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 Introduction to NPAs
2 Research Methodology
3 Objective and Scope of Study
4 Factors for Rise in NPAs
5 Impact, Reasons & Symptoms of NPA
6 Preventive Measures
7 Tools for Recovery
8 Observation and Findings
9 Analysis
10 Finding, Suggestions & Conclusions
11 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 non-priority 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 non-performing 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 evaluate NPAs (Gross and Net) in different banks.

 To study the past trends of NPA
 To calculate the weighted of NPA in risk management in Banking
  To 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 re-negotiations or
rescheduling of outstanding debts should be recognised on an accrual basis over the period of
time covered by the re-negotiated 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 non-recover, 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 doesn’t affect current profit but also future stream
of profit, which may lead to loss of some long-term beneficial opportunity. Another impact
of reduction in profitability is low ROI (return on investment), which adversely affect
current earning of bank.
Liquidity:-
Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to
borrowing money for 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 day’s 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 it’s 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, it’s too
late to retrieve the situation- both in terms of rehabilitation of the project and recovery of
bank’s 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 promoter’s 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 non- serious 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 techno-economic study and promoter’s 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 unit’s
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
Willful default

Unviable Viable

Lok Adalat
Rehabilitation
Debt Recovery
Tribunals
 Securitization
Compromise Act

Asset
Sole Banker Reconstruction

Rephasement of
Fresh Issue of Conversion Fresh WC Limit Repayment Period
Term Loan into WCTL

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 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 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 deposit-investment-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
bank’s 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 risk-management 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.