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The genesis (origin) of an NPA

There are many reasons as to why a loan goes bad. For a business, it could be because it fails to take off.

Such a situation may arise because of sudden health expenditure or job loss or death. Often, as in the US today, it can be because of
over-leveraging, when consumers borrow against most of their assets and, maybe, have unsecured loans too.

In such a case, any hit on income can jeopardize all repayments. They, however, can file for bankruptcy under Chapters 7, 11 and 13
of the United States Bankruptcy Code. Indians don’t have such an option.

In India, the situation has worsened due to banks aggressively pushing loans, even unsecured ones, to individuals to prevent idle assets
on their books. President and founder of International Consumer Rights Protection Council, an NGO, says most customers in India are
not financially educated and banks are luring them to take more and more loans, often without checking their financial position

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 installment 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 installment 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 installment 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.
Basis of non-performing assets

The basis of treating a credit facility as N.P.As is as detailed below: ASSET- In respect of which interest has remained past due for six


Inclusive of unpaid interest, when the installments is overdue for more than six months/on which interest amount remained past due
for six months.

2. Bills: - Which remains overdue for six months


The interest in respect of a debt/income on a receivable in the nature of short-term loans/advances, which remains overdue for a period
of six months.


Any dues on account of these/reimbursement of expenses rendered, which remained overdue for a period of six months.


The installments, which has become overdue for a period of more than twelve months.


The balance outstanding including interest accrued made available to the borrower/beneficiary in the same capacity when any of the
credit facilities become N.P.A

Identification of assets as NPAs should be done on an ongoing

The system should ensure that identification of NPAs is done on an on-going basis and doubts in asset classification due to any reason
are settled through specified internal channels within one month from the date on which the account would have been classified as
NPA as per prescribed norms. Banks should also make provisions for NPAs as at the end of each calendar quarter i.e. as at the end of
March/ June/ September/ December, so that the income and expenditure account for the respective quarters as well as the P&L
account and balance sheet for the year end reflects the provision made for NPAs.

Treatment of Accounts as NPAs

Record of Recovery

The treatment of an asset as NPA should be based on the record of recovery. Banks should not treat an advance as NPA merely due to
existence of some deficiencies which are of temporary in nature such as non-availability of adequate drawing power, balance
outstanding exceeding the limit, non-submission of stock statements and the non-renewal of the limits on the due date, etc. Where
there is a threat of loss, or the recoverability of the advances is in doubt, the asset should be treated as NPA.
Borrowers have been regularized by repayment of overdue amounts through genuine sources (not by sanction of additional facilities
or transfer of funds between accounts), the accounts need not be treated as NPAs. In such cases, it should, however, be ensured that
the accounts remain in order subsequently and a solitary credit entry made in an account on or before the balance sheet date which
extinguishes the overdue amount of interest or installment of principal is not reckoned as the sole criteria for treatment the account as
a standard asset.

Types of non-performing assets

Classified as 1) gross NPA 2) net NPA

1) 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.

2) 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.

Difference between gross NPA and net NPA

Gross NPA is the amount outstanding in the borrowal account, in books of the bank other than the interest which has been recorded
and not debited to the borrowal account. Net NPAs is the amount of gross NPAs less (1) interest debited to borrowal and not
recovered and not recognized as income and kept in interest suspense (2) amount of provisions held in respect of NPAs and (3) amount
of claim received and not appropriated.

The Reserve Bank of India defines Net NPA as

Net NPA = Gross NPA – (Balance in Interest Suspense account + DICGC/ECGC claims
Received and held pending adjustment + Part payment received and kept in suspense
Account + Total provisions held).
The Reserve Bank of India Banks has advised the banks to compute their Gross
Advances, Net Advances, Gross NPAs and Net NPAs as per the following format w.e.f.
September 2009.


Banks should classify their assets into the following broad groups, viz.

1. Standard Assets
2. Sub-standard Assets 3.Doubtful Assets
4. Loss Assets
1. Standard Assets

Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the
business. Such an asset should not be an NPA.
2. Sub-standard Assets

(I) with effect from March 31, 2005 an asset would be classified as Sub-standard if it remained NPA for a period less than or equal to
12 months. In such cases, the current net worth of the borrowers/ guarantors or the current market value of the security charged is not
enough to ensure recovery of the dues to the banks in full. In other words, such assets will have well defined credit weaknesses that
jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if
deficiencies are not corrected.

(ii) An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or rescheduled after
commencement of production, should be classified as substandard and should remain in such category for at least 12 months of
satisfactory performance under the re-negotiated or rescheduled terms. In other words, the classification of an asset should not be
upgraded merely as a result of rescheduling, unless there is satisfactory compliance of this condition.

3) Doubt full assets

With effect from March 31, 2005, an asset is required to be classifieds doubtful, if it has remained NPA for more than 12 months. For
Tier I banks, the 12-month period of classification of a substandard asset in doubtful category is effective from April 1, 2009. As in
the case of sub-standard assets, rescheduling does not entitle the bank to upgrade the quality of an advance automatically. A loan
classified as doubtful has all the weaknesses inherent as that classified as sub-standard, with the added characteristic that the
weaknesses Make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable
and improbable.

Note: Consequent to change in asset classification norms w.e.f. March 31, 2005 banks are permitted to phase the consequent
additional provisioning over a five year period commencing from the year ended March 31, 2005, with a minimum of 10 % of the
required provision in each of the first two years and the balance in equal installments over the subsequent three years.

4) Loss Assets A loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation
Department or by the Reserve Bank of India inspection but the amount has not been written off, wholly or partly. In other words, such
an asset is considered un-collectible and of such little value that its continuance as a bankable asset is not warranted although there
may be some salvage or recovery value.

Guidelines for Classification of Assets

Basic Considerations

(I) broadly speaking, classification of assets into above categories should be done taking into account the degree of well defined credit
weaknesses and extent of dependence on collateral security for realization of dues.

(ii) In respect of accounts where there are potential threats to recovery on account of erosion in the value of security and existence of
other factors such as, frauds committed by borrowers, it will not be prudent for the banks to classify them first as sub-standard and
then as doubtful after expiry of 12 months from the date the account has become NPA. Such accounts should be straight away
classified as doubtful asset or loss asset, as appropriate, irrespective of the period for which it has remained as NPA.

Internal System for Classification of Assets as NPA

I) Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs,
especially in respect of high value accounts. The banks may fix a minimum cut-off point to decide what would constitute a high value
account depending upon their respective business levels. The cut-off point should be valid for the entire accounting year.

(ii) Responsibility and validation levels for ensuring proper asset classification may be fixed by the bank.

(iii) The system should ensure that doubts in asset classification due to any reason are settled through specified internal channels
within one month from the date on which the account would have been classified as NPA as per extant guidelines.

(iv) RBI would continue to identify the divergences arising due to non-compliance, for fixing accountability. Where there is willful
non-compliance by the official responsible for classification and is well documented, RBI would initiate deterrent action including
imposition of monetary penalties.

Income Recognition – Policy

1. The policy of income recognition has to be objective and based

on the record of recovery. Income from non-performing assets
(NPA) is not recognized on accrual basis but is booked as
income only when it is actually received. Therefore, banks
should not take to income account interest on non-performing
assets on accrual basis.

2. 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.

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

4. If Government guaranteed advances become 'overdue' and

thereby NPA, the interest on such advances should not be
taken to income account unless the interest has been realized.

Provisional norms and disclosure norms of NPA

RBI guidelines on provisioning requirement of bank advances

As and when an asset is classified as an NPA, the bank has to further sub-classify it into sub-standard, loss and doubtful assets. Based
on this classification, bank makes the necessary provision against these assets.

Reserve Bank of India (RBI) has issued guidelines on provisioning requirements of bank advances where the recovery is doubtful.
Banks are also required to comply with such guidelines in making adequate provision to the satisfaction of its auditors before declaring
any dividends on its shares.

In case of loss assets, guidelines specifically require that full provision (100%) for the amount outstanding should be made by the
concerned bank. This is justified on the grounds that such an asset is considered uncollectible and cannot be classified as bankable

Also in case of doubtful assets, guidelines requires the bank concerned to provide entirely the unsecured portion and in case of secured
portion an additional provision of 20%-50% of the secured portion should be made depending upon the period for which the advance
has been considered as doubtful.
For instance, for NPAs which are up to 1-year old, provision should be made of 20% of secured portion, in case of 1-3 year old NPAs
up to 30% of the secured portion and finally in case of more than 3 year old NPAs up to 50% of secured portion should be made by
the concerned bank.

In case of a sub-standard asset, a general provision of 10% of total outstanding should be made.

Standard Assets – general provision of a minimum of 0.25%

Reserve Bank of India (RBI) has merely laid down the minimum provisioning requirement that should be complied with by the
concerned bank on a mandatory basis. However, where there is a substantial uncertainty to recovery, higher provisioning should be made
by the bank concerned.


Standard assets General provision of 0.25%

Sub standard assets 10% on total outstanding balance, 10 %

on unsecured exposures identified as
sub-standard & 100% for unsecured
“doubtful” assets.

Doubtful debts 100% to the extent advance not covered by

realizable value of security. In case of
secured portion, provision may be made in
the range of 20% to 100% depending on
the period of asset remaining sub-standard

Loss assets 100% of the out standing

Disclosure Norms:
Banks should disclose in balance sheets maturity pattern of advances, deposits, investments and borrowings. Apart from this, banks
are also required to give details of their exposure to foreign currency assets and liabilities and movement of bad loans. These
disclosures were to be made for the year ending March 2000

In fact, the banks must be forced to make public the nature of N.P.As being written off. This should be done to ensure that the
taxpayer’s money given to the banks, as capital is not used to write off private loans without adequate efforts and punishment of
defaulters. # A Close look: For the future, the banks will have to tighten their credit evaluation process to prevent this scale of sub-
standard and loss assets. The present evaluation process in several banks is burdened with a bureaucratic exercise, sometimes
involving up to 18 different officials, most of whom do not add any value (information or judgment) to the evaluation. But whether
this government and its successors will continue to play with bank funds remains to be seen. Perhaps even the loan waivers and loan
"melas" which are often decried by bankers form only a small portion of the total N.P.As. As mentioned above, much more stringent
disclosure norms are the only way to increase the accountability of bank management to the taxpayers. A lot therefore
depends upon the seriousness with which a new regime of regulation is pursued by RBI and the newly formed Board for Financial

Treatment of NPAs – Borrower-wise and not Facility-wise

(i) In respect of a borrower having more than one facility with a bank, all the facilities granted by the bank will have to be treated as
NPA and not the particular facility or part thereof which has become irregular.

(ii) However, in respect of consortium advances or financing under multiple banking arrangements, each bank may classify the
borrowal accounts according to its own record of recovery and other aspects having a bearing on the recoverability of the advances.

Global Developments and NPAs

The core banking business is of mobilizing the deposits and utilizing it for lending to industry. Lending business is generally
encouraged because it has the effect of funds being transferred from the system to productive purposes which results into economic

However lending also carries credit risk, which arises from the failure of borrower to fulfill its contractual obligations either during the
course of a transaction or on a future obligation
A question that arises is how much risk can a bank afford to take? Recent happenings in the business world - Enron, WorldCom,
Xerox, Global Crossing do not give much confidence to banks. In case after case, these giant corporate became bankrupt and failed to
provide investors with clearer and more complete information thereby introducing a degree of risk that many investors could neither
anticipate nor welcome. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit

Due to this, banks are restricting their lending operations to secured avenues only with adequate collateral on which to fall back upon in
a situation of default.

Why such huge levels of NPAs exist in the Indian banking system (IBS)?

The origin of the problem of burgeoning NPAs lies in the quality of managing credit risk by the banks concerned. What is needed is
having adequate preventive measures in place namely, fixing pre-sanctioning appraisal responsibility and having an effective post-
disbursement supervision. Banks concerned should continuously monitor loans to identify accounts that have potential to become non-

Why NPAs have become an issue for banks and financial institutions in India?

To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However,
increasing NPAs have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at
the same time banks are forced to make provision on such assets as per the Reserve Bank of India (RBI) guidelines.

Also, with increasing deposits made by the public in the banking system, the banking industry cannot afford defaults by borrower s
since NPAs affects the repayment capacity of banks.

Further, Reserve Bank of India (RBI) successfully creates excess liquidity in the system through various rate cuts and banks fail to utilize
this benefit to its advantage due to the fear of burgeoning non-performing assets.

Health code system

A critical analysis of a comprehensive and uniform credit monitoring was introduced in 1985-86 by RBI by way of the Health Code
System in banks, which inter alia, provided information regarding the health of individual advances, the quality of credit portfolio and
extent of advances causing in relation to total advances. It was considered that such information would be of immense use to bank
management for control purposes. The RBI advised all commercial banks to introduce the Health Code Classification indicating the
quality of individual advances in the following eight categories with a health code assigned to each borrowal account:
1. Satisfactory: Conduct is satisfactory, all terms and conditions are compiled with, all accounts are in order, and safety of the
account is not in doubt.
2. Irregular: The safety of the advances is not suspected, though there may be occasional irregularities, which may be considered
to be as a short-term phenomenon.
3. Sick-Viable: Advances to units, which are sick but viable under nursing and unit in respect of which nursing/revival programs
are taken up.
4. Sick-Nonviable/Sticky:

The irregularities continue to persist and there are no immediate prospects of regularization, the accounts could throw some of the
usual signs of incipient sickness.
5. Advances Recalled: Accounts where the repayment is highly doubtful and nursing is not considered worthwhile, includes
where decisions have been taken to recall the advances.
6. Suit Filed Accounts: Accounts where legal actions or recovery proceedings have been initiated.

7. Decreed Debts: Where decrees have been obtained.

8. Bad and Doubtful Debts: Where the recoverability of the banks’ dues has become doubtful on account of shortfall in value of
security, difficulty in enforcing and realizing the securities, or inability/unwillingness of the borrowers to repay the banks’ dues partly
or wholly.

According to recent study conducted by the RBI, the underlying reasons for NPAs in India can be classified into two
heads, namely:

a) internal factors
b) external factors


The following internal factors contribute to NPAs in the order of performance:

1. Defective Lending process

There are three cardinal principles of bank lending that have been followed by the commercial banks since long
Principles of safety
Principle of liquidity
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:

a. Capacity to pay

b. Willingness to pay

Capacity to pay depends upon:

1. Tangible asset
2. success in business
Willingness to pay
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.

2. 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
3. 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.

• Purpose of the loan

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 4.
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

5. 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
Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom
industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), And the handloom sector Orissa hand loom WCS ltd

6. 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.

7. 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.


The external factors that contribute to NPAs are the following:

1. 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.

2. 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.

3. 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.
4. Industrial sickness

Improper project handling , ineffective management , lack of adequate resources , lack of advance technology , day to day changing
govt. Policies give birth to industrial sickness. Hence the banks that finance those industries ultimately end up with a low recovery of
their loans reducing their profit and liquidity.

5. 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.

6. 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 Cooperative 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.


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.


1. 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.

2. 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. Routine payments and dues.

3. 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.

4. 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.
Preventive measures of NPAs

1. 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.

2. 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 have intelligent
inputs with regard to promoters' sincerity, and capability to achieve turnaround. Bases 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

3. Timeliness and adequacy of resources

Longer the delay in response, grater 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.
4. 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.

5. 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 align 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.

6. 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 arrangement

Different Approaches to Valuation of Non Performing Assets

N.P.As are by-product of most financial systems and the level of N.P.As is an indicator of the health of the financial system of an
economy. Valuation techniques should present the situation, which maximize the overall interest of all the concerned parties.

The broad objectives of the valuation framework are essentially:

1. To set a sound basis for the selling bank/institution to finalize the
Sale of assets,
2. To provide a basis for the fair market value of the assets,
3. To promote transparency of the valuation processes and,.
4. To comply with internationally accepted practices.

The valuation of an asset or the pool of assets is a precursor to any restructuring exercise. Any valuation exercise shall attempt to
address the following issues:
• The fair market value of the asset should represent the price at which market participants would undertake a restructuring.
• The transaction value should reflect the potential for income generation and return of principal, balanced against the applicable
risk profile and market lending margins.
• The valuation framework should allow for valuation of specific assets as well as a portfolio of assets (i.e. portfolio of loans to
be acquired from a bank.) In most cases, a single value will apply to each loan required. For larger loans, however, an element
of risk/return sharing with the selling bank may be considered.

There are various methodologies used to value the companies or their debt. Typically, cash flows, assets or replacement values, or a
combination of these, are considered when determining the value of the company or its debt. Some of the widely used approaches
towards valuation of an NPA by the valuation firms are detailed as under:

1. Discounted Cash Flows

One of the commonly used methods for estimating the value of the company’s debt is the anticipated cash flow. The cash flow stream
will represent the interest and principal payments expected to be received by the lender, primarily out of the internal cash flow
generation from underlying business activities. Where the asset is a partly completed project, the cash flow stream will have to take
onto account whether the project will be completed and if so how it will be financed. If certain lenders decide to fund through
extended facility, this will be taken into account I the asset’s cash flow stream. Essentially the decision on the project’s financial
viability will be determined by using an incremental cash flow analysis. Normally, the value of a healthy asset is computed as the
discounted value of the expected future cash flows. However, a company is distress or an NPA may have negative earnings and may
be likely to incur operating losses for the next few years. For such companies, the estimation of future cash flows is not so easy, as
there is a strong possibility of bankruptcy. Under such a scenario the asset valuation is also based on subjective parameters. A
company under financial distress has some or all of the following characteristics: operating loss, inability to meet the debt obligations
and high debt equity ratio. When dealing with such cases, the credit analysts need to evaluate the possibility and timing of positive
financial performance of the company of infusion of additional funds and the overall macro economic environment. If the company is
expected to improve its financial position in the future, the following discounted cash flow model may be used for the distress
companies/ NPAs.

2. Liquidation Value Approach

If the loan is in default with no or low expectations of its being services, the cash flow from liquidation of the asset and collateral will
be the primary approach rather than net present value of the cash flow. In this case, the take out of the lender is primarily by way of
exercise of their rights on the assets and attached collateral. The liquidation value of the company is the aggregate of the value of the
assets of the company if solid at the market rates, net of transactions and legal costs. The estimation of the assets becomes quite
complicated when the assets of the company cannot be easily separated like in a steel, textile or petrochemical plant. If such assets are
sold individually, majority of the asset may not fetch a price closer to their books value. Further, when such sale is to take place at a
quick place, the value of the assets further fall down, as it is more or less equal to forced sale of the assets. As a result of this forced
sale, the seller has to accept a discount on the fair market value of such assets. In most cases, such a realization is not able to cover
even the secured debt fully and hence the valuation of the debt would be limited by this realized value. This approach has been widely
used in countries like Thailand where a significant number of loans were secured by real estate and other marketable securities of
various kinds.

3. Earning Model

In performing companies, the P/E ration of the industry or other similar companies may be used as a tool for determining the market
value of the assets of company. If the debt of the company is more than its assets, then a proportionate discount may be applied to the
debt. The above approach, however, cannot be used for most of the N.P.As, as they would have negative EPS. In such cases, the cash
earning per share of the company and cash P/E ratio of the similar companies may be used to arrive at a market value of the NPA

4. Case Specific Valuation Model -

Depending on case to case, various models have been evolved and used for specific requirements. I shall discuss here one of such
models to provide an insight as to how provide varied models can be from the conventional approaches.

Segmentation into buckets:

For a huge portfolio of small loans, different kind of approach may be used for arriving at the realistic valuation. One of them is
categorizing the loans in various buckets and then analyzing a sample picked from various buckets. Post currency crisis of late 1990’s
in Thailand, the price of real estate had declined to abysmally low levels and majority of the property-linked loans had become N.P.As
in the books of the local banks. One of the leading financial companies in the world was contemplating to purchase these loans
totaling over 20,000 small loans. For arriving at the appropriate valuation, they had followed the following methodology:

■ Segmentation of the assets in various buckets.

■ Selection of a sample out of each bucket.
■ Detailed analysis of each sample.
■ Statistical extrapolation of the sample to the entire bucket.
■ Arriving at the final range of the valuation of the portfolio.

1. LokAdalat:

Lok Adalat institutions help banks to settle disputes involving account in "doubtful" and "loss" category, with outstanding balance
of Rs.5 lakh for compromise settlement under Lok Adalat. Debt recovery tribunals have been empowered to organize Lok Adalat
to decide on cases of NPAs of Rs. 10 lakh and above. This mechanism has proved to be quite effective for speedy justice and
recovery of small loans. The progress through this channel is expected to pick up in the coming years.

Referring the cases to lakadalats constituted under the legal services authorities act, 1987 which help in resolving disputes
between the parties by conciliation, mediation, compromise, or amicable settlement. Every award of the lokadalt shall be deemed
to be a decree of a civil court.

2. CDR: -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 substandard accounts with consortium/multiple banking arrangements.

The objective of CDR is to ensure a timely and transparent mechanism for restructuring of the debts of viable corporate entities
affected by internal and external factors, outside the purview of BIFR, DRT or other legal proceedings.

The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All participants in the CDR mechanism must
enter the ICA with necessary enforcement and penal clauses.

The scheme applies to accounts having multiple banking/ syndication/ consortium accounts with outstanding exposure of Rs.10 crore
and above. The CDR system is applicable to standard and sub-standard accounts with potential cases of NPAs getting a priority.
Packages given to borrowers are modified time & again Drawback of CDR – Reaching of consensus amongst the creditors delays the
3.DRT ACT: -

The banks and FIs can enforce their securities by initiating recovery proceeding under the Recovery if Debts due to Banks and FI
act, 1993 (DRT Act) by filing an application for recovery of dues before the Debt Recovery Tribunal constituted under the Act. On
adjudication, a recovery certificate is issued and the sale is carried out by an auctioneer or a receiver.

DRT has powers to grant injunctions against the disposal, transfer or creation of third party interest by debtors in the properties
charged to creditor and to pass attachment orders in respect of charged properties. In case of non-realization of the decreed amount by
way of sale of the charged properties, the personal properties if the guarantors can also be attached and sold. However, realization is
usually time-consuming. Steps have been taken to create additional benches.


For claims below Rs.10 lacks, the banks and FIs can initiate proceedings under the Code of Civil Procedure of 1908, as amended, in
a civil court.

The courts are empowered to pass injunction orders restraining the debtor through itself or through its directors, representatives, etc
from disposing of, parting with or dealing in any manner with the subject property.

Courts are also empowered to pass attachment and sales orders for subject property before judgment, in case necessary.

The sale of subject property is normally carried out by way of open public auction subject to confirmation of the court. The
foreclosure proceedings, where the DRT Act is not applicable, can be initiated under the Transfer of Property Act of 1882 by filing a
mortgage suit where the procedure is same as laid down under the CPC.


BIFR has been given the power to consider revival and rehabilitation of companies under the Sick Industrial Companies (Special
Provisions) Act of 1985 (SICA), which has been repealed by passing of the Sick Industrial Companies (Special Provisions) Repeal
Bill of 2001.

The board of Directors shall make a reference to BIFR within sixty days from the date of finalization of the duly audited accounts for
the financial year at the end of which the company becomes sick. The company making reference to BIFR to prepare a scheme for its
revival and rehabilitation and submit the same to BIFR the procedure is same as laid down under the CPC.The shelter of BIFR
misused by defaulting and dishonest borrowers It is a time consuming process.


In December 2002, the Indian Parliament passed the Companies Act of 2002 (Second Amendment) to restructure the Companies Act,
1956 leading to a new regime of tackling corporate rescue and insolvency and setting up of NCLT.

NCLT will abolish SICA; have the jurisdiction and power relating to winding up of companies presently vested in the High Court and
jurisdiction and power exercised by Company Law Board

The second amendments seeks to improve upon the standards to be adopted to measure the competence, performance and services of a
bankruptcy court by providing specialized qualification for the appointment of members to the NCLT.

However, the quality and skills of judges, newly appointed or existing, will need to be reinforced and no provision has been made for
appropriate procedures to evaluate the performance of judges based on the standards
Writing off of NPAs

1. In terms of Section 43(D) of the Income Tax Act 1961, income by way of interest in relation to such categories of bad and
doubtful debts as may be prescribed having regard to the guidelines issued by the RBI in relation to such debts, shall be
chargeable to tax in the previous year in which it is credited to the bank’s profit and loss account or received, whichever is

2. This stipulation is not applicable to provisioning required to be made as indicated above. In other words, amounts set aside
for making provision for NPAs as above are not eligible for tax deductions.

3. Therefore, the banks should either make full provision as per the guidelines or write-off such advances and claim such tax
benefits as are applicable, by evolving appropriate methodology in consultation with their auditors/tax consultants. Recoveries
made in such accounts should be offered for tax purposes as per the rules.

4 Write-off at Head Office Level

Banks may write-off advances at Head Office level, even though the relative advances are still outstanding in the branch
books. However, it is necessary that provision is made as per the classification accorded to the respective accounts. In other
words, if an advance is a loss asset, 100 percent provision will have to be made therefore.

Credit Risk and NPAs

Quite often credit risk management (CRM) is confused with managing non-performing assets (NPAs). However there is an
appreciable difference between the two. NPAs are a result of past action whose effects are realized in the present i.e. they represent credit
risk that has already materialized and default has already taken place.

On the other hand managing credit risk is a much more forward-looking approach and is mainly concerned with managing the
Quality of credit portfolio before default takes place. In other words, an attempt is made to avoid possible default by properly managing
credit risk.

Considering the current global recession and unreliable information in financial statements, there is high credit risk in the banking and
lending business.

To create a defense against such uncertainty, bankers are expected to develop an effective internal credit risk models for the purpose of
credit risk management.

How important is credit rating in assessing the risk of default for lenders?

Fundamentally Credit Rating implies evaluating the creditworthiness of a borrower by an independent rating agency. Here objective is
to evaluate the probability of default. As such, credit rating does not predict loss but it predicts the likelihood of payment problems.

Credit rating has been explained by Moody's a credit rating agency as forming an opinion of the future ability, legal obligation and
willingness of a bond issuer or obligor to make full and timely payments on principal and interest due to the investors.

Banks do rely on credit rating agencies to measure credit risk and assign a probability of default.
Credit rating agencies generally slot companies into risk buckets that indicate company's credit risk and is also reviewed periodically.
Associated with each risk bucket is the probability of default that is derived from historical observations of default behavior in each risk

However, credit rating is not fool-proof. In fact, Enron was rated investment grade till as late as a month prior to it's filing for Chapter 11
bankruptcy when it was assigned an in-default status by the rating agencies. It depends on the information available to the credit rating
agency. Besides, there may be conflict of interest which a credit rating agency may not be able to resolve in the interest of investors and

Stock prices are an important (but not the sole) indicator of the credit risk involved. Stock prices are much more forward looking in
assessing the creditworthiness of a business enterprise. Historical data proves that stock prices of companies such as Enron and
WorldCom had started showing a falling trend many months prior to it being downgraded by credit rating agencies.
Usage of financial statements in assessing the risk of default for lenders

For banks and financial institutions, both the balance sheet and income statement have a key role to play by providing valuable
information on a borrower’s viability. However, the approach of scrutinizing financial statements is a backward looking approach. This
is because; the focus of accounting is on past performance and current positions.

The key accounting ratios generally used for the purpose of ascertaining the creditworthiness of a business entity is that of debt-equity
ratio and interest coverage ratio. Highly rated companies generally have low leverage. This is because; high leverage is followed by
high fixed interest charges, non-payment of which results into a default.
Capital Adequacy Ratio (CAR) of RBI and Basle committee on banking supervision (BCBS)
Reserve Bank of India (RBI) has issued capital adequacy norms for the Indian banks. The minimum CAR which the Indian Banks
are required to meet at all times is set at 9%. It should be taken into consideration that the bank's capital refers to the ability of bank
to withstand losses due to risk exposures.

To be more precise, capital charge is a sort of regulatory cost of keeping loans (perceived as risky) on the balance sheet of banks. The
quality of assets of the bank and its capital are often closely related. Quality of assets is reflected in the quantum of NPAs. By this, it
implies that if the asset quality was poor, then higher would be the quantum of non-performing assets and vice-versa.

Market risk is the risk arising due to the fluctuations in value of a portfolio due to the volatility of market prices.

Operational risk refers to losses arising due to complex system and processes.

It is important for a bank to have a good capital base to withstand unforeseen losses. It indicates the capability of a bank to sustain
losses arising out of risky assets.

The Basel Committee on Banking Supervision (BCBS) has also laid down certain minimum risk based capital standards that apply to
all internationally active commercial banks. That is, bank's capital should at least be 8% of their risk-weighted assets. This in fact helps
bank to provide protection to the depositors and the creditors

The main objective here is to build a sort of support system to take care of unexpected financial losses thereby ensuring healthy
financial markets and protecting depositors.

Excess liquidity? No problem, but no lending please!!!

One should also not forget that the banks are faced with the problem of increasing liquidity in the system. Further, Reserve Bank of
India (RBI) is increasing the liquidity in the system through various rate cuts. Banks can get rid of its excess liquidity by increasing its
lending but, often shy away from such an option due to the high risk of default.

In order to promote certain prudential norms for healthy banking practices, most of the developed economies require all banks to
maintain minimum liquid and cash reserves broadly classified into Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio

Cash Reserve Ratio (CRR) is the reserve which the banks have to maintain with itself in the form of cash reserves or by way of current
account with the Reserve Bank of India (RBI), computed as a certain percentage of its demand and time liabilities. The objective is to
ensure the safety and liquidity of the deposits with the banks.

On the other hand, Statutory Liquidity Ratio (SLR) is the one which every banking company shall maintain in India in the form of cash,
gold or unencumbered approved securities, an amount which shall not, at the close of business on any day be less than such percentage
of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight, as the Reserve Bank of
India (RBI) may specify from time to time.

A rate cut (for instance, decrease in CRR) results into lesser funds to be locked up in RBI's vaults and further infuses greater funds into
a system. However, almost all the banks are facing the problem of bad loans, burgeoning non-performing assets, thinning margins, etc.
as a result of which, banks are little reluctant in granting loans to corporate.

As such, though in its monetary policy RBI announces rate cut but, such news are no longer warmly greeted by the bankers.

High cost of funds due to NPAs

Quite often genuine borrowers face the difficulties in raising funds from banks due to mounting NPAs. Either the bank is reluctant in
providing the requisite funds to the genuine borrowers or if the funds are provided, they come at a very high cost to compensate the
lender’s losses caused due to high level of NPAs.

Therefore, quite often corporate prefer to raise funds through commercial papers (CPs) where the interest rate on working capital
charged by banks is higher. With the enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002, banks can issue notices to the defaulters to pay up the dues and the borrowers will have to clear their dues
within 60 days. Once the borrower receives a notice from the concerned bank and the financial institution, the secured assets mentioned
in the notice cannot be sold or transferred without the consent of the lenders.
The main purpose of this notice is to inform the borrower that either the sum due to the bank or financial institution is paid by the
borrower or else the former will take action by way of taking over the possession of assets. Besides assets, banks can also takeover the
management of the company.

Thus the bankers under the aforementioned Act will have the much needed authority to either sell the assets of the defaulting companies
or change their management.

But the protection under the said Act only provides a partial solution. What banks should ensure is that they should move with speed
and charged with momentum in disposing off the assets. This is because as uncertainty increases with the passage of time, there is all
possibility that the recoverable value of asset also reduces and it cannot fetch good price. If faced with such a situation than the very
purpose of getting protection under the Securitization Act, 2002 would be defeated and the hope of seeing a must have growing
banking sector can easily vanish.

Reporting of NPAs to RBI

1) 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 Annex I.

2) 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 and net advances. 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.

3) 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.