Actions Taken by RBI to Tackle the Accumulation of Non Performing Assets (NPAs) in Banks

1. Internal hecks an! ontrol Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance. Though most banks have Early Warning Systems (EWS for identification of potential NPAs! the actual processes follo"ed! ho"ever! differ from bank to bank. The EWS enable a bank to identify the borro"er accounts "hich sho" signs of credit deterioration and initiate remedial action. #any banks have evolved and adopted an elaborate EWS! "hich allo"s them to identify potential distress signals and plan their options beforehand! accordingly. The early "arning signals! indicative of potential problems in the accounts! vi$. persistent irregularity in accounts! delays in servicing of interest! fre%uent devolvement of &'(s! units) financial problems! market related problems! etc. are captured by the system. *n addition! some of these banks are revie"ing their e+posure to borro"er accounts every %uarter based on published data "hich also serves as an important additional "arning system. These early "arning signals used by banks are generally independent of risk rating systems and asset classification norms prescribed by ,-*. The ma.or components'processes of a EWS follo"ed by banks in *ndia as brought out by a study conducted by ,eserve -ank of *ndia at the instance of the -oard of /inancial Supervision are as follo"s0

1esignating ,elationship #anager' (redit 2fficer for monitoring account's Preparation of 3kno" your client) profile

(redit rating system *dentification of "atch4list'special mention category accounts #onitoring of early "arning signals

Relationshi" #anager$ re!it %fficer The ,elationship #anager'(redit 2fficer is an official "ho is e+pected to have complete kno"ledge of borro"er! his business! his future plans! etc. The ,elationship #anager has to keep in constant touch "ith the borro"er and report all developments impacting the borro"able account. As a part of this contact he is also e+pected to conduct scrutiny and activity inspections. *n the credit monitoring process! the responsibility of monitoring a corporate account is vested "ith ,elationship #anager'(redit 2fficer.

&no' your client "rofile (&( ) #ost banks in *ndia have a system of preparing 3kno" your client) (56( profile'credit report. As a part of 356() system! visits are made on clients and their places of business'units. The fre%uency of such visits depends on the nature and needs of relationship. ,ead #ore0 &no' (our ustomer (&( )

re!it Rating )ystem The credit rating system is essentially one point indicator of an individual credit e+posure and is used to identify measure and monitor the credit risk of individual proposal. At the "hole bank level! credit rating system enables tracking the health of banks entire credit portfolio. #ost banks in *ndia have put in place the system of internal credit rating. While most of the banks have developed their o"n models! a fe" banks have adopted credit rating models designed by rating agencies. (redit rating models take into account various types of risks vi$. financial! industry and management! etc. associated "ith a borro"able unit. The e+ercise is generally done at the time of sanction of ne" borro"able account and at the time of revie" ' rene"al of e+isting credit facilities. *atch+list$)"ecial #ention ategory The grading of the bank)s risk assets is an important internal control tool. *t serves the need of the #anagement to identify and monitor potential risks of a loan asset. The purpose of identification of potential NPAs is to ensure that appropriate preventive ' corrective steps could be initiated by the bank to protect against the loan asset becoming non4performing. #ost of the banks have a system to put certain borro"able accounts under "atch list or special mention category if performing advances operating under adverse business or economic conditions are e+hibiting certain distress signals. These accounts generally e+hibit "eaknesses "hich are correctable but "arrant banks) closer attention. The categori$ation of such accounts in "atch list or special mention category provides early "arning signals enabling ,elationship #anager or (redit 2fficer to anticipate credit deterioration and take necessary preventive steps to avoid their slippage into non performing advances. ,arly *arning )ignals *t is important in any early "arning system! to be sensitive to signals of credit deterioration. A host of early "arning signals are used by different banks for identification of potential NPAs. #ost banks in *ndia have laid do"n a series of operational! financial! transactional indicators that could serve to identify emerging problems in credit e+posures at an early stage. /urther! it is revealed that the indicators "hich may trigger early "arning system depend not only on default in payment of installment and interest but also other factors such as deterioration in operating and financial performance of the borro"er! "eakening industry characteristics! regulatory changes! general economic conditions! etc. Early "arning signals can be classified into five broad categories vi$. (7 /inancial (8 2perational (9 -anking (: #anagement and (; E+ternal factors.

-inancial relate! "arning signals generally emanate from the borro"ers) balance sheet! income e+penditure statement! statement of cash flo"s! statement of receivables etc. /ollo"ing common "arning signals are captured by some of the banks having relatively developed EWS. -inancial 'arning signals

Persistent irregularity in the account 1efault in repayment obligation 1evolvement of &('invocation of guarantees 1eterioration in li%uidity'"orking capital position Substantial increase in long term debts in relation to e%uity 1eclining sales 2perating losses'net losses ,ising sales and falling profits 1isproportionate increase in overheads relative to sales ,ising level of bad debt losses 2perational "arning signals &o" activity level in plant 1isorderly diversification'fre%uent changes in plan Nonpayment of "ages'po"er bills &oss of critical customer's /re%uent labor problems Evidence of aged inventory'large level of inventory

#anagement relate! 'arning signals

&ack of co4operation from key personnel (hange in management! o"nership! or key personnel 1esire to take undue risks /amily disputes Poor financial controls /udging of financial statements 1iversion of funds

Banking relate! signals

1eclining bank balances'declining operations in the account 2pening of account "ith other bank

,eturn of out"ard bills'dishonored che%ues Sales transactions not routed through the account /re%uent re%uests for loan

/re%uent delays in submitting stock statements! financial data! etc. Signals relating to e+ternal factors
Economic recession Emergence of ne" competition Emergence of ne" technology

(hanges in government ' regulatory policies Natural calamities

.. #anagement$Resolution of NPAs A reduction in the total gross and net NPAs in the *ndian financial system indicates a significant improvement in management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past "hich include the S,/AES* Act! one time settlement schemes! setting up of the (1, mechanism! strengthening of 1,Ts. /rom the data available of Public Sector -anks as on #arch 97! 8<<9! there "ere 7!;88 numbers of NPAs as on #arch 97! 8<<9 "hich had gross value greater than ,s. ;< million in all the public sector banks in *ndia. The total gross value of these NPAs amounted to ,s. 87; billion. The total number of resolution approaches (including cases "here action is to be initiated is greater than the number of NPAs! indicating some double counting. As can be seen! suit filed and -*/, are the t"o most common approaches to resolution of NPAs in public sector banks. ,ehabilitation has been considered' adopted in only about 79= of the cases. Settlement has been considered only in >= of the cases. *t is likely to have been adopted in even fe"er cases. 1ata available on resolution strategies adopted by public sector banks suggest that (ompromise settlement schemes "ith borro"ers are found to be more effective than legal measures. #any banks have come out "ith their o"n restructuring schemes for settlement of NPA accounts. State -ank of *ndia! ?1/( &imited! #'s. 1un and -radstreet *nformation Services (*ndia Pvt. &td. and #'s. Trans @nion to serve as a mechanism for e+change of information bet"een banks and /*s for curbing the gro"th of NPAs incorporated credit *nformation -ureau (*ndia &imited ((*-*& in Aanuary 8<<7. Pending the enactment of (*- ,egulation -ill! the ,-* constituted a "orking group to e+amine the role of (*-s. As per the recommendations of the "orking group! -anks and /*s are no" re%uired to submit the list of suit4filed cases of ,s. 7< million and above and suit filed cases of "illful defaulters of ,s. 8.; million and above to ,-* as "ell as (*-*&. (*-*& "ill share this information "ith commercial banks and /*s so as to help them minimi$e adverse selection at appraisal stage. The (*-*& is in the process of getting operationalised. /. *illful 0efaulters ,-* has issued revised guidelines in respect of detection of "illful default and diversion and siphoning of funds. As per these guidelines a "illful default occurs "hen a borro"er defaults in meeting its obligations to the lender "hen it has capacity to honor the obligations or "hen funds have been utili$ed for purposes other than those for "hich finance "as granted. The list of "illful defaulters is re%uired to be submitted to SE-* and ,-* to prevent their access to capital markets. Sharing of information of this nature helps banks in their due diligence e+ercise and helps in avoiding financing unscrupulous elements. ,-* has advised lenders to initiate legal measures including criminal actions! "herever re%uired! and undertake a proactive approach in change in management! "here appropriate.