Sie sind auf Seite 1von 109

A Dissertation Report On Analysis of NPA Management with Special Reference to South Indian Bank Submitted in partial fulfillment of the

requirement for the award of the degree of Master of Business Administration Of Bangalore University By

Anupama Narayanan Reg. No: 07XQCM6010

Under the guidance and supervision of Prof. Praveen Bhagawan

M. P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan #43, Race Course Road, BANGALORE-560001 2009
MPBIRLAINSTITUTEOFMANAGEMENT Page1

DECLARATION

I, hereby, declare that this research report entitled Analysis of NPA Management with Special Reference to SOUTH INDIAN BANK submitted in partial fulfillment for the award of Master of Business Administration of Bangalore University is a record of independent work carried out by me under the guidance of Prof. Praveen Bhagawan (Faculty member), M. P. Birla Institute of Management Studies, Bangalore. I, also declare that this report is a result of my own effort and has not been submitted earlier for the award of any degree or diploma of Bangalore University or any other University.

Place: Bangalore Date: -

(Anupama Narayanan) REGD.NO. 07XQCM6010

MPBIRLAINSTITUTEOFMANAGEMENT

Page2

ACKNOWLEDGEMENT

The attitude bliss and emphasis that accompanies the successful completion of my task would be incomplete without the expression of appreciation towards those who helped me colour the mosaic of this project with the tiles of their knowledge, expertise, experience and co-operation. I extend my special thanks to my Respected Guide, Prof. Praveen Bhagawan who has motivated and inspired me throughout my project work with his timely guidance, help, support and supervision.

I am extremely grateful to Dr. N. S. Malavalli for his help and support and for giving me an opportunity to complete my project.

I also would like to thank all executive of South Indian Bank who helped me providing data and information to complete my project.

Anupama Narayanan

MPBIRLAINSTITUTEOFMANAGEMENT

Page3

EXECUTIVE SUMMARY
The most important problem that the Indian banks are facing is the problem of their NPAs. It is only since a couple of years that this particular aspect has been given so much importance. The banks have to overcome these difficulties properly in order to effectively counter the competition faced by the foreign banks. With the framing of laws as per international standards and setting up of Debt recovery tribunal we can say that steps have been taken in this direction. Banks in India have traditionally been saddled with very high Non-Performing Assets. The banking sector was heading for a crisis in 2001 with NPAs crossing a mammoth 64000 crores. Banks burdened with huge NPAs faced uphill tasks in recovering then due to archaic laws and procedures. Realizing the gravity of the situation the government was quick to implement the recommendations of the Narsimham Committee and Andhuarjuna Committee leading to the enactment of the SARFAESI ACT 2002.( Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act). This Act gave the banks the much needed teeth to curb the menace of NPAs. The non performing assets (NPAs) of banks have at last begun shrinking. As reported from surveys, it is understood that there has been substantial improvements in non performing assets and this has been because of several measures such as formation of asset reconstruction companies, debt restructuring norms, securitization, provisioning norms and prudential norms for income recognition. The gross NPAs of the banking system are about 16 per cent of the total assets of the nationalized banks as of 2000-01. This is against a global norm of about 5%. Hence there is a long way to go before we can say that the NPAs of our banks are under control. The improvements in NPAs of individual nationalized banks have been in the order of 10% to 20%, thanks to the various schemes and measures introduced. This paper addresses the results we have achieved so far since the measures have been implemented and the thrust on measures that need to be taken to expedite recovery of NPAs. We also give our suggestions as to how NPA retrieval can be made easy and in what way the NPA scenario is headed. The problem is no doubt about recovery management where the objective is to find out about the reasons behind NPAs and to create networks for recovery. Four Banks MPBIRLAINSTITUTEOFMANAGEMENT Page4

have been randomly picked up and compared with South Indian Bank. The deposit growth loan growth, cost income ratio of these banks have been compared and analysed.

RESEARCH ABSTRACT
A strong banking sector is important for flourishing economy. The failure of the banking sector may have an adverse impact on other sectors. Non-performing assets are one of the major concerns for banks in India. NPAs reflect the performance of banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and networth of banks and also erodes the value of the asset. The NPA growth involves the necessity of provisions, which reduces the over all profits and shareholders value. The issue of Non Performing Assets has been discussed at length for financial system all over the world. The problem of NPAs is not only affecting the banks but also the whole economy. In fact high level of NPAs in Indian banks is nothing but a reflection of the state of health of the industry and trade. This report deals with understanding the concept of NPAs, its magnitude and major causes for an account becoming non-performing, projection with special reference to SOUTH INDIAN BANK.

MPBIRLAINSTITUTEOFMANAGEMENT

Page5

TABLE OF CONTENT
SR.NO. PARTICULAR THEORETICAL BACKGROUND 1.1 1.2 1.3 INTRODUCTION BACKGROUND NPA MANAGEMENT BIGGEST CHALLENGE FOR BANK IN 2009 1.4 NPA IN INDIA- CURRENT SCENARIO RESEARCH DESIGN 2.1 2.2 2.3 2.4 2.5 2.6 NEED OF STUDY RESEARCH OBJECTIVE RESEARCH METHODOLOGY DATA COLLECTION SAMPLING UNIT LITERATURE REVIEW INDUSTRY PROFILE 3.1 THE TRANSFORMATION OF INDIAN BANKING INDUSTRY

3.2 3.3

THE TASK AHEAD CHALLENGES FACING BANKING INDUSTRY IN INDIA

3.4 3.5 3.6

NPA FACTOR FOR RISE IN NPAS PROBLEMS DUE TO NPA

MPBIRLAINSTITUTEOFMANAGEMENT

Page6

3.7 3.8 4.1

WHAT CAUSED SUCH HIGH NPAS IN SYSTEM UNTIL 1995 WHAT CHANGED THE SCENARIO OF NPAS AFTER 1995 COMPANY PROFILE DATA ANALYSIS & INTERPRETATION

5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8

FINANCIAL OF SOUTH INDIAN BANK OPERATIONAL REVIEW FINANCIAL RESULT 2008-09 COMPARISON BASEL REPORT FRAMEWORK AND INDIA BANKING REGULATION AND FRAMEWORK THE BASEL I ACCORD CONCLUSION AND SUGGESTION

LIST OF FIGURES AND CHART


SR.NO. 1 2 3 4 5 6 7 8 PARTICULARS GNNP,NNPA and credit growth over the years Operating expenses/total assets ratio Credit growth over the years Gross NPA in banking system Current shareholding of CIBIL Gross NPA level for various banks Deposits growth over 5 years Unsecured loan as % of total loan

MPBIRLAINSTITUTEOFMANAGEMENT

Page7

Cost income ratio

MPBIRLAINSTITUTEOFMANAGEMENT

Page8

Chapter - 1

Introduction

MPBIRLAINSTITUTEOFMANAGEMENT

Page9

1.1 Background of the study


The crucial role of bank economists in transforming the banking system in India. Economists have to be more mainstreamed within the operational structure of commercial banks. Apart from the traditional functioning of macro-scanning, the inter linkages between treasuries, dealing rooms and trading rooms of banks need to be viewed not only with the day-to-day needs of operational necessity, but also with analytical content and policy foresight. Banking sector reforms in India has progressed promptly on aspects like interest rate deregulation, reduction in statutory reserve requirements, prudential norms for interest rates, asset classification, income recognition and provisioning. But it could not match the pace with which it was expected to do. The accomplishment of these norms at the execution stages without restructuring the banking sector as such is creating havoc. During pre-nationalization period and after independence, the banking sector remained in private hands Large industries who had their control in the management of the banks were utilizing major portion of financial resources of the banking system and as a result low priority was accorded to priority sectors. Government of India nationalized the banks to make them as an instrument of economic and social change and the mandate given to the banks was to expand their networks in rural areas and to give loans to priority sectors such as small scale industries, self-employed groups, agriculture and schemes involving women. To a certain extent the banking sector has achieved this mandate. Lead Bank Scheme enabled the banking system to expand its network in a planned way and make available banking series to the large number of population and touch every strata of society by extending credit to their productive endeavors. This is evident from the fact that population per office of commercial bank has come down from 66,000 in the year 1969 to 11,000 in 2004. Similarly, share of advances of public sector banks to priority sector increased form 14.6% in 1969 to 44% of the net bank credit. The number of deposit accounts of the banking system increased from over 3 Crores in 1969 to over 30 Crores. Borrowed accounts increased from 2.50 lakhs to over 2.68 Crores. Without a sound and effective banking system in India it cannot have a healthy economy.

The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past
MPBIRLAINSTITUTEOFMANAGEMENT Page10

three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. Granting of credit for economic activities is the prime duty of banking. Apart from raising resources through fresh deposits, borrowings and recycling of funds received back from borrowers constitute a major part of funding credit dispensation activity. Lending is generally encouraged because it has the effect of funds being transferred from the system to productive purposes, which results into economic growth. However lending also carries a risk called credit risk, which arises from the failure of borrower. Non-recovery of loans along with interest forms a major hurdle in the process of credit cycle. Thus, these loan losses affect the banks profitability on a large scale. Though complete elimination of such losses is not possible, but banks can always aim to keep the losses at low level. Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures affected under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports in this contemporary period have been neutralized by the ill effects of this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions

1.2 NPA management biggest challenge for banks in 2009


After the global financial turmoil in 2008, Indian banks begin the new year with a lurking fear that their Non Performing Assets (NPA) would go up with their portfolios coming under severe stress. There is already a visible strain on consumer, credit card and vehicle loan portfolios and many banks have taken conscious decision to scale down their advances to risky sectors. Some banks have also revised their credit growth targets downwards as the year has come to a close.

MPBIRLAINSTITUTEOFMANAGEMENT

Page11

The ongoing financial crisis has had its toll on export-related sectors like IT, textile and SMEs. This may indirectly impact banks asset quality. There is, therefore, a pressing need to ensure adequate risk-management mechanisms to overcome this challenge, State-owned Bank of Barodas (BoB) Chairman and Managing Director M D Mallya said. Indian banks witnessed a sharp jump in their gross NPAs for the first time in six years in FY08, compelling many of them to enhance their existing risk assessment tools. Gross NPAs of commercial banks in FY08 escalated by Rs 6,136 crore, according to figures released by the Reserve Bank. Though there was no need to be unduly alarmed, banks need to follow certain standard parameters to ensure the quality of their lending portfolios, Mallya said. Similar view was echoed by ICICI Banks CEO-elect Chanda Kochhar who said the lender has taken a conscious decision to follow certain parameters to ensure asset quality. Despite pressures emanating from global financial markets, Indian banks witnessed a healthy 25-29 per cent average growth in credit disbursals, primarily in housing, auto and infrastructure loans. IndusIand Banks Head of Wholesale Banking Group, J Moses Harding supported this view saying that the present economic downturn has affected the repayment capacities of small firms, exerting pressure on the banks lending portfolios. There is a pressure on SMEs as many of them are unable to repay their advances in the current scenario. This situation is likely to last in the short term. Banks need to adjust their risk management mechanisms to face the situation, Harding said. Banks witnessed a huge credit demand from their corporate clients who found their foreign funding sources drying up in the aftermath of the global meltdown which originated with the subprime crisis in America in mid-2007. The growth in credit in the industry in 2008 was in the range of 25-29 per cent on account of working capital requirements of small-, mid- and large-size industries, and the bankers expect an average 25 per cent rise in their credit in 2009. While state-owned banks were quick to respond to the recent signals from policy-makers by reducing interest rates periodically, many Private Sector Banks (PSB) are yet to follow the suit, mainly owing to pressure on their margins.

MPBIRLAINSTITUTEOFMANAGEMENT

Page12

1.3) NPAs in India - The Current Scenario


For the past few years, the Indian Banking system has been struggling to manage the vast portfolio of bad loans, popularly known as Non-Performing Assets (NPAs). The problem is more acute in the case of PSU banks. As of March 2003, the total NPAs of the private and public sector banks put together stood at a whopping Rs 65,000 crore (Source: Trend and Progress of Banking in India, RBI). NPAs, simply defined, are those loans and advances in respect of which interest and/or principal installment have not been paid for 180 days from the due date. From April 1, 2004, however, any loan on which interest or principal installment is not paid for more than 90 days would be reckoned as NPA. The banking system is, therefore, sure to see a swelling NPA portfolio in the coming years. This poses a serious liquidity and credit risk on the banking system, which unless managed effectively would jeopardize the same. Thus, to prevent the collapse of the whole system due to non-payment of loans by the borrowers, there ought to be some mechanism in place. Two major steps were taken in this regard 1. The RBI directed the banks to maintain compulsory provisions for different types of NPAs; 2. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 was enacted. The SARFAESI Act allowed the banks and financial institutions to take possession of the collateral security given by the defaulting borrowers and sell these assets without having to go through protracted legal procedures. The financial sector reforms in the country were initiated in the beginning of the 1990s.The reforms have brought about a sea change in the profile of the banking sector. Our implementation of the reforms process has had several unique features. Our financial sector reforms were undertaken early in the reform cycle. Notably, the reforms process was not driven by any banking crisis, nor was it the outcome of any external support package. Besides, the design of the reforms was crafted through domestic expertise, taking on board the international experiences in this respect. The reforms were carefully sequenced with
MPBIRLAINSTITUTEOFMANAGEMENT Page13

respect to the instruments to be used and the objectives to be achieved. Thus, prudential norms and supervisory strengthening were introduced early in the reform cycle, followed by interest-rate deregulation and a gradual lowering of statutory preemptions. The more complex aspects of legal and accounting measures were ushered in subsequently when the basic tenets of the reforms were already in place. The public sector banks continue to be a dominant part of the banking system. As on March 31, 2008, the PSBs accounted for 69.9 per cent of the aggregate assets and 72.7 per cent of the aggregate advances of the Scheduled commercial banking system. A unique feature of the reform of the public sector banks was the process of their financial restructuring. The banks were recapitalized by the government to meet prudential norms through recapitalisation bonds. The mechanism of hiving off bad loans to a separate government asset management company was not considered appropriate in view of the moral hazard. The subsequent divestment of equity and offer to private shareholders was undertaken through a public offer and not by sale to strategic investors. Consequently, all the public sector banks, which issued shares to private shareholders, have been listed on the exchanges and are subject to the same disclosure and market discipline standards as other listed entities. To address the problem of distressed assets, a mechanism has been has been developed to allow sale of these assets to Asset Reconstruction Companies which operate as independent commercial entities. As regard the prudential regulatory framework for the banking system, we have come a long way from the administered interest rate regime to deregulated interest rates, from the system of Health Codes for an eight-fold, judgmental loan classification to the prudential asset classification based on objective criteria, from the concept of simple statutory minimum capital and capital-deposit ratio to the risk-sensitive capital adequacy norms initially under Basel I framework and now under the Basel II regime. There is much greater focus now on improving the corporate governance set up through fit and proper criteria, on encouraging integrated risk management systems in the banks and on promoting market discipline through more transparent disclosure standards. The policy endeavor has all along been to benchmark our regulatory norms with the international best practices, of course, keeping in view the domestic imperatives and the country context. The consultative approach of the RBI in formulating the prudential regulations has been the hallmark of the current regulatory regime which enables taking account of a wide diversity of views on the issues at hand.

MPBIRLAINSTITUTEOFMANAGEMENT

Page14

The implementation of reforms has had an all round salutary impact on the financial health of the banking system, as evidenced by the significant improvements in a number of prudential parameters. Let me briefly highlight the improvements in a few salient financial indicators of the banking system. The average capital adequacy ratio for the scheduled commercial banks, which was around two per cent in 1997, had increased to 13.08 per cent as on March 31, 2008. The improvement in the capital adequacy ratio has come about despite significant growth in the aggregate asset of the banking system. This level of capital ratio in the Indian banking system compares quite well with the banking system in many other countries though the capital adequacy of some of the banks in the developed countries has remained under considerable strain in the recent past in the aftermath of the sub-prime crisis. In regard to the asset quality also, the gross NPAs of the scheduled commercial banks, which were as high as 15.7 per cent at end-March 1997, declined significantly to 2.4 per cent as at end-March 2008. The net NPAs of these banks during the same period declined from 8.1 per cent to 1.08 per cent. These figures too compare favourably with the international trends and have been driven by the improvements in loan loss provisioning by the banks as also by the improved recovery climate enabled by the legislative environment. What is noteworthy is that the NPA ratios have recorded remarkable improvements despite progressive tightening of the asset classification norms by the RBI over the years. The reform measures have also resulted in an improvement in the profitability of banks. The Return on Assets (RoA) of scheduled commercial banks increased from 0.4 per cent in the year 1991-92 to 0.99 per cent in 2007-08. The Indian banks would appear well placed in this regard too vis--vis the broad range of ROA for the international banks. The banking sector reforms also emphasized the need to improve productivity of the banks through appropriate rationalisation measures so as to reduce the operating cost and improve the profitability. A variety of initiatives were taken by the banks, including adoption of modern technology, which has resulted in improved productivity. The Business per Employee (BPE), as a measure of productivity, for the public sector banks has registered considerable improvement. The BPE for the public sector banks, which was Rs. 95 lakh in 1998-99, almost doubled to Rs. 188 lakh in 2002 and more than redoubled to Rs. 496 lakh in
MPBIRLAINSTITUTEOFMANAGEMENT Page15

2007. It needs to be noted that the turnaround in the financial performance of the public sector banks, pursuant to the banking sector reforms, has resulted in the market valuation of government holdings in these banks far exceeding the initial recapitalisation cost which is something unique to the Indian banking system. Thus, the recapitalisation of banks by the government has not been merely a holding out operation by the majority owner of the banks. The Indian experience has shown that a strong, pragmatic and non-discriminatory regulatory framework coupled with the market discipline effected through the listing of the equity shares and operational autonomy provided to the banks, can have a significant positive impact on the functioning of the public sector banks.

1.4) THE TASK AHEAD


The public sector banks face certain challenges and hence, need to work further to achieve the desired results, particularly in regard to fuller leveraging of the available technology for rendering better banking services to the public at large. Awareness of electronic payment products As is well known, the financial sector has witnessed a quantum jump in the availability of technological solutions for delivery of financial services, and the RBI too has launched several payment system products for improving the efficiency of the payment system. It is, however, the general perception that the awareness of these products in the system has remained rather limited. This lack of awareness is not confined to only to the members of public at large. It is not uncommon to find that even the branch staff, having direct interface with the banking customers, is not aware of these products and services offered by the bank. This has, therefore, resulted in the continued reliance of the members of public on the traditional methods for availing of various banking services and the benefits of technology have not fully percolated to the level of the customers. I would, therefore, like to urge to take appropriate measures to increase the awareness of the electronic payment products not only among the clientele of the banks but also among the banks own staff so that the members of public can be properly guided and efficient and hassle-free customer service is rendered to them National Electronic Fund Transfer As we are aware, the NEFT was launched by the RBI in November 2005 as a more secure, nationwide retail electronic payment system to facilitate funds transfer by the bank customers, between the networked bank branches in the country. It has, however, been observed that the public sector banks are not the most active users of this product and the
MPBIRLAINSTITUTEOFMANAGEMENT Page16

majority of NEFT outward transactions are originated by a few new-generation private sector banks and foreign banks. For instance, in June 2008, while these banks, as a segment, accounted for a little over 43 per cent each of the aggregate volume of outward and inward NEFT transactions, the share of public sector banks in total outward NEFT transactions was rather low at a little over 12 per cent, of which half the volume was the contribution of the State Bank of India. The RBI has been pursuing the matter with the PSBs for increasing their participation in the NEFT system in terms of the number of NEFT-enabled branches and the number of NEFT transactions originated by them. I would like to urge upon the bankers present here to initiate appropriate measures to stimulate greater usage of this payment medium and thereby, improve their share in this regard. In order to popularise the e-payments in the country, the RBI, on its part, has waived the service charges to be levied on the member banks, till March 31, 2009, in respect of the RTGS and NEFT transactions. The RBI also provides, free of charge, intraday liquidity to the banks for the RTGS transactions. The service charges to be levied by banks from their customers for RTGS & NEFT have, however, been deregulated and left to discretion of the individual bank. It has been our experience that while some of the banks have rationalised their service charges and a few have made it even cost-free to the customers, there are also certain banks that have fixed multiples slabs or unreasonably high service charges, at times linked to the amount of the transaction, for providing these services to their customers even though the RBI provides these services to the banks free of charge. We would therefore, like to take this opportunity to impress upon such banks the need to have proper appreciation of the underlying policy intent of the RBI in waiving the charges for these services, and to adopt a pragmatic approach in determining their own service charges for providing these electronic payment products to their customers. ATM Networks The National Financial Switch (NFS) network started its operations on August 27, 2004 and is owned and operated by Institute for Development and Research in Banking Technology (IDRBT), Hyderabad. NFS is one of the several shared ATM networks which interconnect the banks ATM switches together and thus, enable inter-operability of the ATM cards issued by any bank across the entire network.

MPBIRLAINSTITUTEOFMANAGEMENT

Page17

While there are a few other ATM networks also functioning in the country, the NFS has emerged to be the largest one, with a network of 28,773 ATMs of 31 banks, including 16 public sector banks. The primary objective of any ATM network, like the NFS, is to make the ATM deployment more economical and viable for banks by pooling their respective ATM resources. The main advantage of an ATM network is that it obviates the need for having bank-specific multiple ATM installations in the same geographical area, thereby reducing the entailed costs for the banks but without compromising on the reach of the banks to their customers. From the customers perspective, the ATM card of any bank can be used in any ATM which enables more convenient and wider ATM access to the bank customers of varied banks in different geographical areas. As regards the charges for use of the ATMs connected through any of the ATM networks in the country, while the balance enquiry by the customers is free of any charges, the cash withdrawal from such ATMs, which currently attracts a nominal charge, would also become cost free for the customers from April 1, 2009,. Thus, the networking of the ATMs across the country, by leveraging the technology, is indeed a very customerfriendly development. At end-June 2008, the number of ATMs in the country stood at 36,314 of which the number of ATMs deployed by the PSBs, new-private-sector, old-private-sector and foreign banks was 22,525, 10,552, 2,189 and 1048 ATMs, respectively. At the system level, the banks had planned the installation of another 10,560 ATMs during 2008-09. During the quarter ended June 2008, the daily average number of hits on the ATMs of the PSBs aggregated 31,31,431, with the daily average amount of transactions at Rs. 759.81 crore as against the corresponding figure of 14,91,399 and over Rs. 385 crore for the (old and new) private sector banks, of which the new private sector banks accounted for a loins share at 12,84, 071 hits and around Rs. 329 crore in the value of daily transactions. Credit Cards There has been phenomenal increase in the number of credit cards issued by the banks in India during the last few years and a majority of the PSBs has been in the credit card business since long. The number of credit cards outstanding at the end of June 2008 was 27.02 million as against 24.39 million in June 2007. Of these, the number of credit cards issued by public sector banks was 3.8 million, of which 3.09 million cards were issued by the SBI Cards a

MPBIRLAINSTITUTEOFMANAGEMENT

Page18

joint venture of GE Money and SBI. The usage of credit cards has also recorded an increase of 10.73 per cent during the year this period, which is mainly at the Point of Sale (POS) terminals. In June 2008, the number of transactions by credit cards at POS terminals was 20.6 million as against 17.2 million transactions in June 2007, reflecting an increase of almost 20 per cent during the year. The amount involved in these transactions recorded a growth of 25.6 per cent during the year ended June 2008 with the aggregate value of such transactions at Rs. 5261.63 crore. While the increasing usage of the credit cards is a welcome development in as much as it reduces reliance on currency for settlement of transactions, it also entails certain additional elements of operational risk and can be a potential source of customer complaints. The RBI, based on the complaints received from the credit card holders, had undertaken a study of the credit card operations of the banks. The RBI has since advised the banks in July 2008, the recommendations emerging from the study, for implementation. These recommendations are fairly wide ranging and encompass several issues in the areas of card issuance, card statements, interest and other chares on the cards, using the services of direct selling / marketing agents, redressal of customers grievances, reporting of default information of the card holder to the CIBIL, etc. We would urge the banks to put in place necessary mechanism to ensure meticulous compliance with these instructions of the RBI so as to minimize, if not eliminate, the risks and customer complaints in the area of credit card operations. Satellite banking We might be aware, having regard to much greater reliability of a satellite-based communication link for interconnecting the branches of the banks, particularly in the hilly areas and difficult terrain where terrestrial communication link is difficult to provide, the RBI had constituted a Technical Group to examine the proposal for providing satellite connectivity to the bank branches in such areas. The objective is to enable greater penetration of the electronic payment products in the hinterland areas also, by facilitating the integration of the rural and remote branches with the core bankingsolution platform of the banks and help them providing efficient banking services to their customers. Under the proposal, the RBI would be bearing a part of the leased rentals for the satellite connectivity, provided the banks use it for connecting their branches in the North Eastern States and in the under-banked districts in the rest of the country. Thus, the RBI would be providing an incentive to the banks for adopting the satellite communication technology for networking their branches in the remote areas.
MPBIRLAINSTITUTEOFMANAGEMENT Page19

1.5) Challenges facing Banking industry in India

The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. These multiple changes happening one after other has a ripple effect on a bank trying to graduate from completely regulated sellers market to completed deregulated customers market

MPBIRLAINSTITUTEOFMANAGEMENT

Page20

Deregulation: This continuous deregulation has made the Banking market extremely competitive with greater autonomy, operational flexibility, and decontrolled interest rate and liberalized norms for foreign exchange. The deregulation of the industry coupled with decontrol in interest rates has led to entry of a number of players in the banking industry. At the same time reduced corporate credit off take thanks to sluggish economy has resulted in large number of competitors battling for the same pie. New rules: As a result, the market place has been redefined with new rules of the game. Banks are transforming to universal banking, adding new channels with lucrative pricing and freebees to offer. Natural fall out of this has led to a series of innovative product offerings catering to various customer segments, specifically retail credit Efficiency: This in turn has made it necessary to look for efficiencies in the business. Banks need to access low cost funds and simultaneously improve the efficiency. The banks are facing pricing pressure, squeeze on spread and have to give thrust on retail assets Diffused Customer loyalty: This will definitely impact Customer preferences, as they are bound to react to the value added offerings. Customers have become demanding and the loyalties are diffused. There are multiple choices; the wallet share is reduced per bank with demand on flexibility and customization. Given the relatively low switching costs; customer retention calls for customized service and hassle free, flawless service delivery. Misaligned mindset: These changes are creating challenges, as employees are made to adapt to changing conditions. There is resistance to change from employees and the Seller market mindset is yet to be changed coupled with Fear of uncertainty and Control orientation. Acceptance of technology is slowly creeping in but the utilization is not maximised. Competency Gap: Placing the right skill at the right place will determine success. The competency gap needs to be addressed simultaneously otherwise there will be missed opportunities. The focus of
MPBIRLAINSTITUTEOFMANAGEMENT Page21

people will be on doing work but not providing solutions, on escalating problems rather than solving them and on disposing customers instead of using the opportunity to cross sell. Strategic options with banks to cope with the challenges Leading players in the industry have embarked on a series of strategic and tactical initiatives to sustain leadership. The major initiatives include: Investing in state of the art technology as the back bone of to ensure reliable service delivery savings deposits Making aggressive forays in the retail advances segment of home and personal loans Implementing organization wide initiatives involving people, process and technology to reduce the fixed costs and the cost per transaction Focusing on fee based income to compensate for squeezed spread, (e.g. CMS, trade services) Innovating Products to capture customer mind share to begin with and later the wallet share Improving the asset quality as per Basel II norms

MPBIRLAINSTITUTEOFMANAGEMENT

Page22

1.6) NON PERFORMING ASSETS (NPA)


Action for enforcement of security interest can be initiated only if the secured asset is classified as Nonperforming asset. Non performing asset means an asset or account of borrower, which has been classified by bank or financial institution as sub standard , doubtful or loss asset, in accordance with the direction or guidelines relating to assets classification issued by RBI . An amount due under any credit facility is treated as past due when it is not been paid within 30 days from the due date. Due to the improvement in the payment and settlement system, recovery climate, up gradation of technology in the banking system etc, it was decided to dispense with past due concept, with effect from March 31, 2001. Accordingly as from that date, a Non performing asset shell be an advance where i. Interest and/or instalment of principal remain overdue for a period of more than 180 days in respect of a term loan, ii. The account remains out of order for a period of more than 180 days, in respect of an overdraft/cash credit (OD/CC) iii. The bill remains overdue for a period of more than 180 days in case of bill purchased or discounted. iv. Interest and/or principal remains overdue for two harvest season but for a period not exceeding two half years in case of an advance granted for agricultural purpose, and v. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt 90 days overdue norms for identification of NPA s, from the year ending March 31, 2004, a non performing asset shell be a loan or an advance where; i. Interest and/or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan, ii. The account remains out of order for a period of more than 90 days ,in respect of an overdraft/cash credit (OD/CC)
MPBIRLAINSTITUTEOFMANAGEMENT Page23

iii. The bill remains overdue for a period of more than 90 days in case of bill purchased or discounted. iv. Interest and/or principal remains overdue for two harvest season but for a period not exceeding two half years in case of an advance granted for agricultural purpose, and v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts Out of order An account should be treated as out of order if the outstanding balance remains continuously in excess of sanctioned limit /drawing power. in case where the out standing balance in the principal operating account is less than the sanctioned amount /drawing power, but there are no credits continuously for six months as on the date of balance sheet or credit are not enough to cover the interest debited during the same period ,these account should be treated as out of order. Overdue Any amount due to the bank under any credit facility is overdue if it is not paid on due date fixed by the bank.

1.7) FACTORS FOR RISE IN NPAs


The banking sector has been facing the serious problems of the rising NPAs. But the problem of NPAs is more in public sector banks when compared to private sector banks and foreign banks. A strong banking sector is important for a flourishing economy. The failure of the banking sector may have an adverse impact on other sectors. The Indian banking system, which was operating in a closed economy, now faces the challenges of an open economy. On one hand a protected environment ensured that banks never needed to develop sophisticated treasury operations and Asset Liability Management skills. On the other hand a combination of directed lending and social banking relegated profitability and competitiveness to the background. The net result was unsustainable NPAs and consequently a higher effective cost of banking services.

MPBIRLAINSTITUTEOFMANAGEMENT

Page24

The problem India Faces is not lack of strict prudential norms but i. The legal impediments and time consuming nature of asset disposal proposal. ii. Postponement of problem in order to show higher earnings. iii. Manipulation of debtors using political influence. Macro Perspective behind NPAs A lot of practical problems have been found in Indian banks, especially in public sector banks. For Example, the government of India had given a massive wavier of Rs. 15,000 Crs. under the Prime Minister ship of Mr. V.P. Singh, for rural debt during 1989-90. This was not a unique incident in India and left a negative impression on the payer of the loan. Poverty elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on various grounds in meeting their objectives. The huge amounts of loan granted under these schemes were totally unrecoverable by banks due to political manipulation, misuse of funds and nonreliability of target audience of these sections. Loans given by banks are their assets and as the repayments of several of the loans were poor, the qualities of these assets were steadily deteriorating. Credit allocation became 'Lon Melas', loan proposal evaluations were slack and as a result repayments were very poor. There are several reasons for an account becoming NPA. * Internal factors * External factors EXTERNAL FACTORS Ineffective recovery tribunal The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and advances. Due to their negligence and ineffectiveness in their work the bank suffers the consequence of non-recover, their by reducing their profitability and liquidity.

MPBIRLAINSTITUTEOFMANAGEMENT

Page25

Willful Defaults There are borrowers who are able to payback loans but are intentionally withdrawing it. These groups of people should be identified and proper measures should be taken in order to get back the money extended to them as advances and loans. Natural calamities This is the measure factor, which is creating alarming rise in NPAs of the PSBs. Every now and then India is hit by major natural calamities thus making the borrowers unable to pay back there loans. Thus the bank has to make large amount of provisions in order to compensate those loans, hence end up the fiscal with a reduced profit. Mainly our farmers depends on rain fall for cropping. Due to irregularities of rain fall the framers are not to achieve the production level thus they are not repaying the loans. Industrial sickness Improper project handling , ineffective management , lack of adequate resources , lack of advance technology , day to day changing govt. Policies give birth to industrial sickness. Hence the banks that finance those industries ultimately end up with a low recovery of their loans reducing their profit and liquidity. Lack of demand Entrepreneurs in India could not foresee their product demand and starts production which ultimately piles up their product thus making them unable to pay back the money they borrow to operate these activities. The banks recover the amount by selling of their assets, which covers a minimum label. Thus the banks record the non recovered part as NPAs and has to make provision for it. Change on Govt. policies With every new govt. banking sector gets new policies for its operation. Thus it has to cope with the changing principles and policies for the regulation of the rising of NPAs. The fallout of handloom sector is continuing as most of the weavers Co-operative societies have become defunct largely due to withdrawal of state patronage. The rehabilitation plan worked out by the Central govt to revive the handloom sector has not yet been implemented. So the over dues due to the handloom sectors are becoming NPAs.
MPBIRLAINSTITUTEOFMANAGEMENT Page26

Apart from these factors there may be others external factors which can cause of NPAs, these factors are: 1. Sluggish legal system - Long legal tangles Changes that had taken place in labour laws Lack of sincere effort. 2. Scarcity of raw material, power and other resources. 3. Industrial recession. 4. Shortage of raw material, raw material\input price escalation, power shortage, industrial recession, excess capacity, natural calamities like floods, accidents. 5. Failures, non payment\ over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc. 6. Government policies like excise duty changes, Import duty changes etc., INTERNAL FACTORS Defective Lending process There are three cardinal principles of bank lending that have been followed by the commercial banks since long. i. Principles of safety ii. Principle of liquidity iii. Principles of profitability i. Principles of safety By safety it means that the borrower is in a position to repay the loan both principal and interest. The repayment of loan depends upon the borrowers: a. Capacity to pay b. Willingness to pay Capacity to pay depends upon: 1. Tangible assets 2. Success in business Willingness to pay depends on: 1. Character 2. Honest 3. Reputation of borrower
MPBIRLAINSTITUTEOFMANAGEMENT Page27

The banker should, there fore take utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is capable of carrying it out successfully .he should be a person of integrity and good character. Inappropriate technology Due to inappropriate technology and management information system, market driven decisions on real time basis can not be taken. Proper MIS and financial accounting system is not implemented in the banks, which leads to poor credit collection, thus NPA. All the branches of the bank should be computerized. Improper SWOT Analysis The improper strength, weakness, opportunity and threat analysis is another reason for rise in NPAs. While providing unsecured advances the banks depend more on the honesty, integrity, and financial soundness and credit worthiness of the borrower. 1. Banks should consider the borrowers own capital investment. 2. It should collect credit information of the borrowers from a. From bankers b. Enquiry from market/segment of trade, industry, business. c. From external credit rating agencies. Analyse the balance sheet True picture of business will be revealed on analysis of profit/loss a/c and balance sheet. 3. Purpose of the loan When bankers give loan, he should analyse the purpose of the loan. To ensure safety and liquidity, banks should grant loan for productive purpose only. Bank should analyse the profitability, viability, long term acceptability of the project while financing. Poor credit appraisal system Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the bank gives advances to those who are not able to repay it back. They should use good credit appraisal to decrease the NPAs.

MPBIRLAINSTITUTEOFMANAGEMENT

Page28

Managerial deficiencies The banker should always select the borrower very carefully and should take tangible assets as security to safe guard its interests. When accepting securities banks should consider the 1. Marketability 2. Acceptability 3. Safety 4. Transferability. The banker should follow the principle of diversification of risk based on the famous maxim do not keep all the eggs in one basket; it means that the banker should not grant advances to a few big farms only or to concentrate them in few industries or in a few cities. If a new big customer meets misfortune or certain traders or industries affected adversely, the overall position of the bank will not be affected. Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), and the handloom sector Orissa hand loom WCS ltd (2439.60lakhs). Absence of regular industrial visit The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank officials to the customer point decreases the collection of interest and principals on the loan. The NPAs due to wilful defaulters can be collected by regular visits. Re loaning process Non remittance of recoveries to higher financing agencies and re loaning of the same have already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters and CCBs and PACs, the NPAs of OSCB is increasing day by day. Apart from these the other internal factors are: 1. Funds borrowed for a particular purpose but not use for the said purpose. 2. Project not completed in time.
MPBIRLAINSTITUTEOFMANAGEMENT Page29

3. Poor recovery of receivables. 4. Excess capacities created on non-economic costs. 5. In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets. 6. Business failures. 7. Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns. 8. Willful defaults, siphoning of funds, fraud, disputes, management disputes, misappropriation etc., 9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and followups, delay in settlement of payments\ subsidiaries by government bodies etc.,

1.7) PROBLEMS DUE TO NPA


1. Owners do not receive a market return on there capital .in the worst case, if the banks fails, owners loose their assets. In modern times this may affect a broad pool of shareholders. 2. Depositors do not receive a market return on saving. In the worst case if the bank fails, depositors loose their assets or uninsured balance. 3. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit rates and higher lending rates repress saving and financial market, which hamper economic growth. 4. Non performing loans epitomize bad investment. They misallocate credit from good projects, which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital, and by extension, labour and natural resources. 5. Non performing asset may spill over the banking system and contract the money stock, which may lead to economic contraction. This spill over effect can channelize through liquidity or bank insolvency: a) when many borrowers fail to pay interest, banks may experience liquidity shortage. This can jam payment across the country,
MPBIRLAINSTITUTEOFMANAGEMENT Page30

b) illiquidity constraints bank in paying depositors . c) undercapitalised banks exceeds the banks capital base.

1.8) What caused such high NPAs in the system until 1995?
Some key reasons for huge NPAs until mid-1990s are as follows: Absence of competition: The entire banking sector was state-owned; there was complete absence of any kind of competition from the private sector. Lack of focus and control: The government-controlled operations of banks resulted in favoritisms in terms of lending, besides lack of focus on quality of lending. Managements of banks lacked any control on operations of their banks, while directors largely were influenced by the will of powercircles. Collateral-based lending and a dormant legal recourse system: Collateral was considered king. Under the name of collateral, large sums of loans were disbursed, and in the absence of an active legal recovery system, loan repayment and quality considerations took a back seat. Corruption and bureaucracy: Political interference and lack of supervision increased corruption and redtapism in the banking system. This resulted in complete dilution of credit quality and control procedures. Inadequacy of capital and tools relating to asset quality monitoring: Banks suffered from shortage of capital funds to pursue any meaningful investments in quality control, loan monitoring, etc. This inadequacy of funds, together with the absence of independent management, led to low focus on asset quality tracking and taking corrective actions. The situation changed after 1993, when the Reserve Bank of India (RBI) with the government's support, came up with several decisions on managing Indian banks that had a salutary impact, and the future never looked so much in control henceforth. There was a
MPBIRLAINSTITUTEOFMANAGEMENT Page31

significant decline in the non-performing assets (NPAs) of SCBs in 2003-04, despite adoption of 90 day delinquency norm from March 31, 2004. The gross NPAs of SCBs declined from 4.0 per cent of total assets in 2002-03 to 3.3 per cent in 2003-04. The corresponding decline in net NPAs was from 1.9 per cent to 1.2 per cent. Both gross NPAs and net NPAs declined in absolute terms. While the gross NPAs declined from Rs. 68,717 crore in 2002-03 to Rs. 64,787 crore in 2003-04, net NPAs declined from Rs. 32,670 crore to Rs. 24,617 crore in the same period. There was also a significant decline in the proportion of net NPAs to net advances from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. The significant decline in the net NPAs by 24.7 per cent in 2003-04 as compared to 8.1 per cent in 2002- 03 was mainly on account of higher provisions (up to 40.0 per cent) for NPAs made by SCBs. The decline in NPAs in 2003-04 was witnessed across all bank groups. The decline in net NPAs as a proportion of total assets was quite significant in the case of new private sector banks, followed by PSBs. The ratio of net NPAs to net advances of SCBs declined from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. Among the bank groups, old private sector banks had the highest ratio of net NPAs to net advances at 3.8 per cent followed by PSBs (3.0 per cent) new private sector banks (2.4 per cent) and foreign banks (1.5 per cent) An analysis of NPAs by sectors reveals that in 2003-04, advances to nonpriority sectors accounted for bulk of the outstanding NPAs in the case of PSBs (51.24 per cent of total) and for private sector banks (75.30 per cent of total). While the share of NPAs in agriculture sector and SSIs of PSBs declined in 2003-04, the share of other priority sectors increased. The share of loans to other priority sectors in priority sector lending also increased. Measures taken to reduce NPAs include reschedulement, restructuring at the bank level, corporate debt restructuring, and recovery through Lok Adalats, Civil Courts, and debt recovery tribunals and compromise settlements. The recovery management received a major fillip with the enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 enabling banks to realise their dues without intervention of courts and tribunals. The Supreme Court in its judgment dated April 8, 2004, while upholding the constitutional validity of the Act, struck down section 17 (2) of the Act as unconstitutional and contrary to Article 14 of the Constitution of India. The Government amended the relevant provisions of the Act to address the concerns expressed by the Supreme Court regarding a fair deal to borrowers through an ordinance dated November 11, 2004. It is expected that the momentum in the recovery of NPAs will be resumed with
MPBIRLAINSTITUTEOFMANAGEMENT Page32

the amendments to the Act. The revised guidelines for compromise settlement of chronic NPAs of PSBs were issued in January 2003 and were extended from time to time till July 31, 2004. The cases filed by SCBs in Lok Adalats for recovery of NPAs stood at 5.20 lakh involving an amount of Rs. 2,674 crore (prov.). The recoveries effected in 1.69 lakh cases amounted to Rs. 352 crore (prov.) as on September 30, 2004. The number of cases filed in debt recovery tribunals stood at 64, 941 as on June 30, 2004, involving an amount of Rs. 91,901 crore. Out of these, 29, 525 cases involving an amount of Rs. 27,869 crore have been adjudicated. The amount recovered was to Rs. 8,593 crore. Under the scheme of corporate debt restructuring introduced in 2001, the number of cases and value of assets restructured stood at 121 and Rs. 69,575 crore, respectively, as on December 31, 2004. Iron and steel, refinery, fertilisers and telecommunication sectors were the major beneficiaries of the scheme. These sectors accounted for more than two-third of the values of assets restructured Capital adequacy ratio The concept of minimum capital to risk weighted assets ratio (CRAR) has been developed to ensure that banks can absorb a reasonable level of losses. Application of minimum CRAR protects the interest of depositors and promotes stability and efficiency of the financial system. At the end of March 31, 2004, CRAR of PSBs stood at 13.2 per cent, an improvement of 0.6 percentage point from the previous year. There was also an improvement in the CRAR of old private sector banks from 12.8 per cent in 2002- 03 to 13.7 per cent in 2003-04. The CRAR of new private sector banks and foreign banks registered a decline in 2003-04. For the SCBs as a whole the CRAR improved from 12.7 per cent in 2002-03 to 12.9 per cent in 2003-04. All the bank groups had CRAR above the minimum 9 per cent stipulated by the RBI. During the current year, there was further improvement in the CRAR of SCBs. The ratio in the first half of 2004-05 improved to 13.4 per cent as compared to 12.9 per cent at the end of 2003-04. Among the bank groups, a substantial improvement was witnessed in the case of new private sector banks from 10.2 per cent as at the end of 2003-04 to 13.5 percent in the first half of 2004-05. While PSBs and old private banks maintained the CRAR at almost the same level as in

MPBIRLAINSTITUTEOFMANAGEMENT

Page33

the previous year, the CRAR of foreign banks declined to 14.0 per cent in the first half of 2004-05 as compared to 15.0 per cent as at the end of 2003-04.

The above picture is self-explanatory. Over the period of time, Indian commercial banks have shown tremendous improvement in terms of quality of credit. NPAs, both at gross and net levels, as a percentage of advances, have fallen consistently. The gross NPA/Advances ratio has fallen from 16% in FY97 to less than 2.5% in FY08. Banks displayed great control over credit quality, as even in times of falling IIP and GDP growth, they continued to show fewer NPAs. This is a very impressive indicator that highlights the fact that Indian banking has shown substantial improvement in terms of asset quality management even in adverse macroeconomic conditions. FY99, FY01 and FY02 saw considerable fall in industrial production from the then existing levels. However, this did not lead to any increase in bank NPAs. On the contrary, banks improved NPA ratios considerably through the exercise of strong asset quality monitoring programmes. The current environment is again indicating a decline in GDP, and IIP growth rates as slowdown hits demand and consumption across all major sectors. However, we strongly believe that managements of top Indian banks have put 'NPA Management and Control' as one of their top priorities, and that even though there would be a jump in NPAs as a proportion of total assets, the banking sector has the ability to withstand this jump and still emerge as a strong performer in these extremely difficult times.

1.9) PROBLEMS DUE TO NPA


MPBIRLAINSTITUTEOFMANAGEMENT Page34

1. Owners do not receive a market return on there capital .in the worst case, if the banks fails, owners loose their assets. In modern times this may affect a broad pool of shareholders. 2. Depositors do not receive a market return on saving. In the worst case if the bank fails, depositors loose their assets or uninsured balance. 3. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit rates and higher lending rates repress saving and financial market, which hamper economic growth. 4. Non performing loans epitomize bad investment. They misallocate credit from good projects, which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital, and by extension, labour and natural resources. 5. Non performing asset may spill over the banking system and contract the money stock, which may lead to economic contraction. This spill over effect can channelize through liquidity or bank insolvency: a) when many borrowers fail to pay interest, banks may experience liquidity shortage. This can jam payment across the country, b) illiquidity constraints bank in paying depositors . c) undercapitalised banks exceeds the banks capital base.

1.10) What caused such high NPAs in the system until 1995?
Some key reasons for huge NPAs until mid-1990s are as follows: Absence of competition: The entire banking sector was state-owned; there was complete absence of any kind of competition from the private sector. Lack of focus and control: The government-controlled operations of banks resulted in favoritisms in terms of lending, besides lack of focus on quality of lending. Managements of banks lacked any control on operations of their banks, while directors largely were influenced by the will of powercircles.
MPBIRLAINSTITUTEOFMANAGEMENT Page35

Collateral-based lending and a dormant legal recourse system: Collateral was considered king. Under the name of collateral, large sums of loans were disbursed, and in the absence of an active legal recovery system, loan repayment and quality considerations took a back seat. Corruption and bureaucracy: Political interference and lack of supervision increased corruption and redtapism in the banking system. This resulted in complete dilution of credit quality and control procedures. Inadequacy of capital and tools relating to asset quality monitoring: Banks suffered from shortage of capital funds to pursue any meaningful investments in quality control, loan monitoring, etc. This inadequacy of funds, together with the absence of independent management, led to low focus on asset quality tracking and taking corrective actions. The situation changed after 1993, when the Reserve Bank of India (RBI) with the government's support, came up with several decisions on managing Indian banks that had a salutary impact, and the future never looked so much in control henceforth. There was a significant decline in the non-performing assets (NPAs) of SCBs in 2003-04, despite adoption of 90 day delinquency norm from March 31, 2004. The gross NPAs of SCBs declined from 4.0 per cent of total assets in 2002-03 to 3.3 per cent in 2003-04. The corresponding decline in net NPAs was from 1.9 per cent to 1.2 per cent. Both gross NPAs and net NPAs declined in absolute terms. While the gross NPAs declined from Rs. 68,717 crore in 2002-03 to Rs. 64,787 crore in 2003-04, net NPAs declined from Rs. 32,670 crore to Rs. 24,617 crore in the same period. There was also a significant decline in the proportion of net NPAs to net advances from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. The significant decline in the net NPAs by 24.7 per cent in 2003-04 as compared to 8.1 per cent in 2002- 03 was mainly on account of higher provisions (up to 40.0 per cent) for NPAs made by SCBs. The decline in NPAs in 2003-04 was witnessed across all bank groups. The decline in net NPAs as a proportion of total assets was quite significant in the case of new private sector banks, followed by PSBs. The ratio of net NPAs to net advances of SCBs declined from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. Among the bank groups, old private sector banks had the highest ratio of net NPAs to net advances at 3.8 per cent
MPBIRLAINSTITUTEOFMANAGEMENT Page36

followed by PSBs (3.0 per cent) new private sector banks (2.4 per cent) and foreign banks (1.5 per cent) An analysis of NPAs by sectors reveals that in 2003-04, advances to nonpriority sectors accounted for bulk of the outstanding NPAs in the case of PSBs (51.24 per cent of total) and for private sector banks (75.30 per cent of total). While the share of NPAs in agriculture sector and SSIs of PSBs declined in 2003-04, the share of other priority sectors increased. The share of loans to other priority sectors in priority sector lending also increased. Measures taken to reduce NPAs include reschedulement, restructuring at the bank level, corporate debt restructuring, and recovery through Lok Adalats, Civil Courts, and debt recovery tribunals and compromise settlements. The recovery management received a major fillip with the enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 enabling banks to realise their dues without intervention of courts and tribunals. The Supreme Court in its judgment dated April 8, 2004, while upholding the constitutional validity of the Act, struck down section 17 (2) of the Act as unconstitutional and contrary to Article 14 of the Constitution of India. The Government amended the relevant provisions of the Act to address the concerns expressed by the Supreme Court regarding a fair deal to borrowers through an ordinance dated November 11, 2004. It is expected that the momentum in the recovery of NPAs will be resumed with the amendments to the Act. The revised guidelines for compromise settlement of chronic NPAs of PSBs were issued in January 2003 and were extended from time to time till July 31, 2004. The cases filed by SCBs in Lok Adalats for recovery of NPAs stood at 5.20 lakh involving an amount of Rs. 2,674 crore (prov.). The recoveries effected in 1.69 lakh cases amounted to Rs. 352 crore (prov.) as on September 30, 2004. The number of cases filed in debt recovery tribunals stood at 64, 941 as on June 30, 2004, involving an amount of Rs. 91,901 crore. Out of these, 29, 525 cases involving an amount of Rs. 27,869 crore have been adjudicated. The amount recovered was to Rs. 8,593 crore. Under the scheme of corporate debt restructuring introduced in 2001, the number of cases and value of assets restructured stood at 121 and Rs. 69,575 crore, respectively, as on December 31, 2004.

MPBIRLAINSTITUTEOFMANAGEMENT

Page37

Iron and steel, refinery, fertilisers and telecommunication sectors were the major beneficiaries of the scheme. These sectors accounted for more than two-third of the values of assets restructured Capital adequacy ratio The concept of minimum capital to risk weighted assets ratio (CRAR) has been developed to ensure that banks can absorb a reasonable level of losses. Application of minimum CRAR protects the interest of depositors and promotes stability and efficiency of the financial system. At the end of March 31, 2004, CRAR of PSBs stood at 13.2 per cent, an improvement of 0.6 percentage point from the previous year. There was also an improvement in the CRAR of old private sector banks from 12.8 per cent in 2002- 03 to 13.7 per cent in 2003-04. The CRAR of new private sector banks and foreign banks registered a decline in 2003-04. For the SCBs as a whole the CRAR improved from 12.7 per cent in 2002-03 to 12.9 per cent in 2003-04. All the bank groups had CRAR above the minimum 9 per cent stipulated by the RBI. During the current year, there was further improvement in the CRAR of SCBs. The ratio in the first half of 2004-05 improved to 13.4 per cent as compared to 12.9 per cent at the end of 2003-04. Among the bank groups, a substantial improvement was witnessed in the case of new private sector banks from 10.2 per cent as at the end of 2003-04 to 13.5 percent in the first half of 2004-05. While PSBs and old private banks maintained the CRAR at almost the same level as in the previous year, the CRAR of foreign banks declined to 14.0 per cent in the first half of 2004-05 as compared to 15.0 per cent as at the end of 2003-04.

MPBIRLAINSTITUTEOFMANAGEMENT

Page38

The above picture is self-explanatory. Over the period of time, Indian commercial banks have shown tremendous improvement in terms of quality of credit. NPAs, both at gross and net levels, as a percentage of advances, have fallen consistently. The gross NPA/Advances ratio has fallen from 16% in FY97 to less than 2.5% in FY08. Banks displayed great control over credit quality, as even in times of falling IIP and GDP growth, they continued to show fewer NPAs. This is a very impressive indicator that highlights the fact that Indian banking has shown substantial improvement in terms of asset quality management even in adverse macroeconomic conditions. FY99, FY01 and FY02 saw considerable fall in industrial production from the then existing levels. However, this did not lead to any increase in bank NPAs. On the contrary, banks improved NPA ratios considerably through the exercise of strong asset quality monitoring programmes. The current environment is again indicating a decline in GDP, and IIP growth rates as slowdown hits demand and consumption across all major sectors. However, we strongly believe that managements of top Indian banks have put 'NPA Management and Control' as one of their top priorities, and that even though there would be a jump in NPAs as a proportion of total assets, the banking sector has the ability to withstand this jump and still emerge as a strong performer in these extremely difficult times.

1.11) What changed the scenario of NPAs after 1995?


Some of the key factors that contributed to the fall in NPAs in the Indian banking Introduction of competition: The RBI opened up gates for the private sector participation in the Indian banking industry. HDFC, the principal mortgage lender, got the first approval to start a private bank in the reform-driven era. HDFC Bank was given permission to carry on commercial banking operations. Many new private banks and foreign banks were allowed later, which brought in the much-required competition in the Indian banking industry. Guidelines on NPAs, income recognition, capital adequacy: One of the key reasons for such a drastic fall in system NPAs was the introduction of asset and capital quality guidelines. These norms, introduced on the basis of the Narasimhan Committee report in 1993, had a revolutionary impact on the way banks managed and controlled their asset book.
MPBIRLAINSTITUTEOFMANAGEMENT Page39

Separation of control: Bank managements were given a free hand to run their businesses as the Ministry of Finance and the RBI moved away from controlling positions to supervising and regulating positions. This enabled boards of Indian banks to take uninfluenced calls as to lending and asset control. Improvement of the legal recourse mechanism: This is another significant step. Through Debt Recovery Tribunal (DRT), Lok Adalat mechanism for small loans, and One-Time Settlement (OTS) mechanism for stressed loans in 1999, the central bank ensured that there is a quick clean-up of sticky assets, so as to enable banks to start functioning with a clean slate. The legal recourse for amounts lent has been an important contributor to asset quality improvement. Capital infusion: Public banks were allowed to bring down the government holding to 51%, thereby enabling flow of fresh money for much-needed banks and also roping in investment interest from market participants. Board of directors now became more independent, and a mixed lot of individuals brought in experience from various segments of the financial world. Establishment of CIBIL: Credit Information Bureau of India Ltd was established in 2000. This institution started to maintain a database of borrowers and their credit history. This served as a very effective tool for loan sanctioning and asset quality maintenance. Banks use the database to ensure credit does not fall in the hands of a borrower, with a bad credit record. Asset Reconstruction Company: ARCs were permitted to operate from 2002; these institutions helped the removal of bank's focus on bad assets by acquiring their bad loans, thereby strengthening their balance sheets. Corporate Debt Restructuring, SICA: The CDR mechanism, sick industries revival enactments enabled addressing issues of troubled borrowers through effective handholding and bank support. This prevented further slippage of asset quality.
MPBIRLAINSTITUTEOFMANAGEMENT Page40

Exposure limits (sector-wise and borrower-wise): The RBI put in place strict exposure limits for banks with respect to sensitive sectors like real estate and capital markets. In addition, limits on amounts a bank can lend to a specific borrower, or a borrower group helped in non-concentration of funds as loans in a few hands, thereby diversifying the risk of default. Risk management tools: The RBI ensured that banks have effective risk measurement, management and control systems in place, so as to avoid credit shocks. Asset liability management (ALM), value at risk (VAR), control on off-balance sheet exposures, credit risk weightages, etc. are few concepts that enabled banks to effectively control NPAs. In this context of a highly improved, dynamic and competitive domestic banking environment, we expect that Indian banks will exercise adequate caution in terms of the quality of their loan-books. In addition, some of the steps (underlined) can be effectively used again by RBI and the government, if the condition of NPAs worsens. Have Indian banks achieved the best asset quality levels? In terms of global comparisons (table below), the performance of Indian banks over the years has surely been exemplary, and with regard to further scope for improvement, there are many countries where GNPA/advances ratio is much below levels at which Indian banks are currently positioned. This shows there is further scope for quality improvements for banks in India.

MPBIRLAINSTITUTEOFMANAGEMENT

Page41

Efficiency and return parameters - Room for betterment?

As can be observed from the above chart, Indian banks have kept their operating expenses under check. From around 3% levels during 1996 and 1997, operating expenses/assets ratio has come down to 1.8% levels by the end of FY2008. Though this is a good indicator reflecting the efficiency of Indian banks, it is still higher as compared with banks in other countries such as China, Malaysia, Korea and Thailand where the ratio is below 1.5%. In addition, one reason that might have contributed positively to Indian banks is the fact that over the past 3-4 years there has been a rapid increase in bank loans, and hence, the balance sheet size of banks. The higher base (as advances and total assets) might have helped in the ratio falling to low levels. Return on assets ratio comparison table above shows that most other banks earn better returns as compared with their Indian peers. Considering the fact that the loan quality is improving and expenses are under control, Indian banks identified the need to improve the profitability. Focus on fee income that is less sensitive to interest rate fluctuations (unlike NIMs and treasury income) has been defined as one key area besides expenses control that Indian banks would strive for in the future to improve the return generated over assets. Providing various value-added financial services under one umbrella has also been aimed at to improve the bottom-line.

MPBIRLAINSTITUTEOFMANAGEMENT

Page42

From the above paragraphs, it can be inferred that though Indian banking has shown tremendous improvement over the years in terms of asset quality and efficiency, the comparison with global peers in terms of these aspects and return on assets shows that there is still ample scope for improvement. Indian Banking - Internal dynamics - Changed circumstances In terms of the domestic scenario, as shown in the chart below, bank credit in FY08 has been\ growing at a slower pace than that observed over the past 4 years. The central bank tried to ensure that the economy does not get overheated by raising the 'repo rate' regularly. Rates were slashed from the period starting October 2008 to support liquidity in the domestic market that had become extremely scarce due to global credit crisis. The average 3-year credit growth steadily rose to 29% during 2005-08 from 14% levels observed between 1996 and 1999. Though the RBI's target credit growth is in the vicinity of 20% for FY09, yearly credit growth as of November 2008 remained at 26%, above the level targeted by the central bank.

MPBIRLAINSTITUTEOFMANAGEMENT

Page43

In addition to the objective of slowing or moderating the pace of credit growth, the RBI had to control the sudden spike in domestic inflation that rose to levels not seen at least for more than a decade. Inflation shot up to above 12% during July 2008 due to a hike in fuel prices and increase in commodity and food prices. However, inflation started to cool off from midSeptember 2008, as global crude and commodity prices crashed due to recession worries. Prices of primary articles, representing food and agriculture products, still remain firm, but the overall inflation has fallen to 9% levels in November 2008. The data indicates how inflation, indicated by the wholesale price index (WPI), shot up from around 4% levels in FY97 to 12% by 1HFY09. The impact of increasing inflation, rising interest rates (repo rate) and slowing credit growth on Indian banks was seen in increasing cost of funds, increasing pressure on the asset quality and squeezing of margins. The movement of BSE Bankex, the share-price index of banks, reflects the impact of all the above factors. An inverse correlation between Inflation and the Bankex movement is clearly observed until September 2008, when global credit crisis started to pull down prices of all bank stocks even when inflation cooled off significantly. Today, the situation is vastly different! Inflation has cooled off to 6% and high credit growth does not pose a threat to RBI anytime soon In short, the following aspects are key arguments for our positive view on Indian banks in the current environment: NPAs will rise to 5% at gross level as a percentage of advances, almost double from current levels. However, considering the regulatory and systemic changes that have happened after mid-1990s, Indian banks have become extremely conscious and strong in terms of managing and maintaining credit quality Credit growth has slowed as compared with previous years, but even assuming a slow GDP growth due to global recession, Indian banks have adequate demand from the system to cater to, and this will ensure decent growth in business. The bank credit is evenly diversified to all major sectors of the economy without undue reliance on any single segment or industry. In terms of credit quality, the return on assets, operating expenses and the scope for private sector credit growth, Indian banks have shown tremendous improvement over a period of time. However, considering global examples, there is enough room to improve further in each

MPBIRLAINSTITUTEOFMANAGEMENT

Page44

of the above parameters. Indian banks withstood the fall in economic growth observed during the periods of Asian economic crisis (FY98-99), and also the global slump seen during FY01-02. Even when global GDPs fell and domestic industrial production declined, NPAs were effectively controlled. The market share of advances and deposits is spread between many banks across public and private sector indicating no concentration of NPA risks in one single bank. GROSS NPA, GROSS ADVANCES

Why it feels that markets expectation of a huge rise in NPAs from current levels may be unreasonable? Bad loans are not concentrated in any single segment. The chart below shows the distribution of gross NPAs of Indian banks as at the end of FY08. Non-concentration of low quality loans in any single borrowing segment will reduce the overall impact of the economic slowdown, as segments like agriculture, among some others, would not add to the pain on account of their non-dependence on the current economic slowdown.

MPBIRLAINSTITUTEOFMANAGEMENT

Page45

The corporate sector of India has improved its financial soundness over the past few years (industry segment borrows 40% of total loans). The debt-equity ratio of Indian companies has fallen to less than 0.5 levels from highs of 1.2 times observed during the mid1990s. Also, the profitability of companies has substantially improved as is evident from the chart below, which shows the growth in shareholders equity (capital + reserves) of BSE-500 companies. These factors provide cushion to lenders on two fronts: one, borrowers quality is good (improved), and the other, there are sufficient reserves with the borrower to tide over the slowdown pain for a while. Speedy legal/quasi-legal recourse in the form of Debt Recovery Tribunals, Lok Adalats, Corporate Debt Restructuring (CDR) mechanism and One-time Settlements have yielded positive results both in terms of time taken to recover the amount lent and also the success rate. Under the CDR mechanism, cases involving INR830bn have been resolved that comprises 165 corporate accounts. Only 31 cases referred to the CDR failed. Securitisation of sticky assets that was made easier for banks by the promulgation of SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) also provides a great impetus to the recovery procedures adopted by banks. Balance sheets of banks would be much cleaner when they dispose of bad loans to a securitisation company. Loans totaling INR9.8bn and INR17.4bn have been sold in FY07 and FY08, respectively, to ARCIL, the biggest asset securitisation company in India. The

MPBIRLAINSTITUTEOFMANAGEMENT

Page46

entry of ARCIL into the retail loan segment, a segment that is currently experiencing high default rates, will benefit Indian banks. CIBIL (Credit Information Bureau of India Ltd) was established in 2000, with SBI and HDFC holding 40% stakes each, and Dun & Bradstreet and TransUnion holding 10% each of the balance. The credit information bureau is a repository of information, which contains the credit history of commercial and consumer borrowers. Member banks/institutions exchange customer credit appraisal-related data, and thus accounts with a poor credit record are identified for proper action. Currently, most banks are members of CIBIL.

MPBIRLAINSTITUTEOFMANAGEMENT

Page47

Besides the above factors, we believe that the RBI will be proactive in modifying the NPArecognition norms, provisioning norms that will enable a wider window for banks to deal with the NPA issue. Even though these measures might cover bad quality loans for a certain period of time, they support the idea to provide recovery time for borrowers to achieve financial health helping banks, at the same time, to provide less to such accounts in the form of NPAs. All these reasons, together with certain other parameters that we have explained in the following paragraphs, make us believe that NPAs will not zoom up to such levels that could pose a threat to the solvency of any banks, or even profitability for that matter! NPAs will rise, but they will not go up to unreasonable levels. Given below is a chart depicting future GNPA levels that we have considered for banks covered in this report. NPAs will show the maximum impact in FY10, though problems in the real economy began to appear from the beginning of 2HFY09. This is due to the fact that NPA-recognition norms prescribe a 90-day period before assigning a mandatory 'nonperforming' tag to the asset head

MPBIRLAINSTITUTEOFMANAGEMENT

Page48

1.12 Literature Survey


Non performing Assets in banking Industry has became a subject of intense importance and discussion . It has assumed greater significance in the world of banking and banks. It has become a barometer of the health of banks and discussions on any bank is incomplete without the mention of NPA, NPA has now become heart of the banking Industry, which in turn, is the heart of finance and economy of a nation

Research articles
NPA VARIATION ACROSS INDIAN COMMERCIAL BANKS By:Indira Rajaraman Sumon Bhaumik Namit Bhatia The Indian Commercial Banking Sector is characterized by both a high average nonperforming share in total bank advances and a high dispersion between banks. This paper presents the findings of a formal attempt to explain inter bank variations in NPAs for the year 1996-97. The specification tests for the impact of region of operation on domestically-owned banks, as measured by percentage branches in each of a set of state cluster. One cluster of three eastern and seven northern-eastern states carries a robust and statistically significant positive coefficient. Another cluster of southern and some northern states carry a significant negative coefficient. These findings bear out those of Demirguc-Kant and Hugizinga on the significance of the operating environment for bank efficiency. No sustainable improvement in the performance efficiency of domestic banks is possible without prior improvement in the enforcement environment in difficult regions of the country. Another finding of some importance is that it is not foreign ownership in and itself so much as the banking efficiency and technology correlates of the country of the origin of the foreign bank which determine NPA performance in the Indian environment.

MPBIRLAINSTITUTEOFMANAGEMENT

Page49

Chapter 2

Research Methodology

MPBIRLAINSTITUTEOFMANAGEMENT

Page50

Research Methodology
2.1 Statement of the problem
This report explores an empirical approach to the analysis of Non-Performing Assets (NPAs) with special reference of South Indian bank in India. The NPAs are considered as an important parameter to judge the performance and financial health of banks. The level of NPAs is one of the drivers of financial stability and growth of the banking sector. This report aims to find the fundamental factors which impact NPAs of banks. A model consisting of two types of factors, viz., macroeconomic factors and bank-specific parameters, is developed and the behavior of NPAs of the three categories of banks is observed. The empirical analysis assesses how macroeconomic factors and bank-specific parameters affect NPAs of a particular category of banks. The macroeconomic factors of the model included are GDP growth rate and excise duty, and the bank-specific parameters are Credit Deposit Ratio (CDR), loan exposure to priority sector, Capital Adequacy Ratio (CAR), and liquidity risk. The results show that movement in NPAs over the years can be explained well by the factors considered in the model for the public and private sector banks. The other important results derived from the analysis include the finding that banks' exposure to priority sector lending reduces NPAs

2.2) Research Objectives


To identify reasons that lead to NPAs. To study the various provisions of the Act with special emphasis on reduction of NPAs. To study why banks and financial institutions are facing the problem of swelling NPAs even after the passing of the Act To formulate methods for efficient recovery

2.3) : RESEARCH METHODOLOGY


The nature of research is exploratory as well as diagnostic as the study is aimed at exploring the impact of securitization Act on the NPAs in the banking sector. This study is based on the discussions conducted with officials of the bank. The various data provided by them, the RBI circulars, journals, magazines, data from internet will be studied and interpretation made thereof.
MPBIRLAINSTITUTEOFMANAGEMENT Page51

2.4) Sampling Design


Sampling unit - The sampling unit was banks especially the loan managers the credit managers and the officers incharge of recovery department The banks were chosen randomly Sample size The total sample size was five banks

2.5) Data Collection


Periodicals and journals

Websites.

2.6) Limitations of the study


Time constraint Inadequate data Cost constraints Limited resources

MPBIRLAINSTITUTEOFMANAGEMENT

Page52

2.7) Chapter scheme


The chapter scheme followed in this report is in the following manner: 1) Introduction a) Background of the study: b) NPA management biggest challenge for Banks in 2009 c) NPA in India Current Scenario This chapter talks about the current scenario of NPA management with respect to various banks in India. 2) Literature survey a) NPA VARIATION ACROSS INDIAN COMMERCIAL BANKS This chapter presents the findings of a formal attempt to explain inter bank variations in NPAs for the year 1996-97. 3) Research Methodology a) Statement of problem: The main problem for which reason this particular research is being conducted is mentioned in this part b) Objectives of the study: This sub-chapter contains the 4 objectives for which the research is being conducted c) Sampling technique: This contains details regarding various sampling design such as sample size, sampling unit and sampling technique adopted d) Data collection technique: This tells us about the sources through which the data has been collected and what all data have been collected for research purpose e) Scope of the study: This contains details regarding to what all areas and what time period this research is restricted to f) Limitations of the study: Some of the major limitations of the study such as time constraint, cost constraints have been listed g) Chapter Scheme:
MPBIRLAINSTITUTEOFMANAGEMENT Page53

This gives the structure of how the report is framed chapter-wise and gives a gist about what comes under each chapter 4) Industry Profile a) This gives a brief about the Banking Industry which have been selected for research purpose and also a gist about the NPA management across Banks of India. 5) Company Profile a) This gives a brief about the South Indian Bank which have been selected for research purpose as its awarded for Best NPA Management. 6) Analysis and interpretation This part analysis the 5 banks on various parameters to find out how they are placed in terms of business growth, efficiency and the comfort they provide in terms of their current financial standing and business exposures. 7) Findings: a) This part contains summary of findings of the entire report in which detail explanation of Basel I and Basel II framework has also been highlighted. 8) Recommendations: This chapter deals with the various suggestions and recommendations which have been given based on the summary of findings 9) Bibliography: This part contains the various sources from which data for the report has been collected which includes journals, articles and websites

MPBIRLAINSTITUTEOFMANAGEMENT

Page54

Chapter 3

Industry Profile

MPBIRLAINSTITUTEOFMANAGEMENT

Page55

3.1 Company Profile

Established in 1929, South Indian Bank (SIB) got its status of Scheduled Bank in 1946. In 1960, SIB expanded by taking over 15 smaller banks. Presently, it has a network of 391 branches and 50 extension counters, spread over 10 States and 2 Union Territories. Started as a private sector bank at Thrissur, a major town (now known as the Cultural Capital of Kerala) to provide for the people a safe, efficient and service oriented repository of savings of the community on one hand and to free the business community from the clutches of greedy money lenders on the other by providing need based credit at reasonable rates of interest. The bank in its 72 year long sojourn has been able to present itself as a vibrant, fast growing, service oriented and trend setting financial intermediary. In Dec. 1998, the Bank, for the first time made a public issue of 1,60,00,000 equity shares of Rs.10/- each at a premium of Rs.22/- per share. ICICI, the premier DFI is the biggest share holder of the Bank with the group company holding 11.38% of the banks equity. SIB was the first among the Kerala based banks to offer a Credit Card to customers in Nov. 1992. Further the bank also has develop an in-house, a fully integrated branch automation software. During 2000-2001 the new product introduced were 'Gold Rush Scheme' and 'Siber Loan', the former has been introduced for the benefit of traders and agriculturists while the latter has been introduced for the general public and students. The bank recently introduce FINACLE, an integrated, on-line enterprise banking solution designed to provide the 'e-platform' for global banking industry developed by INFOSYS. The Bank has joined hands with ICICI Prudential Ltd to market their life insurance products through the Bank's branch network. It has also signed MOU with the Prudential ICICI Asset Management Company Ltd to distribute their Mutual Fund products.

MPBIRLAINSTITUTEOFMANAGEMENT

Page56

During 2005-06, the company came out with a Public Offer of 2,27,27,272 equity shares of Rs.10/- each at a premium of Rs.56/- per share aggregating to Rs.150 Crores through bookbuilding route. ICICI Bank Ltd, a strategic investor in the bank made an exit from the bank by divesting its entire shareholding in March 2006. The Bank also became successful in changing its regional character into a national one by opening new branches in three more States. The Branch network now covers 19 States and Union Territories. During the current Fiscal 2005-2006, the Bank has opened 21 new branches and 11 new Extension counters. At Present the Bank's branch network stands at 450 branches and 45 extension counters. The Bank has an ATM Network of 145 centre with a card base of around 2,50,000. The Bank has also obtained RBI Permission to open one more Regional Office at Pathanamthitta, 18 new branches and 20 ATM centre which are expected to be opened in the current year. Vision Statement: To build a strong brand image to make the South Indian Bank technology driven, customer oriented and the most preferred bank, where passion for excellence is a way of life, innovation is a tradition, commitment to values is unshaken and customer loyalty is abiding, enabling the Bank to achieve an impressive all round, (but better than the peer group) business growth, build a healthy, qualitative and strong asset base and earn commensurate profits. Mission Statement: To become the most preferred and fastest growing among the Kerala based banks, with a strong brand image as customer focused, technology driven and an innovative bank with core competence in fostering relationship banking, garnering core deposits with accent on cost, creating and maintaining high yielding quality assets through focused marketing, qualitative appraisal and effective monitoring, ensuring a high level of internal efficiency through impeccable housekeeping and enhancing shareholder value by achieving the highest net profits amongst the peer group banks of Kerala. Milestones: The FIRST among the private sector banks in Kerala to become a scheduled bank in 1946 under the RBI Act.

MPBIRLAINSTITUTEOFMANAGEMENT

Page57

The FIRST bank in the private sector in India to open a Currency Chest on behalf of the RBI in April 1992. The FIRST private sector bank to open a NRI branch in November 1992. The FIRST bank in the private sector to start an Industrial Finance Branch in March 1993. The FIRST among the private sector banks in Kerala to open an "Overseas Branch" to cater exclusively to the export and import business in June 1993. The FIRST bank in Kerala to develop an in-house, a fully integrated branch automation software in addition to the in-house partial automation solution operational since 1992. The FIRST Kerala based bank to implement Core Banking System. The THIRD largest branch network among Private Sector banks, in India, with all its branches under Core banking System. Effect of Financial Crisis The major financial crisis of the 21st century involves esoteric instruments, unaware regulators, and nervous investors. Starting in the summer of 2007, the United States experienced a startling contraction in wealth, triggered by the sub prime crisis, thereby leading to increase in risk spreads, and decrease in credit market functioning. During boom years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks. Higher default levels, particularly among less credit-worthy borrowers, magnified the impact of the crisis on the financial sector. The same financial crisis, which started last summer, is back with a vengeance. Paul Krugman describes the analogy between credit lending between market players and the financial markets, and motor oil to car engines. The ability to raise cash on short notice, i.e. liquidity, is an essential lubricant for the markets and for the economy as a whole. The drying liquidity has closed shops of a large number of credit markets. Interest rates have been rising across the world, even rates at which banks lend to each other. The freezing up of the financial markets will ultimately lead to a severe reduction in the rate of lending, followed by

MPBIRLAINSTITUTEOFMANAGEMENT

Page58

slowed and drastically reduced business investments, leading to a recession, possibly a nasty one. A collapse of trust between market players has decreased the willingness of lending institutions to risk money. The major reason behind this lack of trust being the bursting of the housing bubble, which caused a lot of AAA labeled investments to turn out to be junk. The IMF has warned the global economy of a spiraled mortgage crisis, starting in the United States, ultimately leading to the largest financial shock since the Great Depression. Since 1864, American Banking has been split into commercial banks and investment banks. But now thats changing. Some of the biggest names on Wall Street, Bear Stearns, Lehman Brothers, and Merrill Lynch, have disappeared into thin air overnight. Goldman Sachs and Morgan Stanley are the only two giants left. Nervous investors have been sending markets plunging down. Even Morgan Stanley, one of the last two big independent investment banks on Wall Street, is struggling to survive at the exchange, though it insists that the company is still in solid shape. Markets all over the world are confronted by all-time low figures in the past couple of years or more, including those of Britain, Germany, and Asia. In India, IT companies, with nearly half of their revenues coming from banking and financial service segments, are close monitors of the financial crisis across the world. The IT giants which had Lehman Brothers and Merrill Lynch as their clients are TCS, Wipro, Satyam, and Infosys Technologies. HCL escaped the loss to a great extent because neither Lehman Brothers nor ML was its client. The government has a reason to worry because the ongoing financial crisis may have an adverse impact on the banks. Lehman Brothers and Merrill Lynch had invested a substantial amount in the stocks of Indian Banks, which in turn had invested the money in derivatives, leading to the exposure of even the derivates market to these investment bankers. The real estate sector is also affected due to the same factor. Lehman Brothers real estate partner had given Rs. 7.40 crores to Unitech Ltd., for its mixed use development project in Santa Cruz. Lehman had also signed a MoU with Peninsula Land Ltd, an Ashok Piramal real estate company, to fund the latters project amounting to Rs. 576 crores. DLF Assets, which holds an investment worth $200 million, is another major real estate organization whose valuations are affected by the Lehman Brothers dissolution.
MPBIRLAINSTITUTEOFMANAGEMENT Page59

Britain has also witnessed the so called bursting of the Brown bubble, in the form of the highest personal debt per capita in the G7 combined with an unsustainable rise in housing prices. The longest period of expansion in the 21st century, which Britain claimed to be ndergoing, eventually revealed itself of being an illusion. The illusion of rising to prosperity has been maintained by borrowing to spend, often in the form of equity withdrawal from increasing expensive houses. The bubble ultimately burst, exposing Britain to the most serious financial crisis since the 1920s. This brings a lot of misery for home owners who are set to see the cost of mortgages soar following the deepening of the banking crisis and the Libor the rate at which banks lend to each other. The impact of the crisis is more vividly observable in the emerging markets which are suffering from one of their biggest sell-offs. Everyone has exposure to everythingeither directly or indirectly, JP Morgan analyst, Brian Johnson Economies with disproportionate offshore borrowings (like that of Australia) are adversely affected by the western financial crunch. Globalization has ensured that none of the economies of the world stay insulated from the present financial crisis in the developed economies. Analysis of the impact of the crisis on India can be on the basis of the following 3 criteria: 1. Availability of global liquidity 2. Demand for India investment and cost thereof 3. Decreased consumer demand affecting Indian exports The main source of Indian prosperity was Foreign Direct Investment (FDI). American and European companies were bringing in truck-loads of dollars and Euros to get a piece of the pie of Indian prosperity. Less inflow of foreign investment will result in the dilution of the element of GDP driven growth. Liquidity is a major driving force of the strong market performances we have seen in emerging markets. Markets such as those of India are especially dependent on global liquidity and international risk appetite. While interest rates in some countries are increasing, countries such as Brazil are decreasing interest rates. In general, rising interest rates tend to have a negative impact on global liquidity and subsequently equity prices as fund may move into bonds and other money markets.
MPBIRLAINSTITUTEOFMANAGEMENT Page60

Indian companies which had access to foreign funds for financing their import and export will be worst hit Foreign funds will be available at huge premiums and will be limited only to the blue-chip companies, thus leading to: o Reduced capacity of expansion leading to supply side pressure o Increased interest rates to affect corporate profitability o Increased demand for domestic liquidity will put interest rates under pressure Consumer demand will face a slow-down in developed economies leading to a reduce demand for Indian goods and services, thus affecting Indian exports o Export oriented units will be worst hit, thus impacting employment o Widening of the trade gap due to reduced exports, leading to pressure on the rupee exchange rate Impact on Financial Markets: o Equity market will continue to remain in bearish mood o Demand for domestic liquidity will push interest rates high and as a result will lead to rupee depreciation and depleted currency reserves Every happy family is alike, but every unhappy family is unhappy in their own way. Leo Tolstoy. While each financial crisis is undoubtedly distinct, there are also striking similarities between them in growth patterns, debt accumulation, and in current account deficits.

MPBIRLAINSTITUTEOFMANAGEMENT

Page61

Chapter - 4

Analysis & Interpretation

MPBIRLAINSTITUTEOFMANAGEMENT

Page62

4.1 FINANCIAL OF SOUTH INDIAN BANK

PERFORMANCE OF SOUTH INDIAN BANK The performance highlights of the bank for the financial year ended 31st March 2008 are as follows:Rs. In Crores SR.NO. KEY PARAMETERS 2007-08 2006-07

1 2 3 4 5 6 7 8 9 10

Deposits Advances Total Business Net Profit Net Worth Capital Adequacy (%) Earning per share (in Rs.) Book Value per Share (in Rs.) Net NPA as % of Net Advances Return on Assets (%)

15156 10754 25910 151.62 1160.98 13.8 18.77* 128.43 0.33 1.01

12239 12239 20547 104.12 723.96 11.08 14.79 102.84 0.98 0.88

The bank has registered a record Net profit of Rs. 151.62 crore. The Bank could achieve this substantial improvement in Net profit mainly on account of higher scale of operations and aggressive NPA recoveries.

MPBIRLAINSTITUTEOFMANAGEMENT

Page63

4.2 OPERATING REVIEW- BUSINESS ACHIEVEMENT


DEPOSITS The Bank could increase its total deposits to Rs. 15156 crore from Rs. 12239 crore last year registering a growth of 23.83%

Break up of the deposits as on 31.03.2008 is as under SR.No. PARTICULAR AMOUNT (in Crores) 773.12 2875.72 11507.28 15156.12 % to Total Deposits 5.1 18.97 75.93 100

1 Current Deposits 2 Saving Deposits 3 Term Deposits TOTAL

ADVANCES:Total advances of the Bank stood at Rs. 10754.36 crore registering a growth of 29.45% from that of the previous year. Total Priority Sector Advances amounted to Rs. 3816.72 crore which is 45.94 % of the Adjusted Net Bank Credit (ANBC) as at the end of the previous year, sas against the target of 40% of the ANBC prescribed by Reserve Bank of India (RBI). Exposure to Agricultural sector amounted to Rs.1489.05 crore forming 17.92% of the ANBC as at the end of the previous year. Split-up of exposure under Priority Sector is furnished below: Amount (Rs. in crores) Agriculture & Allied Activities: (Including eligible RIDF investments) Small Enterprises: Other Priority Sector: Total Priority Sector Advances:
MPBIRLAINSTITUTEOFMANAGEMENT

1489.05

738.46 1589.21 3816.72


Page64

INVESTMENTS The financial year saw RBI continuing its tight monetary policy. During the year, RBI hiked Cash Reserve Ratio (CRR) by 125 basis points to 7.50% resulting in higher cost of funds to the Bank. Ten year benchmark yield at the beginning and end of the financial year remained unchanged at 7.93%. However during the course of the year, the ten-year yields had dropped to a low of 7.50%. The Stock markets showing a spectacular bull run upto December 2007 corrected very sharply during the last quarter of the financial year with index losing nearly 25% of its gains. The capital market also saw a number of companies coming out with Initial Public Offers (IPOs) to augment their capital base and to benefit from the growing confidence of the investors in the capital market during the earlier part of the year. The Bank actively participated in primary market issues which has generated good income. The trading profit during the year was Rs. 31.57 Crore by trading in equity, bonds, mutual funds, etc. During the financial year, the gross investments increased from Rs.3457.00 crore to Rs.4608.00 crore. The incremental investments were mainly due to increase in Statutory Liquidity\ Ratio (SLR) requirements and Non-SLR investments, which are yielding higher returns. NON-PERFORMING ASSETS (NPA) MANAGEMENT During the year 2007-08, the Bank had taken various steps for recovery of non-performing assets and thereby contain the growth of NPAs. Conduct of recovery camps, issue of notice under Securities and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI), one-time settlements, etc. were the major tools used by the Bank for NPA recovery. As a result of the various steps taken, the Bank could recover NPAs to the tune of Rs.172.31 crore during the year against the target of Rs. 130.00 crore. The Gross NPAs of the Bank as on 31.03.2008 were Rs.188.48 crore as against Rs.321.21 crore as on 31.03.2007. The percentage of Gross NPA to Gross Advances came down from 3.94% as on 31.03.2007 to 1.78% as on 31.03.2008.

MPBIRLAINSTITUTEOFMANAGEMENT

Page65

The most notable achievement in NPA management was that the Bank could reduce the percentage of net NPA to net Advances from 0.98% as on 31.03.2007 to 0.33% as on 31.03.2008. CAPITAL ADEQUACY SR.NO. ITEMS Capital to Risk Weighted Asset Ratio 1 (CRAR%) 2 CRAR- Tier I Capital (%) 3 CRAR- Tier II Capital (%) % of shareholding of GOI in Nationalised 4 Bank Amt of subordinated debt raised during the 5 year as Tier II Capital ( Rs in Lakhs NA NIL 31.03.2008 13.8 12.08 1.72 NA NIL 31.03.2007 11.08 8.84 2.24

BUSINESS RATIOS / INFORMATION SR.NO. ITEMS Interest Income as a percentage to working 1 funds Non- interest income as a percentage to 2 working funds Operating profit as a percentage to working 3 funds 4 Return on Assets Business( Deposits plus Advances) per 5 employee 6 Profit per employee (Rs. In Lakhs) 31.03.2008 8.70% 0.83% 1.80% 1.01% 600.00 3.59 31.03.2007 8.26% 0.87% 2.13% 0.88% 508.00 2.69

MPBIRLAINSTITUTEOFMANAGEMENT

Page66

NON PERFORMING NON-SLR INVESTMENT SR.NO. ITEMS Opening Balance Additions during the year since 1st April 2007/2006 Reductions during the above period Closing balance Total provisions held NA 100 1125.25 1045.25 31.03.2008 1225.25 31.03.2007 1517.89 200 492.64 1225.25 1135.25

Asset quality Percentage of net NPAs to net advances works out to 0.33% (0.98 % as on 31.03.2007). Provision for Non-Performing Advances and unrealised interest thereon are deducted from various categories of advances on a proportionate basis except the Provision for Standard Assets, which is included under "Other Liabilities".

MOVEMENTS IN NON PERFORMING ASSETS SR.NO. ITEMS 1 Net NPAs to Net Advances [%] 2 Movement of NPAs (Gross) (a) Opening Balance (b) Additions during the year (c) Reductions during the year (d) Closing Balance 3 Movement of NPAs (Net) (a) Opening Balance (b) Additions during the year (c) Reductions during the year
MPBIRLAINSTITUTEOFMANAGEMENT

2008 0.33

2007 0.98

32121 5795 19068 18848

32782 14434 15095 32121

7781 2627 7011

11820 8647 12686


Page67

(d) Closing Balance Movement of provisions for NPAs 4 (excluding provisions on standard assets) (a) Opening Balance (b) Additions during the year (c) Reductions during the year (d) Closing Balance

3397

7781

23247 1406 10342 14311

20025.06 8228.24 5006.3 23247

4.3 Financial Results 2008-09


The net profit of South Indian Bank has grown by 28 percent to Rs 194.75 crore ( Rs. 151.62 crore last year) for the year 2008-09. Despite the adverse economic environment prevailing over the economy in general and the financial sector in particular, the bank was able to surpass the profit targets set for the year. This performance reported by the bank is encouraging and it demonstrates our continuing commitment to delivering sustainable result Dr. V.A. Joseph, Managing Director andnCEO, said. The board has recommended a 20 % dividend. The bank had made a concerted effort to shore up the current and savings account portfolio during the year which resulted in the net interest margin improving from 2.62 per cent to 2.92 percent. The bank was able to add 6.5lakh new savings and current account deposits during the year. The banks aggregate business volumes surpassed the Rs 30,000 crore mark and touched Rs. 30, 327 crore Rs 18,902 crore by way of deposits and Rs. 12,145 crore in advances. The return on average assets improved from 1.01 per cent to 1.09 percent during the year.

MPBIRLAINSTITUTEOFMANAGEMENT

Page68

Sr.No.

PARTICULAR

2008-09 194.75 358.67 522.88 13.89 14.76 26056

2007-08 151.62 273.35 376.14 13.80 NA 18848

1 Net Profit 2 Operating Profit 3 Net Interest Income ii) Capital Adequacy Ratio 4 (%) a) BASEL I 5 BASEL II iv) NPA Ratios (a) Gross NPA Net NPA 7 8 (b) % of Gross NPA % of Net NPA 9 10 (c) Return on Assets

13431

3397

2.18 1.13

1.78 0.33

0.26 *

0.29 *

4.4 Comparison Comparison of banks on various parameters I analysed the above banks on various parameters to find out how they are placed in terms of business growth, efficiency and the comfort they provide in terms of their current financial standing and business exposures. The growth-related variables indicate the last 5-year CAGR banks achieved in advances and deposits. ICICI Bank was an out performer in Loan growth and Deposit growth compares to other banks.

MPBIRLAINSTITUTEOFMANAGEMENT

Page69

On efficiency-related parameters, the cost/income ratio, quality of advances and the extent of loan loss-loss provision coverage have been reviewed. South Indian Bank has lent out more of unsecured loan when compared to the total loan. Also, we analysed banks that generate the maximum core interest income as a proportion of total income. ICICI Bank and Axis Bank have greater proportions of their income coming from 'other income' and these segments might have greater tendency to show slower growth in the current scenario. A detailed analysis of the above parameters is presented in the ensuing paragraphs. GROWTH METRIC Loan Growth Comparison The chart below shows that the last 5years loan growth achieved by Indians Major Bank. HDFC Bank & ICICI Bank showed consistent growth over the last 3years( even though it shows slightly falling trend in the last 5years.)

100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0.00 HDFC BANK ICICI BANK AXIS BANK BANK OF BARODA SOUTH INDIAN BANK Series1 Series2 Series3 Series4

GROWTH METRIC- Deposit Growth CAGR In terms of deposit growth CAGR achieved by these banks during the last 5years, ICICIBANK and AXIS BANK retain top their deposit growth and showed a constant increase

MPBIRLAINSTITUTEOFMANAGEMENT

Page70

120.00 100.00 80.00 60.00 40.00 20.00 0.00 HDFC BANK ICICI BANK AXIS BANK BANK OF BARODA SOUTH INDIAN BANK Series1 Series2 Series3 Series4

Unsecured Loan as % of Total Loan Unsecured Loan primarily includes personal loans, credit card exposure, priority sector lending in rural areas, education loans, credits to SMEs( small and medium entrepreneurs) up to Rs. 5lakh, etc. Exposure of India Bank towards unsecured loan rose consistently over the years. As shown in the chart below, Bank of Baroda and South Indian Bank has the highest of its total loans exposed to unsecured loans.

70 60 50 40 30 20 10 0 1 2 3 4 5 HDFC BANK ICICI BANK AXIS BANK BOB SOUTH INDIAN BANK

Though there is no direct correlation between loan losses and unsecured loan exposure, in an economic slowdown scenario, such exposure will carry a greater stress, and hence, a higher probability of default. Banks need to be extremely vigilant in terms of monitoring these loans

MPBIRLAINSTITUTEOFMANAGEMENT

Page71

regularly, so that losses in the form of NPAs do not increase unreasonably and dent the quality of the loan book. However, a review of the gross NPA ratio, i.e., GNPA as a percentage of advances indicates that HDFC Bank & South Indian Bank have ensured that the NPA increase is proportionate to that of the loan growth. In fact, PSU banks have shown tremendous improvement in terms of loan quality, as the GNPA ratio for these banks fell from average 8-9% levels to less than 3% levels in the last 5 years. Only ICICI Bank has shown deterioration of its loan quality as reflected in its increasing GNPA ratio. The main reason for this increase is that the bank has substantial exposure to the retail segment, including huge exposure to the real estate segment at almost 36% of total loans that includes close to 30% exposure in the form of housing loans. The retail segment constitutes close to 75% of ICICI Bank's NPAs. GROSS NON PERFORMING ASSETS

8000 7000 6000 5000 4000 3000 2000 1000 0 1 2 3 4 5 HDFC BANK ICICI BANK AXIS BANK BANK OF BARODA SOUTH INDIAN BANK

COST INCOME RATIO In terms of control over costs, the below table explains cost/income ratios of these banks over the last 5 years. At the end of FY08, all banks have a similar cost/income ratio averaging between 30-25%.

MPBIRLAINSTITUTEOFMANAGEMENT

Page72

35 30 25 20 15 10 5 0 HDFC BANK ICICI BANK AXIS BANK BANK OF BARODA SOUTH INDIAN BANK Series1 Series2 Series3 Series4 Series5

4.5 Basel Report Framework and India


RISK MANAGEMENT AND BASEL II In the present volatile and rapidly changing financial scenario, it is very challenging for the banks to manage complex and variable risks in a disciplined manner. It is imperative to have good risk management practices not only to manage risks inherent in the banking business but also to face the risks emanating from financial markets as a whole. The Bank aims to put in place the best risk management structure which proactively identifies and helps in controlling the various risks faced by the Bank, while maintaining proper trade off between risk and return thereby maximising the shareholder value. The Bank's risk management structure is overseen by the Board of Directors and appropriate policies to manage various types of risk are approved by the sub committee of the Board. The subcommittee of the Board also provides strategic guidance while reviewing portfolio behaviour. Senior level Management Committees like Credit Risk Management Committee, Operational Risk Management Committee, Investment Committee, Asset Liability Management Committee, etc. develop and implement the risk policies.

BASEL II

MPBIRLAINSTITUTEOFMANAGEMENT

Page73

The growing concern and recognition of limitation of Basel I which largely ignored both the heterogeneity of the asset class and its differential risk sensitivity, led to the emergence of a new accord, Basel II. Basel II encompasses all three risks inherent in the business 1. Credit Risk 2. Market Risk 3. Operational Risk of which the most difficult and hence controversial part has been assessment , measurement and quantification of Operational Risk. CREDIT RISK The Bank is exposed to credit risks through its lending and investment activities. The credit risk management frameworks integrate both qualitative and quantitative processes to support growth in the asset book while ensuring an acceptable risk level in relation to the return. The aim of credit risk management in this year has been to maintain a healthy credit portfolio in the Bank. In line with the above goal, the Bank has strengthened its risk management processes by fine tuning its internal rating models for measuring credit risk and internal rating migration study to review the risk at the portfolio level and analyse the portfolio behaviour. As a measure towards credit risk mitigation, Bank has strengthened the Credit Sanction and Credit Monitoring departments by inducting more expert and experienced personnel. Credit risks inherent in investments in Non SLR Bonds are being assessed independently by Mid office Treasury using the internal rating models developed by Integrated Risk Management Department (IRMD). Minimum entry level rating for external and internal rating are prescribed in Investment Policy for investments in Non SLR Bonds. Moreover, to strengthen the risk management system, it is proposed that the internal rating done by mid offices shall be independently confirmed by IRMD in the proposed Market Risk Management (MRM) policy. MARKET RISK Market risk results from changes in market value of assets arising due to volatility of market risk factors and their probable impact on income and economic value for the aggregate banking and trading books, due to Asset- Liability mismatches. The Bank adopts a comprehensive approach to manage market risk for its trading and banking book. The market
MPBIRLAINSTITUTEOFMANAGEMENT Page74

risk framework identifies the types of market risks to be covered, the risk metrics and methodologies to be used to capture such risks and the standards governing the management of market risk including limit setting. Market risk measurement on portfolios uses both statistical and non-statistical measures to monitor risks with triggers in cases of breaches in the pre-accepted levels of identified risks. The Bank is also using Value at Risk measure, which provides valuable insights into the risk profile of the Bank's exposures. Regular stress testing is carried out to monitor the Bank's vulnerability to shocks and the impact of extreme market movements. Risk limits for trading book are set according to a number of criteria including market analysis, business strategy, management experience and the Bank's risk appetite. LIQUIDITY RISK Liquidity obligations of the Bank arise from withdrawal of deposits, repayment of purchased funds at maturity, extension of credit and working capital needs. The primary tool of monitoring liquidity is the mismatch analysis, which is monitored over successive time bands on a static basis. The liquidity profile of the Bank is also estimated on a more dynamic basis by considering the growth in deposits and advances, investments, etc, for a short term period of 90 days. Stress tests are conducted in periodic intervals to test the Bank's ability to meet the obligation in a crisis scenario and to assess the impact on the Bank's liquidity to withstand stressed conditions. These positions are reviewed periodically by the Bank's Asset Liability Management Committee. OPERATIONAL RISK A policy on management of operational risk has been approved by the Bank to ensure that the operational risk within the Bank is properly identified, monitored and reported in a structured manner. Bank's Operational Risk Management Committee oversees application of the above said policy directives. Each new product or service introduced is subject to risk review and sign-off process where all relevant risks are identified and assessed by departments independent of the risk taking unit proposing the product. The losses due to technical failures and business disruptions are mitigated through adequate back up facilities, the existence of disaster setup and regular testing rolled over by the Information Technology Division (ITD). The Bank has started computing capital charge under Basel II parallel run as required by RBI guidelines for Credit, Market and Operational risks from June 2006. Bank has fine tuned its
MPBIRLAINSTITUTEOFMANAGEMENT Page75

Basel II parallel run by adopting various credit risk mitigation strategies aided by improved MIS systems during the year which has improved the CRAR of the Bank under Basel II. Further, Bank had appointed a consultant during the year, who is experienced in the Risk Management and Basel II implementation to review risk management processes and the parallel run under Basel II adopted by the Bank. The consultants have completed their assignments and submitted their suggestions / recommendations on various areas of risk management during the year and the Bank is in the process of further fine-tuning the system based on the consultant's recommendations. The Bank has geared up to be Basel II compliant by 31.03.2009 as prescribed by RBI. Various risks in bank Interest Rate Risk (IRR) is the exposure of a Banks financial condition to adverse movements in interest rates. Banks have an appetite for this risk and use it to earn returns. IRR manifests itself in four different ways: re-pricing, yield curve, basis and embedded options. Pricing Risk is the risk to the banks financial condition resulting from adverse movements in the level or volatility of the market prices of interest rate instruments, equities, commodities and currencies. Pricing Risk is usually measured as the potential gain/loss in a position/portfolio that is associated with a price movement of a given probability over a specified time horizon. This measure is typically known as value-at risk (VAR). Foreign Currency Risk is pricing risk associated with foreign currency. The term Market Risk applies to (i) that part of IRR which affects the price of interest rate instruments, (ii) Pricing Risk for all other assets/portfolio that are held in the trading book of the bank and (iii) Foreign Currency Risk. Strategic Risk is the risk arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes. This risk is function of the compatibility of an organizations strategic goals, the business strategies developed to achieve those goals, the resources deployed against these goals, and the quality of implementation. Reputation risk is the risk arising from negative public opinion. This risk may expose the institution to litigation, financial loss, or a decline in customer base.
MPBIRLAINSTITUTEOFMANAGEMENT Page76

Transaction risk is the risk arising from fraud, both internal & external, failed business processes and the inability to maintain business continuity and manage information. Compliance risk is the risk of legal or regulatory sanctions, financial loss or reputation loss that a bank may suffer as a result of its failure to comply with any or all of the applicable laws, regulations, and codes of conduct and standards of good practice. It is also called integrity risk since a banks reputation is closely linked to its adherence to principles of integrity and fair dealing. Credit Risk is most simply defined as the potential of a bank borrower or counter-party to fail to meet its obligations in accordance with agreed terms. For most banks, loans are the largest and most obvious source of credit risk.

4.6 Banking Regulation and Supervision


The Need for Regulation Banking is one of the most heavily regulated businesses since it is a very highly leveraged (high debt-equity ratio or low capital-assets ratio) industry. In fact, it is an irony that banks, which constantly judge their borrowers on debt-equity ratio, have themselves a debt-equity ratio far too adverse than their borrowers! In simple words, they earn by taking risk on their creditors money rather than shareholders money. And since it is not their money (shareholders stake) on the block, their appetite for risk needs to be controlled. Goals and Tools for Bank Regulation and Supervision The main goal of all regulators is the stability of the banking system. However regulators cannot be concerned solely with the safety of the banking system, for if that was the only purpose, it would impose a narrow banking system, in which checkable deposits are fully backed by absolutely safe assets in the extreme, currency. Coexistent with this primary concern is the need to ensure that the financial system operates efficiently. As we have seen, banks need to take risks to be in business despite a probability of failure. In fact, Alan Greenspan puts it very succinctly, `providing institutions with the flexibility that may lead to failure is as important as permitting them the opportunity to succeed. The twin supervisory or regulatory goals of stability and efficiency of the financial system often seem to pull in opposite directions and there is much debate raging on the nature and extent of the trade-off

MPBIRLAINSTITUTEOFMANAGEMENT

Page77

between the two. Though very interesting, it is outside the scope of this report to elaborate upon. Instead, let us take a look at the list of some tools that regulators employ: Restrictions on bank activities and banking-commerce links: To avoid conflicts of interest that may arise when banks engage in diverse activities such as securities underwriting, insurance underwriting, and real estate investment. Restrictions on domestic and foreign bank entry: The assumption here is that effective screening of bank entry can promote stability. Capital Adequacy: Capital serves as a buffer against losses and hence also against failure. Capital adequacy is deemed to control risk appetite of the bank by aligning the incentives of bank owners with depositors and other creditors. Deposit Insurance: Deposit insurance schemes are to prevent widespread bank runs and to protect small depositors but can create moral hazard (which means in simple terms the propensity of both firms and individuals to take more risks when insured). Information disclosure & private sector monitoring: Includes certified audits and/or ratings from international rating agencies. Involves directing banks to produce accurate, comprehensive and consolidated information on the full range of their activities and risk management procedures. Government Ownership: The assumption here is that governments have adequate information and incentives to promote socially desirable investments and in extreme cases can transfer the depositors loss to tax payers! Government ownership can, at times, promote financing of politically attractive projects and not the economically efficient ones. Mandated liquidity reserves: To control credit expansion and to ensure that banks have a reasonable amount of liquid assets to meet their liabilities. Loan classification, provisioning standards & diversification guidelines: These are controls to manage credit risk. Unfortunately, however, there is no evidence that any universal set of best practices is appropriate for promoting well-functioning banks; that successful practices in the United States, for example, will succeed in countries with different institutional settings; or that detailed regulations and supervisory practices should be combined to produce an extensive checklist of best practices in which more checks are better than fewer. There is no broad cross-country evidence on which of the many different regulations and supervisory
MPBIRLAINSTITUTEOFMANAGEMENT Page78

practices employed around the world work best, if at all, to promote bank development and stability.

4.7The Basel I Accord


Basel Committee on Banking Supervision (BCBS) On 26th June 1974, a number of banks had released Deutschmarks to Bank Herstatt in Frankfurt in exchange for dollar payments that were to be delivered in New York. Due to differences in time zones, there was a lag in dollar payments to counter-party banks during which Bank Herstatt was liquidated by German regulators, i.e. before the dollar payments could be affected. The Herstatt accident prompted the G-10 countries (the G-10 is today 13 countries: Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States) to form, towards the end of 1974, the Basel Committee on Banking Supervision (BCBS), under the auspices of the Bank for International Settlements (BIS), comprising of Central Bank Governors from the participating countries. BCBS has been instrumental in standardizing bank regulations across jurisdictions with special emphasis on defining the roles of regulators in cross-jurisdictional situations. The committee meets four times a year. It has around 30 technical working groups and task forces that meet regularly. 1988 Basel Accord In 1988, the Basel Committee published a set of minimal capital requirements for banks, known as the 1988 Basel Accord. These were enforced by law in the G-10 countries in 1992, with Japanese banks permitted an extended transition period. The 1988 Basel Accord focused primarily on credit risk. Bank assets were classified into five risk buckets i.e. grouped under five categories according to credit risk carrying risk weights of zero, ten, twenty, fifty and one hundred per cent. Assets were to be classified into one of these risk buckets based on the parameters of counter-party (sovereign, banks, public sector enterprises or others), collateral (e.g. mortgages of residential property) and maturity. Generally, government debt was categorised at zero per cent, bank debt at twenty per cent, and other debt at one hundred per cent. 100%. OBS exposures such as performance guarantees and letters of credit were brought into the calculation of risk weighted assets using
MPBIRLAINSTITUTEOFMANAGEMENT Page79

the mechanism of variable credit conversion factor. Banks were required to hold capital equal to 8% of the risk weighted value of assets. Since 1988, this framework has been progressively introduced not only in member countries but also in almost all other countries having active international banks. The 1988 accord can be summarized in the following equation: Total Capital = 0.08 x Risk Weighted Assets (RWA) The accord provided a detailed definition of capital. Tier 1 or core capital, which includes equity and disclosed reserves, and Tier 2 or supplementary capital, which could include undisclosed reserves, asset revaluation reserves, general provisions & loanloss reserves, hybrid (debt/equity) capital instruments and subordinated debt. Value at Risk (VAR) VAR is a method of assessing risk that uses standard statistical techniques and provides users with a summary measure of market risk. For instance, a bank might say that the daily VAR of its trading portfolio is rupees 20 million at the 99 per cent confidence level. In simple words, there is only one chance in 100, under normal market conditions, for a loss greater than rupees 20 million to occur. This single number summarizes the bank's exposure to market risk as well as the probability (one per cent, in this case) of it being exceeded. Shareholders and managers can then decide whether they feel comfortable at this level of risk. If not, the process that led to the computation of VAR can be used to decide where to trim risk. Now the definition; VAR summarizes the predicted maximum loss (or worst loss) over a target horizon within a given confidence interval. Target horizon means the period till which the portfolio is held. Ideally, the holding period should correspond to the longest period needed for an orderly (as opposed to a `fire sale) portfolio liquidation. Without going into the related math, it should be mentioned here that there exist three methods of computing VAR, viz. Delta-Normal, Historical Simulation and Monte Carlo Simulation, the last one being the most computation intensive and predictably the most sophisticated one. In a lighter vein, a definition of VAR that was found at the gloriamundi.org web site said, `A number invented by purveyors of panaceas for pecuniary peril intended to mislead senior
MPBIRLAINSTITUTEOFMANAGEMENT Page80

management and regulators into false confidence that market risk is adequately understood and controlled. 1996 Amendment to include Market Risk In 1996, BCBS published an amendment to the 1988 Basel Accord to provide an explicit capital cushion for the price risks to which banks are exposed, particularly those arising from their trading activities. This amendment was brought into effect in 1998. Salient Features Allows banks to use proprietary in-house models for measuring market risks. Banks using proprietary models must compute VAR daily, using a 99th percentile, one tailed confidence interval with a time horizon of ten trading days using a historical observation period of at least one year. The capital charge for a bank that uses a proprietary model will be the higher of the previous day's VAR and three times the average of the daily VAR of the preceding sixty business days. Use of `back-testing (ex-post comparisons between model results and actual performance) to arrive at the `plus factor that is added to the multiplication factor of three. Allows banks to issue short-term subordinated debt subject to a lock-in clause (Tier 3 capital) to meet a part of their market risks. Alternate standardized approach using the `building block approach where general market risk and specific security risk are calculated separately and added up. Banks to segregate trading book and mark to market all portfolio/position in the trading book. Applicable to both trading activities of banks and non-banking securities firms.

MPBIRLAINSTITUTEOFMANAGEMENT

Page81

Evolution of Basel Committee Initiatives

The Basel I Accord and the 1996 Amendment thereto have evolved into Basel II, as depicted in the figure above.

4.8 The New Accord (Basel II)


Close on the heels of the 1996 amendment to the Basel I accord, in June 1999 BCBS issued a proposal for a New Capital Adequacy Framework to replace the 1988 Accord. The proposed capital framework consists of three pillars: minimum capital requirements, which seek to refine the standardised rules set forth in the 1988 Accord; supervisory review of an institution's internal assessment process and capital adequacy; and effective use of disclosure to strengthen market discipline as a complement to supervisory efforts. The accord has been finalized recently on 11th May 2004 and the final draft is expected by the end of June 2004. For banks adopting advanced approaches for measuring credit and operational risk the deadline has been shifted to 2008, whereas for those opting for basic approaches it is retained at 2006.

MPBIRLAINSTITUTEOFMANAGEMENT

Page82

The Need for Basel II The 1988 Basel I Accord has very limited risk sensitivity and lacks risk differentiation (broad brush structure) for measuring credit risk. For example, all corporations carry the same risk weight of 100 per cent. It also gave rise to a significant gap between the regulatory measurement of the risk of a given transaction and its actual economic risk. The most troubling side effect of the gap between regulatory and actual economic risk has been the distortion of financial decision-making, including large amounts of regulatory arbitrage, or investments made on the basis of regulatory constraints rather than genuine economic opportunities. The strict rule based approach of the 1988 accord has also been criticised for its `one size fits all prescription. In addition, it lacked proper recognition of credit risk mitigants such as credit derivatives, securitisation, and collaterals. The recent cases of frauds, acts of terrorism, hacking, have brought into focus the operational risk that the banks and financial institutions are exposed to. The proposed new accord (Basel II) is claimed by BCBS to be `an improved capital adequacy framework intended to foster a strong emphasis on risk management and to encourage ongoing improvements in banks risk assessment capabilities. It also seeks to provide a `level playing field for international competition and attempts to ensure that its implementation maintains the aggregate regulatory capital requirements as obtaining under the current accord. The new framework deliberately includes incentives for using more advanced and sophisticated approaches for risk

MPBIRLAINSTITUTEOFMANAGEMENT

Page83

measurement and attempts to align the regulatory capital with internal risk measurements of banks subject to supervisory review and market disclosure. PILLAR I: Minimum Capital Requirements There is a need to look at proposed changes in the measurement of credit risk and operational risk

Credit Risk Three alternate approaches for measurement of credit risk have been proposed. These are: Standardised Internal Ratings Based (IRB) Foundation Internal Ratings Based (IRB) Advanced The standardised approach is similar to the current accord in that banks are required to slot their credit exposures into supervisory categories based on observable characteristics of the exposures (e.g. whether the exposure is a corporate loan or a residential mortgage loan). The standardised approach establishes fixed risk weights corresponding to each supervisory category and makes use of external credit assessments to enhance risk sensitivity compared
MPBIRLAINSTITUTEOFMANAGEMENT Page84

to the current accord. The risk weights for sovereign, inter-bank, and corporate exposures are differentiated based on external credit assessments. An important innovation of the standardised approach is the requirement that loans considered `past due be risk weighted at 150 per cent unless, a threshold amount of specific provisions has already been set aside by the bank against that loan. Credit risk mitigants (collaterals, guarantees, and credit derivatives) can be used by banks under this approach for capital reduction based on the market risk of the collateral instrument or the threshold external credit rating of recognised guarantors. Reduced risk weights for retail exposures, small and medium size enterprises (SME) category and residential mortgages have been proposed. The approach draws a number of distinctions between exposures and transactions in an effort to improve the risk sensitivity of the resulting capital ratios. The IRB approach uses banks internal assessments of key risk drivers as primary inputs to the capital calculation. The risk weights and resultant capital charges are determined through the combination of quantitative inputs provided by banks and formulae specified by the Committee. The IRB calculation of risk weighted assets for exposures to sovereigns, banks, or corporate entities relies on the following four parameters: Probability of default (PD), which measures the likelihood that the borrower will default over a given time horizon. Loss given default (LGD), which measures the proportion of the exposure that will be lost if a default occurs. Exposure at default (EAD), which for loan commitment measures the amount of the facility that is likely to be drawn in the event of a default. Maturity (M), which measures the remaining economic maturity of the exposure. Operational Risk Within the Basel II framework, operational risk is defined as the risk of losses resulting from inadequate or failed internal processes, people and systems, or external events.

MPBIRLAINSTITUTEOFMANAGEMENT

Page85

Operational risk identification and measurement is still in an evolutionary stage as compared to the maturity that market and credit risk measurements have achieved. As in credit risk, three alternate approaches are prescribed: Basic Indicator Standardised Advanced Measurement (AMA) PILLAR 2: Supervisory Review Process Pillar 2 introduces two critical risk management concepts: the use of economic capital, and the enhancement of corporate governance, encapsulated in the following four principles: Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels. The key elements of this rigorous process are: Board and senior management attention; Sound capital assessment; Comprehensive assessment of risks; Monitoring and reporting; and Internal control review. Principle 2: Supervisors should review and evaluate banks internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process. This could be achieved through: On-site examinations or inspections; Off-site review;
MPBIRLAINSTITUTEOFMANAGEMENT Page86

Discussions with bank management; Review of work done by external auditors; and Periodicreporting. Principle 3: Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum. Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored. Prescriptions under Pillar 2 seek to address the residual risks not adequately covered under Pillar 1, such as concentration risk, interest rate risk in banking book, business risk and strategic risk. `Stress testing is recommended to capture event risk. Pillar 2 also seeks to ensure that internal risk management process in the banks is robust enough. The combination of Pillar 1 and Pillar 2 attempt to align regulatory capital with economic capital. PILLAR 3: Market Discipline The focus of Pillar 3 on market discipline is designed to complement the minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2). With this, the Basel Committee seeks to enable market participants to assess key information about a banks risk profile and level of capitalizationthereby encouraging market discipline through increased disclosure. Public disclosure assumes greater importance in helping banks and supervisors to manage risk and improve stability under the new provisions which place reliance on internal methodologies providing banks with greater discretion in determining their capital needs. There has been some confusion on the extent, medium, confidentiality and materiality of such disclosures. It has been agreed that such disclosures will depend on the legal authority and accounting standards existing in each country. Efforts are in progress to harmonise these disclosures with International Financial Reporting Standards (IFRS) Board Standards (International Accounting Standards 30 & 32).

MPBIRLAINSTITUTEOFMANAGEMENT

Page87

Chapter - 5
Findings, Conclusion And Suggestions

MPBIRLAINSTITUTEOFMANAGEMENT

Page88

The issue of Non-Performing Assets (NPAs) in the financial sector has been an area of concern for all economies and reduction in NPAs has become synonymous with functional efficiency of financial intermediaries. Although NPAs are a balance sheet issue of individual banks and financial institutions, it has wider macroeconomic implications. It is important that, if resolution strategies for recovery of dues from NPAs are not put in place quickly and efficiently, these assets would deteriorate in value over time and only scrap value would be realized at the end. It should, however, be kept in mind that NPAs are an integral part of the business financial sector and the players are in as they are in the business of taking risk and their earnings reflect the risk they take. They operate in an environment, where there would be defaults as well as deterioration in portfolio value, as market movements can never be predicted with certainty. It is in this context, that countries have adopted regulatory measures and the guiding structure has been provided by the Basel guidelines. There are various reasons for assets turning non-performing and there can be alternative resolution strategies. Identification of the reasons and timely action are the key to improved profitability of financial sector intermediaries. In this context, the details of the CAMEL model that RBI introduced for evaluating performance of banks and the need for this arose from the systemic generation of large volume of NPAs. CAMEL covers capital adequacy, asset quality, management quality, earnings ability and liquidity.

MPBIRLAINSTITUTEOFMANAGEMENT

Page89

Indian economy and NPAs Undoubtedly the world economy has slowed down, recession is at its peak, globally stock markets have tumbled and business itself is getting hard to do. The Indian economy has been much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system, cutting of exposures to emerging markets by FIIs, etc. Further, international rating agencies like, Standard & Poor have lowered India's credit rating to sub-investment grade. Such negative aspects have often outweighed positives such as increasing forex reserves and a manageable inflation rate. Under such a situation, it goes without saying that banks are no exception and are bound to face the heat of a global downturn. One would be surprised to know that the banks and financial institutions in India hold non-performing assets worth Rs. 1, 10,000 Crores. Bankers have realized that unless the level of NPAs is reduced drastically, they will find it difficult to survive. Global Developments and NPAs The core banking business is of mobilizing the deposits and utilizing it for lending to industry. Lending business is generally encouraged because it has the effect of funds being transferred from the system to productive purposes which results into economic growth. However lending also carries credit risk, which arises from the failure of borrower to fulfill its contractual obligations either during the course of a transaction or on a future obligation. A question that arises is how much risk can a bank afford to take ? Recent happenings in the business world - Enron, WorldCom, Xerox, Global Crossing do not give much confidence to banks. In case after case, these giant corporates became bankrupt and failed to provide investors with clearer and more complete information thereby introducing a degree of risk that many investors could neither anticipate nor welcome. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit risk. Due to this, banks are restricting their lending operations to secured avenues only with adequate collateral on which to fall back upon in a situation of default. Performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing NPAs have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at the same time banks are forced to make
MPBIRLAINSTITUTEOFMANAGEMENT Page90

provision on such assets as per the Reserve Bank of India (RBI) guidelines. Reserve Bank of India (RBI) has issued guidelines on provisioning requirement with respect to bank advances. In terms of these guidelines, bank advances are mainly classified into: Standard Assets: Such an asset is not a non-performing asset. In other words, it carries not more than normal risk attached to the business. Sub-standard Assets: Which has remained NPA for a period less than or equal to 12 months. Doubtful Assets: This has remained in the sub-standard category for a period of 12 months Loss Assets: Here loss is identified by the banks concerned or by internal auditors or by external auditors or by Reserve Bank India (RBI) inspection. In terms of RBI guidelines, as and when an asset becomes a NPA, such advances would be first classified as a sub-standard one for a period that should not exceed 12 months and subsequently as doubtful assets. It should be noted that the above classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet. Provision Standard Assets general provision of a minimum of 0.25% Substandard Assets 10% on total outstanding balance, 10 % on unsecured exposures identified as sub-standard & 100% for unsecured doubtful assets. Doubtful Assets 100% to the extent advance not covered by realizable value of security. In case of secured portion, provision may be made in the range of 20% to 100% depending on the period of asset remaining sub-standard Loss Assets 100% of the outstanding

MPBIRLAINSTITUTEOFMANAGEMENT

Page91

FINDINGS:Management of NPA
During initial sage the percentage of NPA was higher. This was due to show ineffective recovery of bank credit, lacuna in credit recovery system, inadequate legal provision etc. Various steps have been taken by the government to recover and reduce NPAs. Some of them are. Formation of the Credit Information Bureau (India) Limited (CIBIL) Release of Wilful Defaulters List. RBI also releases a list of borrowers with aggregate outstanding of Rs.1 crore and above against whom banks have filed suits for recovery of their funds Reporting of Frauds to RBI Norms of Lenders Liability framing of Fair Practices Code with regard to lenders liability to be followed by banks, which indirectly prevents accounts turning into NPAs on account of banks own failure Risk assessment and Risk management RBI has advised banks to examine all cases of wilful default of Rs.1 crore and above and file suits in such cases. Board of Directors are required to review NPA accounts of Rs.1 crore and above with special reference to fixing of staff accountability. Reporting quick mortality cases Special mention accounts for early identification of bad debts. Loans and advances overdue for less than one and two quarters would come under this category. However, these accounts do not need provisioning

NPA MANAGEMENT - RESOLUTION


Compromise Settlement Schemes Restructuring / Reschedulement

MPBIRLAINSTITUTEOFMANAGEMENT

Page92

Lok Adalat Corporate Debt Restructuring Cell Debt Recovery Tribunal (DRT) Proceedings under the Code of Civil Procedure Board for Industrial & Financial Reconstruction (BIFR)/ AAIFR National Company Law Tribunal (NCLT) Sale of NPA to other banks Sale of NPA to ARC/ SC under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SRFAESI) The description of these points is as below 1. Restructuring and Rehabilitation a. Banks are free to design and implement their own policies for restructuring/ rehabilitation of the NPA accounts b. Reschedulement of payment of interest and principal after considering the Debt service coverage ratio, contribution of the promoter and availability of security 2. Corporate Debt Restructuring a. The objective of CDR is to ensure a timely and transparent mechanism for restructuring of the debts of viable corporate entities affected by internal and external factors, outside the purview of BIFR, DRT or other legal proceedings b. The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All participants in the CDR mechanism must enter the ICA with necessary enforcement and penal clauses. c. The scheme applies to accounts having multiple banking/ syndication/ consortium accounts with outstanding exposure of Rs.10 crores and above.

MPBIRLAINSTITUTEOFMANAGEMENT

Page93

d. The CDR system is applicable to standard and sub-standard accounts with potential cases of NPAs getting a priority. e. Packages given to borrowers are modified time & again f. Drawback of CDR Reaching of consensus amongst the creditors delays the process DRT Act a. The banks and FIs can enforce their securities by initiating recovery proceeding under the Recovery if Debts due to Banks and FI act, 1993 (DRT Act) by filing an application for recovery of dues before the Debt Recovery Tribunal constituted under the Act. b. On adjudication, a recovery certificate is issued and the sale is carried out by an auctioneer or a receiver. c. DRT has powers to grant injunctions against the disposal, transfer or creation of third party interest by debtors in the properties charged to creditor and to pass attachment orders in respect of charged properties d. In case of non-realization of the decreed amount by way of sale of the charged properties, the personal properties if the guarantors can also be attached and sold. e. However, realization is usually time-consuming f. Steps have been taken to create additional benches 3. Proceeding under Code of Civil Procedure a. For claims below Rs.10 lacs, the banks and FIs can initiate proceedings under the Code of Civil Procedure of 1908, as amended, in a Civil court. b. The courts are empowered to pass injunction orders restraining the debtor through itself or through its directors, representatives, etc from disposing of, parting with or dealing in any manner with the subject property. c. Courts are also empowered to pass attachment and sales orders for subject property before judgment, in case necessary. d. The sale of subject property is normally carried out by way of open public auction subject to confirmation of the court.
MPBIRLAINSTITUTEOFMANAGEMENT Page94

e. The foreclosure proceedings, where the DRT Act is not applicable, can be initiated under the Transfer of Property Act of 1882 by filing a mortgage suit where the procedure is same as laid down under the CPC. BIFR AND AAIFR a. BIFR has been given the power to consider revival and rehabilitation of companies under the Sick Industrial Companies (Special Provisions) Act of 1985 (SICA), which has been repealed by passing of the Sick Industrial Companies (Special Provisions) Repeal Bill of 2001. b. The board of Directors shall make a reference to BIFR within sixty days from the date of finalization of the duly audited accounts for the financial year at the end of which the company becomes sick c. The company making reference to BIFR to prepare a scheme for its revival and rehabilitation and submit the same to BIFR the procedure is same as laid down under the CPC. d. The shelter of BIFR misused by defaulting and dishonest borrowers e. It is a time consuming process 4. SALE OF NPA TO OTHER BANKS a. A NPA is eligible for sale to other banks only if it has remained a NPA for at least two years in the books of the selling bank b. The NPA must be held by the purchasing bank at least for a period of 15 months before it is sold to other banks but not to bank, which originally sold the NPA. c. The NPA may be classified as standard in the books of the purchasing bank for a period of 90 days from date of purchase and thereafter it would depend on the record of recovery with reference to cash flows estimated while purchasing d. The bank may purchase/ sell NPA only on without recourse basis e. If the sale is conducted below the net book value, the short fall should be debited to P&L account and if it is higher, the excess provision will be utilized to meet the loss on account of sale of other NPA.
MPBIRLAINSTITUTEOFMANAGEMENT Page95

5. SARFESI Act 2002 a. SARFESI provides for enforcement of security interests in movable (tangible or intangible assets including accounts receivable) and immovable property without the intervention of the court b. The bank and FI may call upon the borrower by way of a written legal notice to discharge in full his liabilities within 60 days from the date of notice, failing which the bank would be entitled to exercise all or any of the rights set out under the Act. c. Another option available under the Act is to takeover the management of the secured assets d. Any person aggrieved by the measures taken by the bank can proffer an appeal to DRT within 45 days after depositing 75% of the amount claimed in the notice. e. Chapter II of SARFESI provides for setting up of reconstruction and securitization companies for acquisition of financial assets from its owner, whether by raising funds by such company from qualified institutional buyers by issue of security receipts representing undivided interest in such assets or otherwise. f. The ARC can takeover the management of the business of the borrower, sale or lease of a part or whole of the business of the borrower and rescheduling of payments, enforcement of security interest, settlement of dues payable by the borrower or take possession of secured assets g. Additionally, ARCs can act as agents for recovering dues, as manager and receiver. h. Drawback differentiation between first charge holders and the second charge holders Second Amendment & SARFESI a. The second amendment and SARFESI are a leap forward but requirement exists to make the laws predictable, transparent and affordable enforcement by efficient mechanisms outside of insolvency b. No definite time frame has been provided for various stages during the liquidation proceedings c. Need is felt for more creative and commercial approach to corporate entities in financial distress and attempts to revive rather than applying conservative approach of liquidation
MPBIRLAINSTITUTEOFMANAGEMENT Page96

d. Tribunals have largely failed to serve the purpose for which they were set up. NCLT would be over-burdened with workload. Change in eligibility criteria for making a reference would itself generate a greater workload. e. The second amendment stops short of providing a comprehensive bankruptcy code to deal with corporate bankruptcy. f. Does not introduce the required roadmap of the bankruptcy proceeding viz: Application for initiating Appointments & empowerment of trustee Operational and functional independence Accountability to court Monitoring and time bound restructuring Mechanism to sell off Number of time bound attempts for restructuring Decision to pursue insolvency and winding up Strategies for realization and distribution g. Need for new laws & procedures to handle bankruptcy proceedings in consultation with RBI Perceived Impact Adapting to Basel II will be more demanding for some institutions than for others, based on factors including current risk management practices, business size, geographical spread, risk types, specific business, portfolio, and market conditions

MPBIRLAINSTITUTEOFMANAGEMENT

Page97

Impact on various entities in financial markets Apart from banks and regulators, who are directly affected by Basel II, customers, rating agencies, capital markets and other financial companies (outside the scope of Basel II) will also be affected. Banks will have to implement an enterprise-wide risk management framework, which will entail establishing relevant processes and gathering, integrating and analysing large amount of data. Using quantitative methods to manage risk - and to deploy capital based on risks - requires high quality and high frequency data. Customers will find that they have to cope with increased demands for timely information from banks that are on IRB approaches. Risk-based pricing of credit products will become the norm as banks begin differentiating customers as per their risk profiles. Riskier borrowers are likely to find their borrowing costs going up and/or credit lines tightened up. Rating agencies may face more competition as themarket for them will expand and deepen, which will be a driver for them to be more transparent in their rating process. Good quality rated corporates will prefer capital markets to banks for their funding. Securitisation and credit derivatives will increasingly be used as credit risk hedging tools. Basel II is also likely to impact financial institutions that do not have to comply with it. Nonbanking corporations such as credit card companies, leasing companies, auto manufacturers and financiers, or retailers financing arms may not have to fulfill the potentially extensive disclosure requirements prescribed by Basel II nor make investments in managing operational risk, which will put them at a competitive advantage vis--vis banks. Impact on emerging markets and smaller banks In an attempt to assess the impact of Pillar 1 requirements of capital adequacy, BCBS did undertake a few quantitative impact surveys (QIS), the last of which is referred to as QIS- 3. The results indicated that, in general, banks required capital will decrease with respect to credit risks and increase with respect to operational risks. However, in Asia and other emerging markets, several factors may raise the required capital even for credit risks, as real estate continues to be widely used as collateral for business loans, and the standardised approach, which is the most likely approach for many banks, places a 150 per cent risk weight on non-performing loans. Basel II will increase the level of capital that is required for banking institutions in the emerging markets, mainly owing to the new operational risk charge, which will be higher if the basic indicator approach is used. By application of
MPBIRLAINSTITUTEOFMANAGEMENT Page98

differential risk weights on the basis of sovereign rating as a benchmark, the capital inflows in emerging markets could be seriously affected as most of the borrowers in such markets will be categorised under the speculative grade. Smaller banks would find the investments on Basel II compliance too big for their existing budgets. Implications for India The official position of the Reserve Bank of India (RBI), as emphasized in its response to CP3 of BCBS, is as follows, `In its (Basel II) attempt to strive for more accurate measure of risks in banks, the simplicity of the present Capital Accord is proposed to be replaced, with a highly complex methodology which needs the support of highly sophisticated MIS / data processing capabilities. The complexity and sophistication essential for banks for implementing the new capital accord restricts its universal application in the emerging markets. RBI had also suggested that a common definition of `internationally active banks be provided by BCBS. Even the United States of America is not adopting the new accord for all of its banks. But, in the same response, RBI has also affirmed that it is `fully committed to implement the best international practices.

The response from the Indian banking industry is equally positive. `Indian Banks are not averse to making the investment of the effort to embrace global practices, asserts V. Leeladhar, chairman, Indian Banks Association (IBA) and chairman and managing director, Union Bank of India. H.N. Sinor, chief executive officer, IBA, adds `Basel II is a reality that no progressive country can afford to ignore. It provides an opportunity for global integration and ushering in international best practices. Viewed against these brave words from the major Indian banks, the Indian regulator RBI, appears to be more cautious and pragmatic, holding a view that `Banks in emerging markets would, therefore, face serious implementation challenges due to lack of adequate technical skills, under development of financial markets, structural rigidities and less robust legal systems. Besides banks, supervisors would be required to invest considerable resources in upgrading technology systems, and human resources to meet the minimum standards. Having successfully implemented the 1988 Basel Accord, the Indian banking industry is poised to implement the 1996 Amendment for inclusion of market risk in capital adequacy calculations this year. Sinor expects Indian banks to eventually embrace Basel II, albeit slowly and without making noises. Supporting the phased approach taken by RBI with respect to Basel II, Sinor feels
MPBIRLAINSTITUTEOFMANAGEMENT Page99

that `the new accord provides incentives to banks for improving their credit portfolio through risk management. Leeladhar expresses confidence that `in any event, banks will reap the benefits of improved systems and efficiency in the long term. Initially, banks in India will have to adopt the standardised approach (possibly the simplified one) for credit risk, and the basic indicator approach for operational risk calculations. RBI had done a selective impact study last year using these approaches on data sourced from seven major banks. The results of both the RBI study and the QIS-3, suggest an increase of one to two per cent on account of credit risk and eleven per cent on account of operational risk, in the minimum capital requirements, moving from Basel I to Basel II. Kapoor provides the roadmap, saying `Most (Indian) banks are likely to start with simpler, elementary approaches, just adequate to ensure compliance to Basel II norms and gradually adopt more sophisticated approaches. The continued regulatory challenge will be to migrate to Basel II in a non-disruptive manner. Competitive compulsions will ensure that banks make the necessary investments in the appropriate technology and qualified, experience professionals to adopt advanced approaches. `The new accord will reward those banks that use a more sophisticated IRB approach to measure and manage risk. Counters Niall S.K. Booker, chief executive officer, HSBC India and chairman of the IBA Committee on Basel II, `There is the possibility that in international markets access may be easier and costs less for banks adopting a more sophisticated approach.however in a market like India it seems likely that the large domestic players will continue to play a very significant role regardless of the model used. Meanwhile, Leeladhar is hopeful that banks will ultimately adopt the IRB approach for credit risk. The additional capital charge on account of operational risk is considered `harsh by bankers and software suppliers unanimously. But all of them agree that it will benefit banks in the long term by making them sensitive to operational risk. Sinor hopes that the operational risk charge will eventually be calibrated down as the implementation progresses. It is generally agreed the implementation of Basel II is likely to provide momentum for mergers and acquisitions in the Indian banking industry. Shenoy thinks that `The higher disclosure requirements in the banking sector might lead to a growing tendency towards structural changes in the form of mergers and acquisitions. Kapoor provides another reason, saying `as more and more banks move towards the advanced approaches, the gap between the

MPBIRLAINSTITUTEOFMANAGEMENT

Page100

strong and weak banks will increase further, making the weaker banks potential takeover targets Here are a few excerpts, which describe RBIs current approach: `We are now not debating whether to go forward with BaselII but how to implement Basel II. In fact, understanding Basel II concepts is one step away from agreeing to it in principle. Implementing Basel II is another long step away from understanding it. `RBIs approach to the institution of prudential norms has been one of gradual convergence with international standards and best practices with suitable country specific adaptations. Our aim has been to reach global best standards in a deliberately phased manner through a consultative process evolved within the country. RBI had in April 2003 itself accepted in principle to adopt the new capital accord. `RBI has announced, in its Annual Policy statement in May 2004 that banks in India should examine in depth the options available under Basel II and draw a road-map by end December 2004 for migration to Basel II and review the progress made thereof at quarterly intervals. `At a minimum all banks in India, to begin with, will adopt Standardized Approach for credit risk and Basic Indicator Approach for operational risk. After adequate skills are developed, both in banks and at supervisory levels, some banks may be allowed to migrate to IRB Approach. `India has three established rating agencies in which leading international credit rating agencies are stakeholders. However, the level of rating penetration is not very significant as, so far, ratings are restricted to issues and not issuers. Encouraging ratings of issuers would be a challenge. `Basel II could actually imply that the minimum requirements could become procyclical. No doubt prudent risk management policies and Pillars II and III would help in overall stability. We feel that it would be preferable to have consistent prudential norms in good and bad times rather than calibrate prudential norms to counter pro-cyclicality.

MPBIRLAINSTITUTEOFMANAGEMENT

Page101

`Banks adopting IRB Approach will be much more risk sensitive than the banks on Standardised Approach, (so) the banks on Standardised Approach could be inclined to assume exposures to high risk clients, which were not financed by IRB banks. Due to concentration of higher risks, Standardised Approach banks can become vulnerable at times of economic downturns. `Keeping in view the cost of compliance for both banks and supervisors, the regulatory challenge would be to migrate to Basel II in a non-disruptive manner. We would like to continue the process of interaction with other countries to learn from their experiences. Criticism of Basel 2 accord Before we set out to list the concerns that have been voiced against Basel II, we must acknowledge the fact that any attempt to regulate the complexity that current global financial infrastructure presents is far from easy. Trying to model such complexity involves what we would prefer to call `modeling risk, which can be reduced by backtesting the model, but not eliminated entirely. Under this section only general arguments against Basel II have been discussed. The rest appears in the perceived impact section where Basel II prescriptions have different implications for different markets and entities. Pro-cyclicality In simple terms, pro-cyclicality means that banks governed by Basel II (capital tied to risks) will loosen credit in `good times (when risk perceptions are low) and restrict it when times are bad (when risks rise again). If most banks act in this fashion, having adopted the accord, they would accentuate the crisis in bad times, jeopardizing stability. Risk-based financial regulation is inherently pro-cyclic. The pro-cyclicality springs from the treatment of risk as an exogenous variable, whereas in reality, it is endogenous. The actions of a market participant based on a predictive model affects the market and if many participants are using the same model, their combined actions render the basic assumptions of the model on the heterogeneous nature of the market (normal distribution) false. `Requiring banks to run their capital through a stress test to assess what impact worsening economic conditions will have on their loan portfolios, and requiring bank supervisors to evaluate those models independently, increases the safety of the bank. This is one of the measures that will help the banks to be less pro-cyclical because they will have taken into account the whole (business) cycle,
MPBIRLAINSTITUTEOFMANAGEMENT Page102

Fearsome complexity The US Comptroller of Currency, John D. Hawke Jr., considers CP3 (Consultative Paper 3) published by Basel Committee as having `mind-numbing complexity. `Can anyone reasonably assume that a mandate of the complexity of Basel II will be applied with equal forcefulness across such a broad spectrum of supervisory regimes, asks Hawke. The meek answer from BCBS is that the complexity of the new accord results from the complexity it seeks to address. `This (Basel II implementation) is a task of extreme complexity involving the intersection of computer science, mathematics and finance, says Dr. Ron Dembo, founding chairman of Algorithmics Inc., a Toronto- based company specializing in financial risk management software. Heavy Implementation Costs Data monitor estimates that financial institutions worldwide will spend close to US$ 4 billion over two years on upgrading databases and other systems in order to comply with Basel II. Aberdeen Group estimates that banks will spend US $3.2 billion in the next four years preparing for Basel II. `Asian banks are expected to spend between seven to ten per cent of their global IT and business operations budget on Basel II compliance for the next four to six years, observes BIS. While such estimates would be music to the ears of software suppliers and consulting firms, the moot question for banks are `what benefits will accrue from this investment? and `how long will the pay back period be? Credit Risk Concerns Using the standardized approach, un-rated corporate borrowers attract less risk weight (100 per cent) than the lowest rated borrower (150 per cent) giving incentives to high-risk borrowers to remain un-rated. Another argument against Basel II is that it does not resort to full credit risk modelingit fails to take into account portfolio effects of risk mitigation through diversification.

MPBIRLAINSTITUTEOFMANAGEMENT

Page103

Concerns of National Supervisors The New Accord is criticized on the ground of being as much prescriptive as to be lacking in trust for national supervisors. Also, Pillar 2 requires national supervisors to give up armslength supervision in favour of participative implementation. Supervisors also need to invest heavily in people and technology to perform their duties as envisaged in Basel II.

MPBIRLAINSTITUTEOFMANAGEMENT

Page104

Chapter - 6

Recommendations

MPBIRLAINSTITUTEOFMANAGEMENT

Page105

Suggestion After all these points, I just want to say that NPA is a big problem of banks. Due to this crisis the NPA are also increased. Thats why all the banks are facing problems. So banks have to take care of those banks. My recommendations are: 1. Strengthening provision norms and loan classification standards based on forward looking criteria (like future cash flows) were implemented. 2. Through securitization they can reduce NPA 3. Speed of action- the speedy containment of systematic risk and the domestic credit crunch problem with the injection of large public fund for bank recapitalization are critical steps towards normalizing the financial system. 4. Strengthening legal system 5. Maintain required capital adequacy ratio as per basel 2 norms. That means now the provision for NPL will be more. This may look a conservative approach. But it should be implemented to reduce risk. 6. Modification in accounting system 7. Use the concept of credit derivative 8. Aligning of prudential norms with international standard.

MPBIRLAINSTITUTEOFMANAGEMENT

Page106

BIBLIOGRAPHY BOOKS REFERRED: MISHRA and PURI, Economic Environment of Business, Delhi, Himalaya Publishing House,2000edition. C R KOTHARI, RESEARCH METHODOLOGY, Bangalore, Vishwa Prakashan Publishing House .

JOURNALS REFERRED: ICFAI JOURNAL Banking & Regulation Laws , Hyderabad, Reserve Bank of India Act 1934 Pg.no 45- 72 WEBSITES VISITED: Marketresearch.com South Indian Bank.com Google.com RBI.com Businessstandard.com

MPBIRLAINSTITUTEOFMANAGEMENT

Page107

ANNEXURE
SOUTH INDIAN BANK
Year SOURCES OF FUNDS : Capital + Reserves Total + Deposits + Borrowings + Other Liabilities & Provisions + TOTAL LIABILITIES APPLICATION OF FUNDS : Cash & Balances with RBI+ Balances with Banks & money at Call+ Investments + Advances + Fixed Assets + Other Assets + Miscellaneous Expenditure not written off TOTAL ASSETS Contingent Liability+ Bills for collection 973.65 729.00 4,572.23 10,453.75 112.75 248.55 0.00 17,089.93 2,105.35 181.85 699.67 1,245.81 3,430.13 7,918.91 89.59 268.47 0.00 13,652.58 1,640.58 168.15 546.08 797.39 2,739.39 6,370.23 89.80 284.53 0.00 10,827.42 1,295.19 183.05 433.16 268.06 3,133.43 5,365.26 77.60 200.00 0.00 9,477.51 997.24 111.07 404.62 401.46 3,962.09 4,196.82 65.83 223.23 0.00 9,254.05 801.91 123.75 90.41 1,070.58 15,156.12 27.58 745.24 17,089.93 70.41 653.55 12,239.21 32.51 656.90 13,652.58 70.41 570.44 9,578.66 0.72 607.19 10,827.42 47.68 407.58 8,492.31 3.72 526.22 9,477.51 35.78 359.11 8,280.03 79.45 499.68 9,254.05 Mar 08 Mar 07 Mar 06 Mar 05 Mar 04

HDFC BANK
Year SOURCES OF FUNDS : Capital + Reserves Total + Deposits + Borrowings + Other Liabilities & Provisions + TOTAL LIABILITIES APPLICATION OF FUNDS : Cash & Balances with RBI+ Balances with Banks & money at Call+ Investments + Advances + Fixed Assets + Other Assets + Miscellaneous Expenditure not written off TOTAL ASSETS 12,553.18 2,225.16 49,393.54 63,426.90 1,175.13 4,477.10 0.00 133,251.01 5,075.25 3,971.40 30,564.80 46,944.78 966.67 3,796.39 0.00 91,319.29 3,306.61 3,612.39 28,393.96 35,061.26 855.08 2,357.57 0.00 73,586.87 2,650.13 1,823.87 2,541.98 1,008.90 354.43 11,142.80 100,768.60 4,478.86 16,506.32 133,251.01 319.39 6,113.76 6 8,297.94 2,815.39 13,772.81 91,319.29 313.14 4,986.39 55,796.82 2,858.48 9,632.04 73,586.87 309.88 4,209.97 284.79 2,407.09 Mar 08 Mar 07 Mar 06 Mar 05 Mar 04

36,354.25 30,408.86 4,790.01 5,841.87 2,307.82 6,971.42

51,505.98 42,379.98

19,349.81 19,363.46 25,566.30 17,744.51 708.32 1,407.55 0.00 616.91 1,104.22 0.00

51,505.98 42,379.98

MPBIRLAINSTITUTEOFMANAGEMENT

Page108

Contingent Liability+ Bills for collection

593,008.08 6,920.71

328,148.24 214,782.34 140,777.15 82,116.17 4,606.83 2,828.89 2,549.68 2,097.89

AXIS BANK
Year SOURCES OF FUNDS : Capital + Reserves Total + Deposits + Borrowings + Other Liabilities & Provisions + TOTAL LIABILITIES APPLICATION OF FUNDS : Cash & Balances with RBI+ Balances with Banks & money at Call+ Investments + Advances + Fixed Assets + Other Assets + Miscellaneous Expenditure not written off TOTAL ASSETS Contingent Liability+ Bills for collection 7,305.66 5,198.58 33,705.10 59,661.14 922.85 2,832.33 0.00 109,625.66 258,895.60 8,323.39 4,661.03 2,257.28 26,897.16 36,876.48 673.19 1,944.57 0.00 73,309.71 184,164.75 6,274.63 2,429.40 1,212.44 21,527.35 22,314.23 567.71 1,733.50 0.00 49,784.63 98,565.38 4,332.20 3,448.74 1,054.20 15,048.02 15,602.92 518.44 2,127.44 0.00 37,799.76 53,185.74 3,616.98 3,776.93 1,886.27 7,792.76 9,362.95 435.16 896.10 0.00 24,150.17 37,439.67 1,915.81 357.71 8,410.79 87,626.22 5,624.04 7,606.90 109,625.66 281.63 3,111.60 58,785.60 5,195.60 5,935.28 73,309.71 278.69 2,593.49 40,113.53 2,680.93 4,117.99 49,784.63 273.80 2,134.39 31,712.00 1,781.41 1,898.16 37,799.76 231.58 904.84 20,953.90 527.75 1,532.10 24,150.17 Mar 08 Mar 07 Mar 06 Mar 05 Mar 04

MPBIRLAINSTITUTEOFMANAGEMENT

Page109