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Debarshi Ghosh Assistant Professor, Management Science Department Meghnad Saha Institute of Technology, Kolkata, India Email: Contact No: +919331279436

Sukanya Ghosh Assistant Professor, Head, Management Science Department Meghnad Saha Institute of Technology, Kolkata, India Email: Contact No: +919836196040
ABSTRACT This study emphasizes on management of non-performing assets in the perspective of the public sector banks in India under strict asset classification norms, use of latest technological platform based on Core Banking Solution, recovery procedures and other bank specific indicators in the context of stringent regulatory framework of the Reserve Bank of India. Non-performing Asset is an important parameter in the analysis of financial performance of a bank as it results in decreasing margin and higher provisioning requirement for doubtful debts. Various banks from different categories together provide advances to different sectors like agricultural, SSI, priority sector, public sector & others. These advances require pre-sanctioning appraisal and post-disbursement control to contain increasing non-performing assets in the Indian Banking Sector. The reduction of non-performing asset is necessary to improve profitability of banks and comply with the capital adequacy norms as per the Basel Accord. This study traces the movement of the nonperforming assets present in public sector banks of India by analyzing the financial performance of the banks with respect to key performance indicators and management of the non-performing assets under the purview of new policy actions and regulatory compliance of the Reserve Bank of India. Key Words: Non-performing assets, Performance indicators, Regulatory compliance, Capital adequacy norms. 1. INTRODUCTION According to Reserve Bank of India (RBI) (2010), an asset including a leased asset, becomes non-performing when it ceases to generate income for the bank. Since the NPA of banks is an important criterion to assess the financial health of banking sector (Jaynal Ud-Din Ahmed, 2010), identification of potential problem accounts and their close monitoring assumes importance. Though most banks have Early Warning Systems (EWS) for identification of potential non-performing assets (NPAs), the actual processes followed varies from bank to bank. The major components or processes of a EWS followed by banks in India as brought out by a study conducted by Reserve Bank of India at the instance of the Board of Financial Supervision are as follows: Designating Relationship Manager / Credit Officer for monitoring account/s



Preparation of know your client profile Credit rating system Identification of watch-list/special mention category accounts Monitoring of early warning signals The finance ministry has recently asked government banks to shift to a system where non-performing assets (NPAs) are identified by technology. This will help the banks to avoid human interference. The ministry told the government banks to put the system in place by March 2011. However, after requests by public sector banks, the government has given a six-month extension for classifying non-performing assets (NPAs) using technology. Now, the deadline has been extended by six months to September 30, 2011. The countrys largest lender, State Bank of India (SBI), and large banks like Union Bank of India, have told the ministry that they calculate NPAs on the Core Banking Solution (CBS) platform. Punjab & Sind Bank has recently started the CBS rollout. Currently, only Indian Bank and SBI have started calculating NPA under the technological platform called the Core Banking Solution system. Most other PSU banks are in the final stages of migrating to CBS and calculating NPAs under the CBS system. Taori (2000) has dealt with NPAs management of banks and stated that the surest way of containing NPAs is to prevent their occurrences. He suggests proper risk management, strong and effective credit monitoring, co-operative working relationship between banks and borrowers etc as tenets of NPAs management policy. Since, management quality of credit risk by the banks is a reason for ballooning NPAs, banks concerned are continuously monitoring loans to identify accounts that have potential to become non-performing as banks need to maintain have adequate capital to support all the risks. Under the Basel II Norms, banks should maintain a minimum capital adequacy requirement of 8% of risk assets. All commercial banks in India excluding Regional Rural Banks and Local Area Banks have become Basel II compliant. For India, the Reserve Bank of India has mandated maintaining of 9% minimum Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR). The major challenge the country's financial system faces today is to bring informal loans into the formal financial system. By implementing Basel II norms banks involved significant changes in business model in which potential economic impacts can be carefully monitored. It is important to note that RBI has introduced stringent policy norms for Indian banks with the purpose of making Indian banking business at par with global standards and make it more reliable, transparent and safe. These norms are necessary since India is a developing economy and it is witnessing increased capital flows from foreign countries and there is increasing international economic & financial transactions.


Management of non-performing assets (NPAs) by banks remains an area of concern, particularly, due to the
likelihood of deterioration in the quality of restructured advances, RBI said in its annual Report on Trend and Progress of Banking in India for the year ended March 31, 2010. Banking crisis exists in the country if the level of NPAs touches 10 percent of GDP (Khan and Bishnoi, 2001). Though the banking reforms spearheaded by the Narasimham Committee have been proceeding in a phased manner in the country, the high level of NPAs poses a serious hurdle for pushing through the reforms (Velayudham, 2001). The loss of income from NPAs not only brings down the level of income of the banks but also hinders them from quoting finer Prime Lending Rates (PLR) (Jain and Balachandran, 1997). The loan portfolio with NPAs reduces the liquidity position of the credit institution. Loans classified as NPAs affect the interest of both the borrowers and the credit agency. Keeton (1999) uses data from 1982 to 1996 and a vector auto regression model to analyze the impact of credit growth and loan delinquencies in the US. It reports evidence of a


strong relationship between credit growth and impaired assets. Specifically, Keeton (1999) shows that rapid credit growth, which was associated with lower credit standards, contributed to higher loan losses in certain states in the US. In this study loan delinquency was defined as loans which are overdue for more than 90 days or does not accrue interest. Studies that examined other financial systems also provide similar results to those in the US. For instance, Bercoff et al (2002) examine the fragility of the Argentinean Banking system over the 1993-1996 period; they argue that non-performing loans (NPLs) are affected by both bank specific factors and macroeconomic factors. Using a dynamic model and a panel dataset covering the period 1985-1997 to investigate the determinants of problem loans of Spanish commercial and saving banks, Salas and Saurina (2002) reveal that real growth in GDP, rapid credit expansion, bank size, capital ratio and market power explain variation in NPLs. Furthermore, Jimenez and Saurina (2006) examine the Spanish banking sector from 1984 to 2003; they provide evidence that NPLs are determined by GDP growth, high real interest rates and lenient credit terms. This study attributes the latter to disaster myopia, herd behavior and agency problems that may entice bank managers to lend excessively during boom periods. Meanwhile, Rajan and Dhal (2003) utilize panel regression analysis to report that favorable macroeconomic conditions (measured by GDP growth) and financial factors such as maturity, cost and terms of credit, banks size, and credit orientation impact significantly on the NPLs of commercial banks in India. It has also been viewed that banks' lending policy could have crucial influence on non- performing loans (Reddy, 2004). He critically examined various issues relating to terms of credit of Indian banks. Mohan (2003) conceptualized 'lazy banking' while critically analyzing on banks' investment portfolio and lending policy. The Indian viewpoint regarding the concepts of 'credit culture' owing to Reddy (2004) and 'lazy banking' owing to Mohan (2003) has an international perspective since several studies in the banking literature agree that banks' lending policy is a major driver of non-performing loans (McGoven,1998; Sergio,1996; Bloem and Gorters,2001). Sergio (1996) in a study of non-performing loans in Italy found evidence that, an increase in the riskiness of loan assets is rooted in a bank's lending policy adducing to relatively unselective and inadequate assessment of sectoral prospects. Banking business is exposed to various risks such as credit risk, liquidity risk, interest risk, market risk, operational risk, and management risk. But, credit risk stands out as the most detrimental of them all (Iyer, 1999). The risk of erosion in asset value due to simple default or non-payment of dues by the borrowers is credit risk or default risk (Sarma, 1996). 3. THEORETICAL FRAMEWORK According to Peter Spicka (2008) The extent and nature of banking crises vary substantially. A common observation is that financial crises often spread to the real sphere of the economy. So, the stability of the overall financial system depends highly on the financial soundness of banks. This study analyses the financial soundness of Indian banks during the year 2009-10 under the enhanced Basel II framework. The Indian banking system withstood the pressures of the global financial crisis and a factor that facilitated the normal functioning of the banking system even in the face of one of the largest global financial crisis was its robust capital adequacy. Core CRAR reflecting the paid up capital and reserves generally forms the prime measure of the financial strength of any bank. In the case of Indian banks, core capital (measured by Tier I capital) made up about 70 per cent of the total capital at end-March 2010. While the capital adequacy of Indian banks remained robust, there were some emerging concerns with regard to NonPerforming Assets (NPAs). As part of the policy measures adopted to deal with the contagion from the global crisis, the risk weights and provisioning prescriptions had been relaxed in November 2008 as a countercyclical measure. However, in view of large increase in credit to the commercial real estate sector and the extent of restructured advances in this sector, the provision required on standard assets in the commercial real estate sector was increased from 0.40 per cent to 1 per cent in November 2009 for building up cushion against likely deterioration in asset quality. It was decided in October 2009 that banks should augment their provisioning cushions consisting of specific provisions against NPAs as well as floating provisions, and ensure that their total Provisioning Coverage Ratio, including floating provisions, is not less than 70 per cent by September 2010. Banks were advised in June 2010 that adequate care should be taken to ensure that the compromise settlements are done in a fair and transparent manner


and in full compliance with the RBI guidelines. It was also decided that, henceforth, the officer/authority sanctioning a compromise/one time settlement should append a certificate stating that the compromise settlements are in conformity with the Reserve Bank guidelines. 4. METHODOLOGY The study is based on secondary data where a major portion of the data is extracted from Report on Trend and Progress of Banking in India 2009-2010 and statistical tables relating to banks in India as published by RBI. Secondary data was also collected from reports, journals and websites for the latest happenings in the banking sector in India. The study mainly focuses on the composition, trend and management of non-performing assets in public sector banks and RBI norms on capital adequacy. So, the data was mostly used to support the study and for logical analysis of the bank specific parameters through charts and tables. Public sector banks in India include seven banks under the State Bank of India group and twenty other nationalized banks. 5. DATA ANALYSIS The average CRAR of public sector banks under Basel-I and Basel-II framework, at the end of March 2009 and March 2010, has been adequate as can be seen from Table 1. State bank of India and its associate banks have shown an increase in average CRAR of 0.24 per cent under Basel-I norms i.e. from 12.0728 per cent at the end of March 2009 to 12.3128 per cent at the end of March 2010. The group has also shown a marginal increase in average CRAR of 0.1657 per cent under Basel-II norms during the same period. Other nationalized banks have also improved their CRAR requirement by 0.0125 per cent under Basel-I norms and by 0.0495 per cent under Basel-II norms in the same period. This signified that Indian banks successfully managed to meet the increased capital requirement under the changed framework.
(in cent) Table 1: Average CRAR of Public Sector Banks under Basel-I & Basel-II (as on 31.03.09 & 31.03.10) Banks Basel-I (2009) Basel-II (2009) Basel-I (2010) Basel-II (2010) SBI & Its 12.0728 13.3400 12.3128 13.5057 Associates Other 12.0255 13.1380 12.0380 13.1875 Nationalized Banks per

The increase in CRAR, however, cannot undermine the fact that quality of advances has deteriorated as can been seen through increased NPAs of public sector banks in India in recent years (as shown in Chart 1). NPAs of public sector banks in India has shown a steady decline from the high of Rs. 544234.4 millions in the financial year (FY) ending on Mar 31, 2002 to a low of Rs. 386018 millions in the FY 2007. It increased marginally in the FY 2008 to Rs. 397485.2 millions. After 2008 it increased to a higher level of Rs. 440424.8 million in the FY 2009 and jumped to a new high of Rs. 573008.8 million in the FY 2010. The trend has been shown in Chart 1. Within the public sector banks, SBI & its Associate banks have shown the same trend in NPAs as other nationalized banks. It suggests that the trend in NPAs through the years was not bank specific but external factors were into play.


Chart 1 : Non-performing Assets of Public Sector Banks from Mar 31, 2001 to Mar 31, 2010

When we look into the composition of NPAs from FY 2001 to FY 2010 (as shown in Chart 2), we find that proportion of priority sector NPAs is almost consistent throughout the years except for a rise in FY 2010. On the other hand non-priority sector NPAs have shown a consistent decline from a high of Rs. 283707.1 millions in the FY 2002 to a low of Rs.141631.6 millions in the FY 2008.However, it has steadily increased to Rs.192511.5 millions in the FY 2009 and jumped to Rs. 259291.7 millions in the FY 2010. The contribution of non-priority sector in the total NPAs in the FY 2010 (as shown in Chart 3) is almost 45 per cent compared to 54 per cent contribution of the priority sector. Public sector contributes only 1 per cent of the total NPAs in FY 2010. The sectoral NPA ratio of public sector banks in FY 2010 also indicates a rise in NPA ratio for priority sector; though it was lower compared to the rise in nonpriority sector.
Chart 2: Composition of non-performing of Public Sector Banks from Mar 31, 2001 to Mar 31, 2010


Chart 3: Non-performing Assets of Public Sector Banks: Sector-wise as on Mar 31, 2010

If we analyze the movement of Gross non-performing assets (GNPA) to Gross Advances ratio from FY 2005 to FY 2010 (as shown in Table 2), we will find significant improvement in the ratio for Indian public sector banks. The gross NPAs ratio of public sector banks placed at 5.35 per cent at end-March 2005 had declined steadily to 2.23 per cent at end-March 2008. During the crisis year of FY 2009, the gross NPA ratio declined slightly to 2.01 per cent. However, during FY 2010, the gross NPA ratio of public sector banks increased to 2.27 per cent (Table 2) proving deterioration in the quality of advances in the previous years.
Table 2: Gross NPAs to Gross Advances Ratio from March 31, 2005 to March 31, 2010 (in per cent) Gross NPAs to Gross Advances Ratio (as on Mar 31) Banks SBI & Its Associates 2005 5.32 2006 1.04 2007 2.59 2008 2.58 2009 2.55 2010 2.82

Other Nationalized Banks Public Sector Banks













It is important to note that the growth in NPAs of banks has largely followed a lagged cyclical pattern with regard to credit growth. De Lis et al. (2001) refer to a strong positive impact of credit growth on problem loans with a lag of three years. According to B.M.Mishra and S.Dhal (2010) the credit risk as reflected in non-performing loans could be influenced by the business cycle. This underlines the pro-cyclical nature of the banking system, wherein asset


quality can get compromised during periods of high credit growth ( i.e. before FY 2009) and this can result in the creation of non-performing assets for banks in the following years. Chart 4 reflects the Gross NPA and Gross Advances of public sector banks as on Mar31, 2010. The significant increase in NPAs during FY 2010 by the priority and non-priority sectors can be contributed to the worldwide economic recession period in FY 2008 and its aftereffects.
Chart 4: Gross Non-performing Assets and Gross Advances of public sector banks as on Mar 31, 2010

Chart 5 shows the movement of NPAs in public sector banks from the end of March 2009 to the end of March 2010. From the chart we find that Gross NPAs has increased by almost 33.3 per cent from end- March of 2009 to endMarch of 2010. After netting out provisions, there was an also significant rise of Net NPA of public sector banks from end- March of 2009 to end-March of 2010 by 40.1 per cent. The negative movement of NPAs can be credited to the
Chart 5: Movement of Non-performing Assets in Public Sector Banks


poor lending policies taken by the bank in the pre-recession years and ineffective monitoring and recovery procedures in the post-lending years. Inability of the banks to monitor and control the NPAs in the post-recession years proves the absence of proper pre-sanctioning appraisal and post-disbursement control within the public sector banks in India.

6. FINDINGS The Indian public sector banks has been consistently maintaining capital adequacy ratio well above the Basel II norm of 8 per cent and Reserve Bank of India (RBI) norm of 9 per cent. The quality of advances in Indian public sector banks has deteriorated over the years due to aggressive lending policies undertaken by the banks. The increase in non-performing assets in the FY 2010 can be contributed to the economic recession in 2008-09. Amount of priority sector (including agriculture, SSIs and others) non-performing assets is not showing any signs of decline and require government intervention to curb the misuse of lenient lending policies specific to this sector. Quality of lending and recovery in non-priority sector has been improving over the years. However, adequate control measures need to be taken to check uninhibited lending during years of high economic growth. Public sector banks in India, over the years, have been able to control non-performing assets because of stringent regulatory norms of RBI. Though the banks have been able to strengthen its capital adequacy requirements, enhancement in monitoring and recovery procedures is required to improve the overall management of nonperforming assets. Use of core banking solution (CBS) by public sector banks in India to regularly monitor the movement of non-performing assets is definitely a step in the right direction.

7. CONCLUSION The pressing problem that banks all over the world are facing in recent times is spiraling of non-performing assets. NPAs adversely affect lending activity of banks as non-recovery of loan installment and the interest on the loan harms the usefulness of loan-disbursement process. So, considerable importance has been given, in recent times, to strengthen the capital adequacy requirements like the measure of CRAR to measure the capacity of banks to absorb losses arising from non-performing assets. Regarding capital adequacy, public sector banks in India have been able to manage high level of CRAR to provide adequate cushion for any unexpected losses. However, increase of nonperforming assets in recent years remain an area of concern and should be addressed with earnest efforts during the periods of disbursement of loans and recovery of the same. Recently, certain serious concerns have been expressed from different sections and by the Debt Recovery Tribunals over the method in which compromise settlements has been effected by banks. It was observed that the banks adopted different parameters to different borrowers, and agreed for a lesser amount as against claimed amount, despite availability of ample securities and thereby ignoring RBI guidelines. So, we can conclude that though public sector banks in India have shown resilience during the periods of economic slowdown, management of non-performing assets through improved quality of advances and recovery procedures is crucial for banks to maintain their survival and growth.


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