MANAGEMENT OF NPAs IN

BANKING INDUSTRY
PROJECT REPORT

FOR
M.B.A. (W) BANKING & INSURANCE (IIND TRIMESTER)
UNIVERSITY SCHOOL OF MANAGEMENT STUDIES
GGSIP UNIVERSITY

UNDER THE SUPERVISION OF:

Dr. DIVYA VERMA
(PROJECT GUIDE)

SUBMITTED BY:
SAURABH DADHICH
Enroll No: 0561668908
Email id: saurabhdadhich@yahoo.com
Mob:9818225352

MBA (WEEKEND) PROGRAMME

Project Assessment Performa
1. Name of the Student : SAURABH DADHICH (0561668908)
2. Programme : MBA/(B&I)

Project Type: Minor

3. Session : 2008 - 2010

Trimester: III

4. Supervisor(s) : Dr. Divya Verma

Contact No.: 098998411851
E-mail:
Project Title: MANAGEMENT OF NPAs IN BANKING INDUSTRY

Sign. of the Student

Sign. of the Coordinator

Sign. of the Supervisor

----------------------------------------------------------------------------------------------S.N
o.

Details of
the
Interaction
with the
supervisor
(s)with Date

Remarks of the supervisor

Supervis
or
Signature

1
2
3
4
5
6. Internal Evaluation of 40 marks (in figure and words) : ______
_______________
Note : Supervisor is requested to provide the remarks of each interaction
to the candidate in the above proforma.

Signature
of the Supervisor

Signature of the Dean

ACKNOWLEDGEMENT
This Report could not have been written
without Dr. Divya Verma who not only served
as my supervisor but also encouraged and
helped me through out my project by providing
me his valuable suggestions and feed back.
She guided me through out the process never
accepting less than my best efforts.
And finally but immensely to all whose efforts
and contribution is now obscure in my mind, I
offer my sincere thanks.

PREFACE
In order to understand what is the impact
of Non Performing Assets on the banking sector
in terms of banks' asset quality. A high level of
NPAs in the banking system can severely affect
the economy in many ways. Management and
financial resources of the banking system are
diverted to resolution of NPA causing an
opportunity loss for productive use of
resources. Large scale NPAs, when left
unattended, cause continued economic and
financial degradation.
The study will be undertaken based on
literature preview from various resources like
national daily newspapers, financial news
papers, web sites of various entities like RBI,
World Bank, and Indian Bankers association
and internet research and a report got a shape.
This Report will help the reader to understand
impact of NPAs, various measures taken to
improve the efficiency and profitability and for
finding out the real solution to making realistic

provisions based on assessment of realizations

from NPAs towards their dues.

TABLE OF CONTENTS
1
2
3
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5
6
7
8
9
10
11

Introduction to NPAs
Research Methodology
Objective and Scope of Study
Factors for Rise in NPAs
Impact, Reasons & Symptoms of NPA
Preventive Measures
Tools for Recovery
Observation and Findings
Analysis
Finding, Suggestions & Conclusions
Bibliography

INTRODUCTION
TO
THE PROJECT
The accumulation of huge non-performing assets in banks has
assumed great importance. The depth of the problem of bad debts
was first realized only in early 1990s. The magnitude of NPAs in banks
and financial institutions is over Rs.1,50,000 crores.
While gross NPA reflects the quality of the loans made by banks, net
NPA shows the actual burden of banks. Now it is increasingly evident
that the major defaulters are the big borrowers coming from the nonpriority sector. The banks and financial institutions have to take the
initiative to reduce NPAs in a time bound strategic approach.
Public sector banks figure prominently in the debate not only because
they dominate the banking industries, but also since they have much
larger NPAs compared with the private sector banks. This raises a
concern in the industry and academia because it is generally felt that
NPAs reduce the profitability of a bank, weaken its financial health and
erode its solvency.
For the recovery of NPAs a broad framework has evolved for the
management of NPAs under which several options are provided for
debt recovery and restructuring. Banks and FIs have the freedom to
design and implement their own policies for recovery and write-off
incorporating compromise and negotiated settlements.

What is NPA???
The three letters NPA Strike terror in banking sector and business
circle today. NPA is short form of Non Performing Asset. The dreaded
NPA rule says simply this: when interest or other due to a bank remains
unpaid for more than 90 days, the entire bank loan automatically

turns a non performing asset. The recovery of loan has always been
problem for banks and financial institution. To come out of these first
we need to think is it possible to avoid NPA, no can not be then left is
to look after the factor responsible for it and managing those factors.

DEFINITIONS:
An asset, including a leased asset, becomes non-performing when it
ceases to generate income for the bank.
A non-performing asset (NPA) was defined as a credit facility in
respect of which the interest and/ or instalment of principal has
remained past due for a specified period of time.
With a view to moving towards international best practices and to
ensure greater transparency, it has been decided to adopt the 90
days overdue norm for identification of NPAs, from the year ending
March 31, 2004. Accordingly, with effect from March 31, 2004, a nonperforming asset (NPA) shall be a loan or an advance where;
Interest and/ or instalment of principal remain overdue for a
period of
more than 90 days in respect of a term loan,
The account remains out of order for a period of more than
90 days, in respect of an Overdraft/Cash Credit (OD/CC),
The bill remains overdue for a period of more than 90 days in
the case of bills purchased and discounted,
Interest and/or instalment of principal remains overdue for
two harvest seasons but for a period not exceeding two half
years in the case of an advance granted for agricultural
purposes, and
Any amount to be received remains overdue for a period of
more than 90 days in respect of other accounts.

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. As a facilitating measure for
smooth transition to 90 days norm, banks have been advised to move
over to charging of interest at monthly rests, by April 1, 2002.
However, the date of classification of an advance as NPA should not be
changed on account of charging of interest at monthly rests. Banks
should, therefore, continue to classify an account as NPA only if the
interest charged during any quarter is not serviced fully within 180
days from the end of the quarter with effect from April 1, 2002 and 90
days from the end of the quarter with effect from March 31, 2004.

RESEARCH METHODOLOGY
Type of Research:

The research methodology adopted for carrying out the

study were
In this project Descriptive research methodologies were use.
At the first stage theoretical study is attempted.
At the second stage Historical study is attempted.
At the Third stage Comparative study of NPA is undertaken.

SCOPE OF THE STUDY

Concept of Non Performing Asset

Guidelines

Impact of NPAs

Reasons for NPAs

Preventive Measures

Tools to manage NPAs

SAMPLING PLAN
To prepare this Project we took five banks from public sector as well as
five banks from private sector.

OBJECTIVES OF THE STUDY

The basic idea behind undertaking the Grand Project on NPA was to:

To
To
To
To

evaluate NPAs (Gross and Net) in different banks.

study the past trends of NPA
calculate the weighted of NPA in risk management in Banking
analyze financial performance of banks at different level of

NPA
To evaluate profitability positions of banks
To evaluate NPA level in different economic situation.
To Know the Concept of Non Performing Asset
To Know the Impact of NPAs
To Know the Reasons for NPAs
To learn Preventive Measures

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

Gross NPAs
Gross Advances

B. Net NPA:
Net NPAs are those type of NPAs in which the bank has deducted the
provision regarding NPAs. Net NPA shows the actual burden of banks.
Since in India, bank balance sheets contain a huge amount of NPAs and
the process of recovery and write off of loans is very time consuming,
the provisions the banks have to make against the NPAs according to
the central bank guidelines, are quite significant. That is why the
difference between gross and net NPA is quite high.It can be calculated
by following:
Net NPAs =

Gross NPAs Provisions

Gross Advances - Provisions

INCOME RECOGNITION
Income recognition Policy

The policy of income recognition has to be objective and based

on the record of recovery. Internationally income from non-performing

assets (NPA) is not recognised on accrual basis but is booked as
income only when it is actually received. Therefore, the banks should
not charge and take to income account interest on any NPA.

However, interest on advances against term deposits, NSCs,

IVPs, KVPs and Life policies may be taken to income account on the
due date, provided adequate margin is available in the accounts.

Fees and commissions earned by the banks as a result of renegotiations or rescheduling of outstanding debts should be recognised
on an accrual basis over the period of time covered by the renegotiated or rescheduled extension of credit.

If Government guaranteed advances become NPA, the interest

on such advances should not be taken to income account unless the
interest has been realised.
Reversal of income:

If any advance, including bills purchased and discounted,

becomes NPA as at the close of any year, interest accrued and credited
to income account in the corresponding previous year, should be
reversed or provided for if the same is not realised. This will apply to
Government guaranteed accounts also.
Leased Assets

The net lease rentals (finance charge) on the leased asset

accrued and credited to income account before the asset
became non-performing, and remaining unrealised, should be
reversed or provided for in the current accounting period.
The term 'net lease rentals' would mean the amount of finance
charge taken to the credit of Profit & Loss Account and would be
worked out as gross lease rentals adjusted by amount of
statutory depreciation and lease equalisation account.
As per the 'Guidance Note on Accounting for Leases' issued by
the Council of the Institute of Chartered Accountants of India
(ICAI), a separate Lease Equalisation Account should be opened
by the banks with a corresponding debit or credit to Lease
Adjustment Account, as the case may be. Further, Lease
Equalisation Account should be transferred every year to the
Profit & Loss Account and disclosed separately as a deduction
from/addition to gross value of lease rentals shown under the
head 'Gross Income'.

Appropriation of recovery in NPAs

Interest realised on NPAs may be taken to income account
provided the credits in the accounts towards interest are not out
of fresh/ additional credit facilities sanctioned to the borrower
concerned.
In the absence of a clear agreement between the bank and the
borrower for the purpose of appropriation of recoveries in NPAs
(i.e. towards principal or interest due), banks should adopt an
accounting principle and exercise the right of appropriation of
recoveries in a uniform and consistent manner.
Interest Application:
There is no objection to the banks using their own discretion in debiting
interest to an NPA account taking the same to Interest Suspense

Account or maintaining only a record of such interest in performa

accounts.
Reporting of NPAs
Banks are required to furnish a Report on NPAs as on 31st March
each year after completion of audit. The NPAs would relate to the
banks global portfolio, including the advances at the foreign
branches. The Report should be furnished as per the prescribed
format given in the Annexure I.
While reporting NPA figures to RBI, the amount held in interest
suspense account, should be shown as a deduction from gross
NPAs as well as gross advances while arriving at the net NPAs.
Banks which do not maintain Interest Suspense account for
parking interest due on non-performing advance accounts, may
furnish the amount of interest receivable on NPAs as a foot note
to the Report.
Whenever NPAs are reported to RBI, the amount of technical
write off, if any, should be reduced from the outstanding gross
advances and gross NPAs to eliminate any distortion in the
quantum of NPAs being reported.

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. The NPAs in PSB
are growing due to external as well as internal 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 nonrecover, their by reducing their profitability and liquidity.
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 ours farmers depends on rain fall for cropping. Due to
irregularities of rain fall the farmers are not to achieve the production
level thus they are not repaying the loans.
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 government to revive the
handloom sector has not yet been implemented. So the over dues due
to the handloom sectors are becoming NPAs.

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

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:
Capacity to pay depends upon:
Tangible assets
Success in business
Willingness to pay depends on:
Character
Honest
Reputation of borrower
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.

Banks should consider the borrowers own capital investment.

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.

Analyze the balance sheet.True picture of business will be

revealed on analysis of profit/loss a/c and balance sheet.

When bankers give loan, he should analyze the purpose of the loan. To
ensure safety and liquidity, banks should grant loan for productive
purpose only. Bank should analyze the profitability, viability, long term
acceptability of the project while financing.
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.
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.
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 willful
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.

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.
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) Undercapitalized banks exceeds the banks capital base.
The three letters Strike terror in banking sector and business circle
today. NPA is short form of Non Performing Asset. The dreaded NPA
rule says simply this: when interest or other due to a bank remains
unpaid for more than 90 days, the entire bank loan automatically
turns a non performing asset. The recovery of loan has always been
problem for banks and financial institution. To come out of these first
we need to think is it possible to avoid NPA, no can not be then left is
to look after the factor responsible for it and managing those factors.
Interest and/or instalment of principal remains overdue for
two harvest seasons but for a period not exceeding two half
years in the case of an advance granted for agricultural
purposes, and
Any amount to be received remains overdue for a period of
more than 90 days in respect of other accounts.
As a facilitating measure for smooth transition to 90 days norm, banks
have been advised to move over to charging of interest at monthly
rests, by April 1, 2002. However, the date of classification of an
advance as NPA should not be changed on account of charging of

interest at monthly rests. Banks should, therefore, continue to classify

an account as NPA only if the interest charged during any quarter is not
serviced fully within 180 days from the end of the quarter with effect
from April 1, 2002 and 90 days from the end of the quarter with effect
from March 31, 2004.

Impact of NPA
Profitability:NPA means booking of money in terms of bad asset, which occurred
due to wrong choice of client. Because of the money getting blocked
the prodigality of bank decreases not only by the amount of NPA but
NPA lead to opportunity cost also as that much of profit invested in
some return earning project/asset. So NPA doesnt affect current profit
but also future stream of profit, which may lead to loss of some longterm beneficial opportunity. Another impact of reduction in profitability
is low ROI (return on investment), which adversely affect current
earning of bank.
Liquidity:Money is getting blocked, decreased profit lead to lack of enough cash
at hand which lead to borrowing money for shot\rtes period of time
which lead to additional cost to the company. Difficulty in operating the
functions of bank is another cause of NPA due to lack of money.

Involvement of management:Time and efforts of management is another indirect cost which bank
has to bear due to NPA. Time and efforts of management in handling
and managing NPA would have diverted to some fruitful activities,
which would have given good returns. Now days banks have special
employees to deal and handle NPAs, which is additional cost to the
bank.
Credit loss:Bank is facing problem of NPA then it adversely affect the value of
bank in terms of market credit. It will lose its goodwill and brand
image and credit which have negative impact to the people who are
putting their money in the banks.

SYMPTOMS OF NPAs
Four categories of early symptoms:(1)

Financial:

Non-payment of the very first installment in case of term loan.

Bouncing of cheque due to insufficient balance in the accounts.

Irregularity in installment.

Irregularity of operations in the accounts.

Unpaid over due bills.

Declining Current Ratio.

Payment which does not cover the interest and principal amount

of that installment.

While monitoring the accounts it is found that partial amount is

diverted to sister concern or parent company.
(2)

Operational and Physical:

If information is received that the borrower has either initiated

the process of winding up or are not doing the business.

Overdue receivables.

Stock statement not submitted on time.

External non-controllable factor like natural calamities in the city

where borrower conduct his business.

Frequent changes in plan.

Non payment of wages.

(3)

Attitudinal Changes:

Use for personal comfort, stocks and shares by borrower.

Avoidance of contact with bank.
Problem between partners.
(4)

Others:

Changes in Government policies.

Death of borrower.

 Competition in the market.

Preventive Measurement For NPA

Early Recognition of the Problem:Invariably, by the time banks start their efforts to get involved in a
revival process, its too late to retrieve the situation- both in terms of
rehabilitation of the project and recovery of banks dues. Identification
of weakness in the very beginning that is : When the account starts
showing first signs of weakness regardless of the fact that it may not
have become NPA, is imperative. Assessment of the potential of revival
may be done on the basis of a techno-economic viability study.
Restructuring should be attempted where, after an objective
assessment of the promoters intention, banks are convinced of a
turnaround within a scheduled timeframe. In respect of totally unviable
units as decided by the bank, it is better to facilitate winding up/ selling
of the unit earlier, so as to recover whatever is possible through legal
means before the security position becomes worse.

Identifying Borrowers with Genuine Intent:-

Identifying borrowers with genuine intent from those who are nonserious with no commitment or stake in revival is a challenge
confronting bankers. Here the role of frontline officials at the branch
level is paramount as they are the ones who has intelligent inputs with
regard to promoters sincerity, and capability to achieve turnaround.
Base don this objective assessment, banks should decide as quickly as
possible whether it would be worthwhile to commit additional finance.
In this regard banks may consider having Special Investigation of
all financial transaction or business transaction, books of account in
order to ascertain real factors that contributed to sickness of the
borrower. Banks may have penal of technical experts with proven
expertise and track record of preparing techno-economic study of the
project of the borrowers.

Borrowers having genuine problems due to temporary mismatch in

fund flow or sudden requirement of additional fund may be entertained
at branch level, and for this purpose a special limit to such type of
cases should be decided. This will obviate the need to route the
additional funding through the controlling offices in deserving cases,
and help avert many accounts slipping into NPA category.

Timeliness and Adequacy of response:Longer is the delay in response, greater the injury to the account and
the asset. Time is a crucial element in any restructuring or
rehabilitation activity. The response decided on the basis of technoeconomic study and promoters commitment, has to be adequate in
terms of extend of additional funding and relaxations etc. under the
restructuring exercise. The package of assistance may be flexible and
bank may look at the exit option.

Focus on Cash Flows:-

While financing, at the time of restructuring the banks may not be

guided by the conventional fund flow analysis only, which could yield a
potentially misleading picture. Appraisal for fresh credit requirements
may be done by analyzing funds flow in conjunction with the Cash Flow
rather than only on the basis of Funds Flow.

Management Effectiveness:The general perception among borrower is that it is lack of finance that
leads to sickness and NPAs. But this may not be the case all the time.
Management effectiveness in tackling adverse business conditions is a
very important aspect that affects a borrowing units fortunes. A bank
may commit additional finance to an aling unit only after basic viability
of the enterprise also in the context of quality of management is
examined and confirmed. Where the default is due to deeper malady,
viability study or investigative audit should be done it will be useful
to have consultant appointed as early as possible to examine this
aspect. A proper techno- economic viability study must thus become
the basis on which any future action can be considered.

Multiple Financing:-

A.

During the exercise for assessment of viability and restructuring,

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

B.

In some default cases, where the unit is still working, the bank
should make sure that it captures the cash flows (there is a
tendency on part of the borrowers to switch bankers once they default,
for fear of getting their cash flows forfeited), and ensure that such cash
flows are used for working capital purposes. Toward this end, there
should be regular flow of information among consortium members. A
bank, which is not part of the consortium, may not be allowed to offer
credit facilities to such defaulting clients. Current account facilities may
also be denied at non-consortium banks to such clients and violation
may attract penal action. The Credit Information Bureau of India
Ltd.(CIBIL) may be very useful for meaningful information exchange
on defaulting borrowers once the setup becomes fully operational.

C.

In a forum of lenders, the priority of each lender will be different.

While one set of lenders may be willing to wait for a longer time to
recover its dues, another lender may have a much shorter timeframe
in mind. So it is possible that the letter categories of lenders may be
willing to exit, even a t a cost by a discounted settlement of the
exposure. Therefore, any plan for restructuring/rehabilitation may take
this aspect into account.

D.

Corporate Debt Restructuring mechanism has been

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

TOOLS FOR RECOVERY OF NPAS

Credit Default

Inability to Pay

Unviable

Willful default

Viable

Rehabilitation
Compromise

Consortium Finance
Fresh Issue of
Conversion
Term
Loan Debt Restructuring
into WCTL
Corporate

Lok Adalat
Debt Recovery
Tribunals

Sole Banker
Fresh WC Limit

Securitization
Act

Asset
Reconstruction
Rephasement of
Repayment Period

MANAGEMENT OF NPAS: SECURITIZATION

1. 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 NonPerforming 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 instalment 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.

2. Securitization
Securitization is the process of conversion of existing assets or future
cash flows into marketable securities. For the purpose of distinction,
the conversion of existing assets into marketable securities is known as
asset-backed securitization and the conversion of future cash flows into
marketable securities is known as future-flows securitization.
The purpose of the Securitization Act is to promote the setting up of
asset reconstruction / securitization companies to take over the Non
Performing Assets (NPA) accumulated with the banks and public

financial institutions. The Act provides special powers to lenders and

securitization / asset reconstruction companies, to enable them to take
over of assets of borrowers without first resorting to courts.
The Act was welcomed by the banking community, but resisted by the
borrower community. The validity was challenged in various courts on
the ground that it was predominantly in favor of lenders. Hence,
lenders were unable to enforce the provisions in full. But the crux of
the issue was whether the Act would be an effective tool to make a
drastic difference to the NPA menace.
3. Securitization - Relevance to the Banking Sector
The growth in credit off take of banks has been the second highest in
the last 55 years. But at the same time the incremental credit deposit
ratio for the past one-year has been greater than one. Thus, for every
Rs 100 worth of deposit coming into the system more than Rs 100 is
being disbursed as credit. So, the mismatch between the credit given
and the funds received creates an issue of proper management of
increased credit off-take.
One of the measures adopted by the banks to cater to this credit boom
is by selling their investments in government securities and giving the
amount raised as loans. But there is a limit to such credit funding due
to minimum SLR requirements of 25% in government and semi
government securities.
Once the banks reach this level of 25 per cent, they cannot sell any
more government securities to generate liquidity. And given the pace
of credit off take, some banks could reach this level very fast. So
banks, in order to keep giving credit, need to ensure that more
deposits keep coming in.
Securitization also helps banks to sell off their NPAs to asset
reconstruction companies (ARCs). ARCs, which are typically
publicly / government owned, act as debt aggregators and are
engaged in acquiring bad loans from the banks at a discounted price,
thereby helping banks to focus on core activities. On acquiring bad

loans ARCs restructure them and sell them to other investors as 'Pass
Through Certificates' (PTCs), thereby freeing the banking system to
focus on normal banking activities.
4. Future Outlook
Securitization is expected to become more popular in the near future in
the banking sector. Banks are expected to sell off a greater amount of
NPAs to ARCIL by 2007, when they have to shift to Basel-II norms.
Blocking too much capital in NPAs can reduce the capital adequacy of
banks and can be a hindrance for banks to meet the Basel-II norms.
Thus, banks will have two options - either to raise more capital or to
free capital tied up in NPAs and other loans through securitization

BASEL II Primer: New Capital Adequacy

Framework for Banks.
Banking industry is the backbone of any country's economy; the
sounder it is, the better the performance of the financial markets and
the economy as a whole. Just like any other industry, banking industry
is susceptible to various types of risks which might occasionally occur
in losses, and at times they tend to be so severe that they take entire
firm down with them. To hedge against such risks, banks keep a
minimum buffer of equity and provisions (regulatory capital), given a
certain amount of various kinds of risks.
The size of this regulatory capital was determined by Based Accord
(Basel I) earlier and now by Basel II Framework. Basel Committee
on Banking Supervision (BCBS) is responsible to frame these rules;
the committee has members from various (13) countries that are
represented by their respective central banks or equivalent authority.
Basel II Framework on capital adequacy takes into account the
elements of credit risk in various types of assets in the balance sheet
as well as off-balance sheet business and also attempts to strengthen
the capital base of banks. BCBS released the "International
Convergence of Capital Measurement and Capital Standards: A

Revised Framework" on 26 June 2004. This was then updated in

November 2005 to include trading activities and the treatment of
double default effects. The revised framework seeks to arrive at
significantly more risk-sensitive approaches to capital requirements
and provides a range of options to determine the capital requirements
for credit risk and operational risks.

ANALYSIS
For the purpose of analysis and comparison between private sector
and public sector banks, we take five-five banks in both sector to
compare the non performing assets of banks. For understanding we
further bifurcate the non performing assets in priority sector and non
priority sector, gross NPA and net NPA in percentage as well as in
rupees, deposit investment advances.
Deposit Investment Advances is the first in the analysis because
due to these we can understand the where the bank stands in the
competitive market. As at end of march 2008, in private sector ICICI
Bank is the highest deposit-investment-advances figures in rupees
crore, second is HDFC Bank and KOTAK Bank has least figures.
In public sector banks Punjab National Bank has highest depositinvestment-advances but when we look at graph first three means
Bank of Baroda and Bank of India are almost the similar in numbers
and Dena Bank is stands for last in public sector bank. When we
compare the private sector banks with public sector banks among
these banks, we can understand the more number of people prefer to
choose public sector banks for deposit-investment.
But when we compare the private sector bank ICICI Bank with the
public sector banks ICICI Bank is more deposit-investment figures and
first in the all banks.
There are two concepts related to non-performing assets_ gross and
net. Gross refers to all NPAs on a banks balance sheet irrespective of
the provisions made. It consists of all the non standard assets, viz.
sub standard, doubtful, and loss assets. A loan asset is classified as
sub standard if it remains NPA up to a period of 18 months;

doubtful if it remains NPA for more than 18 months; and loss,

without any waiting period, where the dues are considered not
collectible or marginally collectible.
Net NPA is gross NPA less provisions.
Since in India, bank balance
sheets contains a huge amount of NPAs and the process of recovery
and write off of loans is very time consuming, the provisions the banks
have to make against the NPA according to the central bank guidelines,
are quite significant.
Here, we can see that there are huge difference between gross and net
NPA. While gross NPA reflects the quality of the loans made by
banks, net NPA shows the actual burden of banks.
The
requirements for provisions are :

100% for loss assets

100% of the unsecured portion plus 20-50% of the secured

portion, depending on the period for which the account has remained
in the doubtful category

10% general provision on the outstanding balance under the sub

standard category.

FINDINGS & SUGGESTIONS

After the global financial turmoil in 2008, Indian banks begin the new
year with a lurking fear that their Non Performing Assets 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.
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 riskmanagement mechanisms to overcome this challenge. 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 (Rs 61.36 billion), according to figures released by
the Reserve Bank.
Despite pressures emanating from global financial markets, Indian
banks witnessed a healthy 25 to 29 per cent average growth in credit
disbursals, primarily in housing, auto and infrastructure loans. 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 to 29 per cent on account of working capital requirements
of small, mid and large-sized industries, bankers expect an average 25
per cent in their credit in 2009.
While government-owned banks were quick to respond to the recent
signals from policy-makers by reducing interest rates periodically,
many private banks are yet to follow suit, mainly owing to pressure on
their margins.
Government-owned banks have effected an up to 1 to 1.5 per cent
reduction in their Prime Lending Rates in the recent past heeding calls
from the government and the Reserve Bank to do so in order to ensure
a credit pick-up. PLR is the benchmark rate, based on which private
banks lend to their customers.

BIBLIOGRAPHY
1. www.coolavenues.com/know/fin/arvind_archana_1.php3) on 13
April, 09
2. The Hindu Business Line - Saturday, Dec 06, 2008
3. THE HINDU group of publications- 13/4/09

4. Role of Asset Reconstruction Companies - THE CHARTERED

ACCOUNTANT April 13, 2009
5. www.indiabudget.nic.in