger in terms of infrastructure. Lokadalats The institution of Lokadalat constituted under the Legal Services Authorities Act, 1987 helps in resolving disputes between the parties by conciliation, mediation, compromise or amicable settlement. It is known for effecting mediation and counselling between the parties and to reduce burden on the court, especially for small loans. Cases involving suit claims up to Rs. 1 million can be brought before the Lokadalat and every award of the Lokadalat shall be deemed to be a decree of a Civil Court and no appeal can lie to any court against the award made by the Lokadalat. Several people of particular localities various social organizations are approaching Lokadalats which are generally presided over by two or three senior persons including retired senior civil

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servants, defence personnel and judicial officers. They take up cases which are suitable for settlement of debt for certain consideration. Parties are heard and they explain their legal position. They are advised to reach to some settlement due to social pressure of senior bureaucrats or judicial officers or social workers. If the compromise is arrived at, the parties to the litigation sign a statement in presence of Lokadalats which is expected to be filed in court to obtain a consent decree. Normally, if such settlement contains a clause that if the compromise is not adhered to by the parties, the suits pending in the court will proceed in accordance with the law and parties will have a right to get the decree from the court. In general, it is observed that banks do not get the full advantage of the Lokadalats. It is difficult to collect the concerned borrowers willing to go in for compromise on the day when the Lokadalat meets. In any case, we should continue our efforts to seek the help of the Lokadalat. Enactment of SRFAESI Act The The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SRFAESI) provides the formal legal basis and regulatory framework for setting up Asset Reconstruction Companies (ARCs) in India. In addition to asset reconstruction and ARCs, the Act deals with the following largely aspects, Securitization and Securitization Companies Enforcement of Security Interest

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 Creation of a central registry in which all securitization and asset reconstruction transactions as well as any creation of security interests has to be filed. The Reserve Bank of India (RBI), the designated regulatory authority for ARCS has issued Directions, Guidance Notes, Application Form and Guidelines to Banks in April 2003 for regulating functioning of the proposed ARCS and these Directions/ Guidance Notes cover various aspects relating to registration, operations and funding of ARCS and resolution of NPAs by ARCS. The RBI has also issued guidelines to banks and financial institutions on issues relating to transfer of assets to ARCS, consideration for the same and valuation of instruments issued by the ARCS. Additionally, the Central Government has issued the security enforcement rules (Enforcement Rules), which lays down the procedure to be followed by a secured creditor while enforcing its security interest pursuant to the Act. The Act permits the secured creditors (if 75% of the secured creditors agree) to enforce their security interest in relation to the underlying security without reference to the Court after giving a 60 day notice to the defaulting borrower upon classification of the corresponding financial assistance as a non-performing asset. The Act permits the secured creditors to take any of the following measures: Take over possession of the secured assets of the borrower including right to transfer by way of lease, assignment or sale; Take over the management of the secured assets including the right to transfer by way of lease, assignment or sale;
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 Appoint any person as a manager of the secured asset (such person could be the ARC if they do not accept any pecuniary liability); and Recover receivables of the borrower in respect of any secured asset which has been transferred. After taking over possession of the secured assets, the secured creditors are required to obtain valuation of the assets. These secured assets may be sold by using any of the following routes to obtain maximum value. By obtaining quotations from persons dealing in such assets or otherwise interested in buying the assets;
By inviting tenders from the public;

By holding public auctions; or By private treaty.

Lenders have seized collateral in some cases and while it has not yet been possible to recover value from most such seizures due to certain legal hurdles, lenders are now clearly in a much better bargaining position vis-a-vis defaulting borrowers than they were before the enactment of SRFAESI Act. When the legal hurdles are removed, the bargaining power of lenders is likely to improve further and one would expect to see a large number of NPAs being resolved in quick time, either through security enforcement or through settlements. Under the SRFAESI Act ARCS can be set up under the Companies Act, 1956. The Act designates any person holding not less than 10% of the paid-up equity capital of the ARC as a sponsor and prohibits any sponsor from holding a controlling interest in, being the holding company of or being in control of the
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ARC. The SRFAESI and SRFAESI Rules/ Guidelines require ARCS to have a minimum net-owned fund of not less than Rs. 20,000,000. Further, the Directions require that an ARC should maintain, on an on-going basis, a minimum capital adequacy ratio of 15% of its risk weighted assets. ARCS have been granted a maximum realization time frame of five years from the date of acquisition of the assets. The Act stipulates several measures that can be undertaken by ARCs for asset reconstruction. These include: Enforcement of security interest; Taking over or changing the management of the business of the borrower; The sale or lease of the business of the borrower; Settlement of the borrowers dues; and Restructuring or rescheduling of debt. ARCS are also permitted to act as a manager of collateral assets taken over by the lenders under security enforcement rights available to them or as a recovery agent for any bank or financial institution and to receive a fee for the discharge of these functions. They can also be appointed to act as a receiver, if appointed by any Court or DRT.

Compromise Settlement Schemes

1) One Time Settlement Schemes NPAs in all sectors, which have become doubtful or loss as on 31st March 2000 are covered under this scheme. The scheme also covers NPAs
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classified as sub-standard as on 31st March 2000, which have subsequently become doubtful or loss. All cases on which the banks have initiated action under the SRFAESI Act and also cases pending before Courts/DRTs/BIFR, subject to consent decree being obtained from the Courts/DRTs/BIFR are covered. However cases of wilful default, fraud and malfeasance are not covered. As per the OTS scheme, for NPAs up to Rs. 10crores, the minimum amount that should be recovered should be 100% of the outstanding balance in the account. 2) Negotiated Settlement Schemes The RBI/Government has been encouraging banks to design and implement policies for negotiated settlements, particularly for old and unresolved NPAs. The broad framework for such settlements was put in place in July 1995. Specific guidelines were issued in May 1999to public sector banks for one-time settlements of NPAs of small scale sector. This scheme was valid until September 2000 and enabled banks to recover Rs 6.7 billion from various accounts. Revised guidelines were issued in July 2000 for recovery of NPAs of Rs. 50 million and less. These guidelines were effective until June 2001 and helped banks recover Rs. 26 billion.

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CHAPTER 3 ANALYSIS AND INTERPRETATIONS

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Net NPAs of Different Bank Groups in India

Table: 3.1 Net NPAs of Banks in India

Public YEAR Sector Banks 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 27977 27958 24877 19335 16904 14566 15145 17836 21155 29644 Private Sector Banks 3700 6676 3963 4128 4212 3171 4028 5647 7411 6205 Foreign Banks 785 920 903 933 639 808 927 1247 2996 2975

Source: www.rbi.org.in From the above it is observed that net NPA of public sector banks has a declining trend up to year 2005-06 and after that it has a rising trend till 2008-09. The same trend has been observed in both Private and Foreign Sector Banks. The declining trend from 2003 to 2006 of NPA was due to the
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implementation of Securitization Act (2002). But the increase in NPA was increasing in absolute term, as NPA as per cent of advance shows a declining trend in Public Sector Banks while that of in Private and Foreign Sector Banks shows an upward trend that is increase in NPA as per cent of advance after 2006. The increase in NPA as per cent of advance of Private and Foreign Sector Banks is because of they have a major proportion of lending in non- priority sectors includes Medium and large scale industries which was highly affected by global financial crisis.

35000 30000 25000 20000 15000 10000 5000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Public Sector Banks Private Sector Banks Foreign Banks

Figure:3.1 Net NPAs of Banks in India

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Table: 3.2
Composition of NPAs of Public Sector Banks - 2001 To 2010 Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Priority Sector 24156 25150 24938 23840 23397 22374 22954 25287 24318 30848 Non-priority Sector 27854 28371 26781 25698 23849 18664 15158 14163 19251 25929 Public Sector 1163 902 1087 610 450 341 490 299 474 524

Source: www.rbi.org.in

From the above chart it is observed that public sector category is the least contributor towards the NPA of public sector bank. In the initial years from 2001 to 2005, Non-priority sector contributes more towards NPA than priority sector. But in later years from 2006 it is other way round, where priority sector contributes more than Non-priority sector. Priority sector consist of advance given to agriculture, SSI, & other priority sector advances. Non priority sector consist of large industries, medium industries & other non-priority sectors. In case of priority sector, it started falling from 2003 up to 2005 over previous year. But in the later years i.e. from 2006 there is rise NPA because of

35

defaults on the loan given to the farmers. It was highest in 2008. In order to reduce that, waiver package of Rs. 60,000 crore was announced in union budget of 2008.It may also be noted that the increase in NPAs was more noticeable in priority sector, which have been more active in the real estate and housing loans segments. NPA in non-priority sector is reducing constantly from 2002 to 2008 i.e. by 50%and increasing in preceding years. Though the advance given to nonpriority sector was higher than priority sector, NPAs of non-priority sector is comparatively lesser from 2006 onwards.

35000 30000 25000 20000 15000 10000 5000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Priority Sector Non-priority Sector Public Sector

Figure:3.2 Composition of NPAs of Public Sector Banks

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Table: 3.3 Composition of NPAs of Private Sector Banks - 2001 To 2009 Priority Sector 1835 2546 2445 2482 2188 2284 2884 3419 3640 Non-Priority Sector 4452 9090 9327 7796 6569 5541 6353 9558 13172 Public Sector 123 31 95 75 42 4 3 0 75

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: http://www.rbi.org

From the above it is observed that public sector contributes very negligible towards the overall NPA of foreign banks. The major reason for this is that on an average only 3.5%of total advance is made towards public sector category. Priority sector category on an average constitutes almost 34%of the total advances made by the private sector banks. While average NPA of priority sector constitutes of 25%of total NPA. In later years from 2007 to 2009 there is increase in NPA of priority sector. In these years more advances was given to agriculture & housing sector. In the year 2007-08, the real estate market was on boom, which encouraged people to take more loans. But after the subprime

37

crisis there was sudden fall in real estate market & people became default to pay the loan. In case of non-priority sector, the average advances made are 60.5%of total advance made by private sector banks. But the average NPA of nonpriority sector is almost 74%which is highest amongst the entire category. We can see the declining trend in NPA of non-priority sector from 2003 to 2006. This is as a result of Securitization Act, 2002.

14000 12000 10000 8000 6000 4000 2000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009

Priority Sector Non-Priority Sector Public Sector

Figure: 3.3 Composition of NPAs of Private Sector Banks

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Table: 3.4 Composition of NPAs of Foreign Sector Banks 2007 To 2009

Year 2007 2008 2009

Priority Sector 331 402 649

Non-Priority Sector 2120 2712 6506

Public Sector 0 0 0

Source: http://www.rbi.org

It is observed from the chart there is no NPA in public sector category in all the three years because there was no advance made to public sector category. Nonpriority sector contributes highest towards the NPA of foreign banks because non-priority sector constitute approximately 65%of the total advances made by foreign banks. So NPA will also be more in non-priority sector. NPA is low in priority sector because very few advances are made in priority sector & that too are made to SSI. The advances are made to medium & large scale industries in non-priority sector. As foreign banks are having global presence they are more affected by the global meltdown & financial crisis of 2008. So its effect is seen by sudden rise in NPA in 2009.

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7000 6000 5000 4000 3000 2000 1000 0 2007 2008 2009 Priority Sector Non-Priority Sector Public Sector

Figure: 3.4 Composition of NPAs of Foreign Sector Banks

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Table: 3.5 Net NPA to Net Advance of Public, Private & Foreign Sector Banks: 200001 to 2008-09

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Public Sector Banks 6.74 5.82 4.53 2.98 2.1 1.3 1.1 0.8 0.7

Private Sector Banks 2.27 2.49 2.32 1.32 1.9 1 1 1.2 1.5

Foreign Banks 1.82 1.89 1.76 1.49 0.9 0.8 1 0.9 1.7

Source: www.rbi.org

From the above it is clearly observed that only public sector banks have succeeded in reducing net NPA against net advances made over the period of time. It is constantly reducing each year, whereas in case of private sector bank it has reduced in 2005-06 then it got stable and started rising from 2007-08 onwards. In case of foreign banks it is fluctuating over the years. Public sector banks have been able to reduce this ratio by 66.7%from 2005 to 2009. Public sector banks as a result of stringent checks & control able to manage low ratio

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compare to other banks. In the year 2008-09 the ratio increased by 89%for foreign banks where the foreign banks were badly affected by the global meltdown. Even for private sector bank the ratio increased by 25%in 2009 due to financial crises & also for public sector bank the reduction in 2009 was the lowest i.e. 12.5%.

8 7 6 5 4 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Public Sector banks Private Sector Banks Foreign Banks

Figure: 3.5 Net NPA to Net Advance of Public, Private & Foreign Sector Banks

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Table: 3.6 Classification of Loan Asset of Public Sector Banks in percentage Year 2004 2005 2006 2007 2008 2009 2010 Standard Asset 92.2 94.6 96.1 97.2 97.7 97.9 97.7 Sub-Standard Asset 2.6 1.2 1.1 1.0 1.0 0.9 1.1 Doubtful Asset 4.3 3.4 2.3 1.5 1.1 1.0 0.9 Loss Asset 0.9 0.7 0.5 0.3 0.2 0.2 0.2

Source: http://www.rbi.org.in

The above frequency distribution chart states that standard asset is increasing every year & on the contrary all the other types of asset i.e. Sub-standard, Doubtful & Loss Asset are decreasing every asset. This proves that public sector banks have succeeded in reducing NPA over the years. Public sector banks have taken various measures to reduce NPA also convert Sub-Standard, Doubtful & loss asset into the above category Standard, Sub-Standard & Doubtful asset. The rise in sub-standard ratio has major proportion indicates that there is a high scope of up gradation or improvement in NPA recovery in initial stage because it will be very easy to recover the loan as minimum duration of default.

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100%

98%

96%

Loss Asset Doubtful Asset Sub-Standard Asset

94%

92%

Standard Asset

90%

88% 2004 2005 2006 2007 2008 2009 2010

Figure: 3.6 Classification of Loan Asset of Public Sector Banks

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Table: 3.7 Classification of Loan Asset of Private Sector Banks in percentage Year 2004 2005 2006 2007 2008 2009 2010 Standard Asset 94.2 96.1 97.4 97.6 97.3 96.8 97.1 Sub-Standard Asset 1.8 1.0 0.8 1.1 1.5 2.0 1.4 Doubtful Asset 3.6 2.5 1.5 1.0 0.9 1.0 1.1 Loss Asset 0.5 0.4 0.3 0.2 0.3 0.3 0.2

Source: http://www.rbi.org

The above chart clearly states that the rise in the standard assets over the years compensates the fall in the other three types of assets. But in the year 2009, the percentage of Sub-Standard asset is highest among all the year. In 2009 percentage of standard asset has reduced by 0.5% which is compensated by increase in Sub-Standard & doubtful assets. This increase is due to interest & principle amount unpaid due to financial crisis in 2009. The percentage of doubtful asset has reduced to a great extent amongst all. So the private sector banks have managed to reduce the doubtful asset.

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101 100 99 98 97 96 95 94 93 92 91 2004 2005 2006 2007 2008 2009 2010 Loss Asset Doubtful Aseet Sub-Standard Asset Standard Asset

Figure: 3.7 Classification of Loan Asset of Private Sector Banks

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Table: 3.8 Classification of Loan Asset of Foreign Sector Banks in percentage Year 2004 2005 2006 2007 2008 2009 2010 Standard Asset 95.2 97.0 97.9 98.1 98.1 95.7 95.7 Sub-Standard Asset 1.6 0.9 1.0 1.1 1.2 3.5 2.9 Doubtful Asset 1.8 1.3 0.7 0.5 0.5 0.6 0.86 Loss Asset 1.5 0.8 0.5 0.4 0.2 0.2 0.4

Source: http://www.rbi.org

The proportion of Standard Asset is increasing from 2004 and started getting stable in 2007 & 2008. But it has fallen in 2009. The proportion of other three types of assets is falling over the years, but in 2009 there is great increase in the proportion of Sub-Standard asset which is as a result of decrease in proportion of Standard asset. This increase in Sub-Standard asset is because of interest & principle amount unpaid, due to poor global conditions, for the loan provided in a 2008. The interest & principle amount remained unpaid for period of more than 180 days but less than 1 year.

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101 100 99 98 97 96 95 94 93 92 2004 2005 2006 2007 2008 2009 2010 Loss Asset Doubtful Asset Sub-Standard Asset Standard Asset

Figure: 3.8 Classification of Loan Asset of Foreign Sector Banks

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Table: 3.9 Net NPAs & Net Profit of Public Sector Banks: 2000-01 to 2008-09 Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: http://www.rbi.org Net NPA (%) 6.74 5.82 4.53 2.98 2.1 1.3 1.1 0.8 0.7 Net Profit 4317 8301 12295 16546 15784 16539 20152 26592 34394

It is observed from the above there exist no particular relationship between net profit & net NPA of public sector banks. There is constant increase in net profit from 2000-01 to 2003-04 & from 2005-06 to 2008-09. On the contrary public sector banks have managed to reduce net NPA constantly from 2001-02 to 2005-06. Although, the percentage of reduction over the previous year is low compared to percentage of rise in profit over previous year.

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40000

Net NPA(%)
7 6 5 4.53 4 16546 3 2 4317 1 0 2001 2002 2003 2004 2005 2006 8301 12295 2.98 2.1 15784 6.74 5.82

Net Profit
34394 26592 20152 16539 35000 30000 25000 20000 15000 10000 1.3 1.1 0.8 0.7 5000 0 2007 2008 2009

Figure: 3.9 Net NPAs & Net Profit of Public Sector Banks

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Table: 3.10 Net NPAs & Net Profit of Private Sector Banks: 2000-01 to 2008-09

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Net NPA (%) 2.27 2.49 2.32 1.32 1.9 1 1 1.2 1.5

Net Profit 1142 1179 2958 3481 3533 4975 6465 9522 10868

Source: http://www.rbi.org It is clearly observed that there is continuous rise in net profit of private sector banks over the years. The average of percentage increase in net profits of private sector banks comes to approximately 34%.On the contrary there is no continuous rise/fall in net NPA. But overall there is rise in net NPA from 200001 to 2008-09. The average of percentage rise in net NPA comes to almost 15%.

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12000

Net NPA
2.49 2.5 2.27 2.32 2 1.32 1.5 3533 1 2958 0.5 1142 1179 3481

Net Profit
9522

10868 10000

1.9 4975 1

8000 6465 1.5 1.2 1 4000 6000

2000

0 2001 2002 2003 2004 2005 2006 2007 2008 2009

Figure: 3.10 Net NPAs & Net Profit of Private Sector Banks

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Table: 3.11 Net NPA & Net Profit of Foreign Banks: 2000-01 to 2008-09 Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 Net NPA (%) 1.82 1.89 1.76 1.49 0.9 0.8 1 0.9 1.7 Net Profit 945 1492 1824 2243 3098 4109 5343 7544 8459

Source: http://www.rbi.org

Fromthe above it is clear that net profit of foreign banks is increasing throughout the period from 2000-01 to 2008-09. The average of percentage increase in net profit comes to 32%. There is no continuous upward or downward movement. But overall there is rise in net NPA of foreign banks. The average of percentage increase in net NPA basis comes to approximately 25%.So this shows there is positive relationship between net NPA & net profit of foreign banks.

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2 1.8 1.6 1.4 1.2 1 0.8 0.6 1824 0.4 0.2 0 2001 2002 2003 1492 945 2243 1.49 1.82 1.89 1.76

Net NPA

Net Profit
7544

8459

9000 8000

1.7 5343 4109 0.9 3098 0.8 1 0.9

7000 6000 5000 4000 3000 2000 1000 0

2004

2005

2006

2007

2008

2009

Figure: 3.11 Net NPA & Net Profit of Foreign Banks

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CHAPTER 4

FINDINGS, SUGGESTIONS AND CONCLUSION

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Introduction
Nonperforming assets are the greatest threat faced by banking industry. The money borrowed by the bankers is really the money of depositors, who has given it for safekeeping and for some return on investment. When the borrowers are not repaying the loans in time, it will adversely influence the financial health of the banks and in turn will influence the level of risk of the depositors and the investors in banks. RBI has given proper guidelines to banks to reduce the level of NPAs and the procedures to be adopted in connection with its accounting. The present study attempts to evaluate the level of NPAs in different bank groups and its impact on their profitability. Following are the major findings. NPAs were more noticeable in respect of new private sector and foreign banks, which have been more active in the real estate and housing loans segments. It shows a upward trends over the years as compared to others.

Among all three sectors, public sector banks have managed to reduce NPAs over the years. NPA profile in the less than 2% category of public sector banks was reached to 100% in 2008-09 as compared to Private and Foreign sector banks which was around 80%.

Public sector banks have managed to increase the standard assets over the years. The proportion of standard assets in Private sector banks reduced in 2008 and 2009 which was compensated by increase in sub-

56

standard and doubtful assets. In Foreign sectors banks the proportion of sub-standard asset has increased tremendously by 3.5% of loan assets in 2009 which was 1.2% of loan assets in 2008. Public banks have significantly reduced their NPA even in the phase of economic crisis. NPA and Net profit of all banks i.e. public sector, private sector and foreign banks has increased during the y Net NPA against net advances increased more in Foreign and Private sector banks in 2008-09 while Public sector banks have succeeded in reducing net NPA against net advances made over the period of time. The trend of NPA in various banks varies as the sector of banks changes. The trend of NPA in public sector banks shows a decreasing trend. Whereas trend of NPA in private sector banks and foreign banks does not moves stable.

Suggestions:
Uneven scale of repayment schedule with higher repayment in the initial years normally should be preferred. Private sector & Foreign banks should focus more on recovery of substandard & doubtful assets. Preventive measures for NPA should be adopted by all banks.

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Conclusion
The level of NPAs of Indian commercial banks had declined considerably in the recent past. But in case of those banks having more exposure to real estate, housing finance are even now facing threats on account of non-performing assets. Since the health of the financial system depends heavily on the health of the banking system of the country, it is the responsibility of the regulator and the bank management to minimise the threat of irregular repayment by the borrowers. The NPA is one of the biggest problems that the Indian Banks are facing today. If the proper management of the NPAs is not undertaken it would hamper the business of the banks. If the concept of NPAs is taken very lightly it would be dangerous for the Indian banking sector. The NPAs would destroy the current profit, interest income due to large provisions of the NPAs, and would affect the smooth functioning of the recycling of the funds. Banks also redistribute losses to other borrowers by charging higher interest rates. Lower deposit rates and higher lending rates repress savings and financial markets, which hampers economic growth. Public sector banks are more efficient than private sector & foreign banks with regard to the management of nonperforming assets. Even among private sector bank, old private sector banks are more efficient than new private sector banks. But efficient management of NPA is not the sole factor that determines the overall efficiency of banks.

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BIBLIOGRAPHY
1. Bloem, A.M., &Gorter, C.N (2001), The Macroeconomic Statistical Treatment of Non-Performing loans, Discussion Paper, Statistics

Department of the IMF, Decembere1, 2001. 2. Gupta, L.C (1983): Financial Ratios for Monitoring Corporate Sickness, Oxford University Press, New Delhi. 3. Bhatia, U (1988), Predicting Corporate Sickness in India, Studies in Banking & Finance, 7, 57-71 4. Reddy, Y.V., (2004), Credit Policy, Systems, and Culture, Reserve Bank of India Bulletin, March. 5. Sergio, M, (1996), Non-performing bank loans: Cyclical patterns and sectoral risk, Review of Economic Conditions in Italy. Rome: Jan-Jun 1996. , Issue. 1 6. McGoven, John (1998), Why bad loans happen to good banks, The Journal of Commercial Lending. Philadelphia: Feb 1993. Vol. 75, Issue. 6

Websites:
1. http://rbi.org.in 2. http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13652 3. http://rbi.org.in/scripts/AnnualPublications.aspx?head=StatisticalTables Relating to Banks of India 4. http://rbi.org.in/scripts/AnnualPublications.aspx?head=TrendandProgres sof Banking in India

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