INTRODUCTION NON-PERFORMING ASSETS The world is going faster in terms of services and physical products.

However ithas been researched that physical products are available because of the service industries.In the nation economy also service industry plays vital role in the boosting up of theeconomy. The nations like U.S, U.K, and Japan have service industries more than 55%.The banking sector is one of appreciated service industries. The banking sector playslarger role in channelising money from one end to other end. It helps almost every personin utilizing the money at their best. The banking sector accepts the deposits of the peopleand provides fruitful return to people on the invested money. But for providing the better returns plus principal amounts to the clients; it becomes important for the banks to earn.the main source of income for banks are the interest that they earn on the loans that have been disbursed to general person, businessman, or any industry for its development.Thus, we may find the input-output system in the banking sector. Banks first, accepts thedeposits from the people and secondly they lend this money to people who are in the needof it. By the way of channelising money from one end to another end, Banks earn their profits.However, Indian banking sector has recently faced the serious problem of NonPerforming Assets. This problem has been emerged largely in Indian banking sector sincethree decade. Due to this problem many Public Sector Banks have been adverselyaffected to their performance and operations. In simple words Non Performing Assets problem is one where banks are not able to recollect their landed money from the clientsor clients have been in such a condition that they are not in the position to provide the borrowed money to the banks.The problem of NPAs is danger to the banks because it destroys the healthyfinancial conditions of the them. The trust of the people would not be anymore if the banks have higher NPAs. So. The problem of NPAs must be tackled out in such a waythat would not destroy the operational, financial conditions and would not affect theimage of the banks. recently, RBI has taken number steps to reduce NPAs of the Indian banks. And it is also found that the many banks have shown positive figures in reducing NPAs as compared to the past years.

MEANING OF NPAS An asset is classified as non-performing asset (NPAs) if the borrower does not pay dues in the form of principal and interest for a period of 180 days. However witheffect from March 2004, default status would be given to a borrower if dues were not paid for 90 days. If any advance or credit facilities granted by bank to a borrower becomenon-performing, then the bank will have to treat all the advances/credit facilities grantedto that borrower as nonperforming without having any regard to the fact that there maystill exist certain advances / credit facilities having performing status WHAT IS A NPAs (NON PERFORMING ASSETS) Action for enforcement of security interest can be initiated only if the securedasset is classified as Non Performing Asset. Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating toasset classification issued by RBI. An amount due under any credit facility is treated as "past due" when ithas not been paid within 30 days from the due date. Due to theimprovement in the payment and settlement systems, recovery climate,upgradation of technology in the banking system, etc., it was

decided todispense with 'past due' concept, with effect from March 31, 2001.Accordingly, as from that date, a Non performing asset (NPA) shell be anadvance where Interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, The account remains 'out of order' for a period of more than 180 days, inrespect of an overdraft/ cash Credit (OD/CC), The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, Interest and/ or installment of principal remains overdue for two harvestseasons but for a period not exceeding two half years in the case of anadvance granted for agricultural purpose, and Any amount to be received remains overdue for a period of more than 180days in respect of other accounts.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, form the year ending March 31, 2004. Accordingly, with effect form March 31,2004, a non-performing asset (NPA) shell 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 he account remains 'out of order' for a period of more than 90 days, inrespect 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 harvestseasons but for a period not exceeding two half years in the case of anadvance granted for agricultural purpose, and Any amount to be received remains overdue for a period of more than 90days in respect of other accounts CLASSIFICATION OF LOANS In India the bank loans are classified on the following basis. Performing Assets: Loans where the interest and/or principal are not overdue beyond 180 days at theend of the financial year. Non-Performing Assets: Any loan repayment, which is overdue beyond 180 days or two quarters, isconsidered as NPA. According to the securitisation and reconstruction of financial assetsand enforcement of security interest ordinance, 2002 non-performing asset(NPA)means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with thedirections or guidelines relating to asset classifications issued by the Reserve BankInternationally, income from non-performing assets is not recognized on accrual basis, but is taken into account as income only when it is actually received. It has beendecided to adopt similar practice in our country also. Banks have been advised that theyshould not charge and take to income account the interest on all Nonperforming assets.An asset becomes non-performing for a bank when it ceases to generate income

The basis for treating a credit facility as non-performing is as follows INCOME RECOGNITION:

s n 1

Nature of Credit Fac ility Term Loans

Basis for Treatingas NPA A term loan is to be treated as NPA if interest remains past due f or a period of 4quarters for the year ended 31-3-1993,3quarters for the year ended 31-3-1994 and2 quarters for the year ended 31-3-1995and onwards.Past due means an amount reaming outstanding or unpaid for 30 days beyond duedate. For e.g., interest due on 31-3-1993 becomes past due on 30-4-1993, if it is notreceived by that date A cash credit or overdraft account should be treated as NPA if the account remainsout of order for a period of four quartersduring the year ended 31-3-1993,threequarters during the year ended 31-3-1994and two quarters during the year ended 31-3-1995 and onwards. An account may betreated as out of order if any of thefollowing three conditions is metThe balance outstanding in the accountremains continuously in excess of thesanctioned limit or drawing power. OR The balance outstanding is within thelimit/drawing power, but there are nocredits in the account continuously for a period of six months as on the date of the balance sheet of the bank OR There are some credits but the creditsare not enough to cover the interestdebited to the account during the sameperiod

Cash Credit & Overdr afts

Bill Purchased and Di scounted

An account should be treated as NPA if the bill remains overdue and unpaid for a period of four quarters during the year ended 31 st March, 1994 and two quartersduring the year ended 31 st March, 1995 andonwards.It may be added that overdue interestshould not be charged and taken to incomeaccount in respect of overdue bills unless itis realized Any other credit facility should be treatedas NPA if any amount to be received inrespect of that facility remains past due for a period of four quarters during the year ended 31 st March 1993. There quartersduring the year ended 31 st March 1994 andtwo quarters during the year ended 31 st March 1995 and onwards

Other Accounts

ASSET CLASSIFITION: S.n Category of assets 1 Standard Assets Basis for Deciding the category An asset, which does not disclose any problem and also does not carry more thannormal risk attached to the business, itshould not fall under this category of NPA. An asset, which has been identified as NPAfor a period not exceeding two years.In the case of term loan, if installments of principal are overdue for more than one year but not exceeding two years, it is to betreated as substandard asset.An asset where the terms of the loanagreement regarding interest and principalhave been re-negotiated or rescheduledshould be classified as sub-standard andshould remain in such category for at leasttwo years of satisfactory performance under the re-negotiated or rescheduled terms.In other words, the classification of assetsshould not be upgraded merely as a result of rescheduling unless there is satisfactorycompliance of the above condition. An asset, which remains NPA for more thantwo years.Here too, rescheduling does not entitle a bank to upgrade the quality of an advanceautomatically. In the case of a term loan, if installments of principal are overdue for more than twoyears, it is to be treated as doubtful. An asset where loss has been identified bythe bank or internal/external auditors or byRBI inspection but the amount has not beenwrittenoff, wholly or partly. In other words,such an asset is considered unrealizable andof such little value that its continuance as a bankable asset is not warranted althoughthere may be some salvage or recoveryvalue.

Sub-Standard Assets

Doubtful Assets

Loss Assets

After liberalization the Indian banking sector developed very appreciate. The RBI also nationalized good amount of commercial banks for proving socio economic services to the people of the nation. The Public Sector Banks have shown very good performance as far as the financial operations are concerned. If we look to the glance of the financial operations, we may find that deposits of public to the Public Sector Banks have increased from859,461.95crore to 1,079,393.81crore in 2010, the investments of the Public Sector Banks have increased from 349,107.81crore to 545,509.00crore, and however the advances have also been increased to 549,351.16crore from 414,989.36crore in 2010.The total income of the public sector banks have also shown good performance since the last few

years and currently it is 128,464.40crore. The Public Sector Banks have also shown comparatively good result. The gross profits of the Public Sector Banks currently 29,715.26crore which has been doubled to the last to last year, and the net profit of the Public Sector Banks is 12,295,47crore.However, the only problem of the Public Sector Banks these days are the increasing level of the non performing assets. The non performing assets of the Public Sector Banks have been increasing regularly year by year. If we glance on the numbers of non performing assets we may come to know that in the year 1997 the NPAs were47,300crore and reached to 80,246crore in 2002.The only problem that hampers the possible financial performance of the Public Sector Banks is the increasing results of the non performing assets. The non performing assets impacts drastically to the working of the banks. The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks, but at the same time banks are required to make provisions for such NPAs from their current profits.

NPAs have a deleterious effect on the return on assets in several ways They erode current profits through provisioning requirements They result in reduced interest income They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future, and They limit recycling of funds, set in asset-liability mismatches, etc. The RBI has also tried to develop many schemes and tools to reduce the non performing assets by introducing internal checks and control scheme, relationship managers as stated by RBI who have complete knowledge of the borrowers, credit rating system, and early warning system and so on. The RBI has also tried to improve the securitization Act and SRFAESI Act and other acts related to the pattern of the borrowings .Though RBI has taken number of measures to reduce the level of the non performing assets the results is not up to the expectations. To improve NPAs each bank should be motivated to introduce their own precautionary steps. Before lending the banks must evaluate the feasible financial and operational prospective results of the borrowing companies. They must evaluate the business of borrowing companies by keeping in considerations the overall impacts of all the factors that influence the business.

2. Objective of the study To know why NPAs are the great challenge to the Public Sector Banks To understand what is Non Performing Assets and what are the underlying reasons for the emergence of the NPAs. To understand the impacts of NPAs on the operations of the Public Sector Banks. To know what steps are being taken by the Indian banking sector to reduce the NPAs? To evaluate the comparative ratios of the Public Sector Banks with concerned to the NPAs.

4. Limitations of the study The limitations that I felt in my study are: It was critical for me to gather the financial data of the every bank of the Public Sector Banks so the better evaluations of the performance of the banks are not possible. Since my study is based on the secondary data, the practical operations as related to the NPAs are adopted by the banks are not learned. Since the Indian banking sector is so wide so it was not possible for me to cover all the banks of the Indian banking sector.

INDIAN BANKING SECTOR Banking in India has its origin as early as the Vedic period. It is believed that the transition from money lending to banking must have occurred even before Manu, the great Hindu Jurist, who has devoted a section of his work to deposits and advances and laid down rules relating to rates of interest. During the Mogul period, the indigenous bankers played a very important role in 0lending money and financing foreign trade and commerce. During the days of the East India Company, it was the turn of the agency houses to carry on the banking business. The General Bank of India was the first Joint Stock Bank to be established in the year 1786. The others which followed were the Bank of Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued till 1906 while the other two failed in the meantime. In the first half of the 19th century the East India Company established three banks; the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. These three banks also known as Presidency Banks were independent units and functioned well. These three banks were amalgamated in 1920 and a new bank, the Imperial Bank of India was established on 27th January 1921. With the passing of the State Bank of India Act in 1955 the undertaking of the Imperial Bank of India was taken over by the newly constituted State Bank of India. The Reserve Bank which is the Central Bank was created in 1935 by passing Reserve Bank of India Act 1934. In the wake of the Swadeshi Movement, a number of banks with Indian management were established in the country namely, Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda Ltd, the Central Bank of India Ltd. On July 19, 1969, 14 major banks of the country were nationalised and in 15thApril 1980 six more commercial private sector banks were also taken over by the government. Indian Banking: A Paradigm shift-A regulatory point of view The decade gone by witnessed a wide range of financial sector reforms, with many of them still in the process of implementation. Some of the recently initiated measures by the RBI for risk management systems, anti money laundering safeguards and corporate governance in banks, and regulatory framework for non bank financial companies, urban cooperative banks, government debt market and forex clearing and payment systems are aimed at streamlining the functioning of these instrumentalities besides cleansing the aberrations in these areas. Further, one or two all India development financial institutions have already commenced the process of migration towards universal banking set up. The banking sector has to respond to

these changes, consolidate and realign their business strategies and reach out for technology support to survive emerging competition. Perhaps taking note of these changes in domestic as well as international arena All of we will agree that regulatory framework for banks was one area which has seen a sea-change after the financial sector reforms and economic liberalisation and globalisation measures were introduced in 1992-93. These reforms followed broadly the approaches suggested by the two Expert Committees both set up under the chairmanship of Shri M. Narasimham in 1991 and 1998, the recommendations of which are by now well known. The underlying theme of both the Committees was to enhance the competitive efficiency and operational flexibility of our banks which would enable themto meet the global competition as well as respond in a better way to the regulatory and supervisory demand arising out of such liberalisation of the financial sector. Most of there commendations made by the two Expert Committees which continued to be subject matter of close monitoring by the Government of India as well as RBI have been implemented. Government of India and RBI have taken several steps to :- (a) Strengthen the banking sector,(b) Provide more operational flexibility to banks,(c) Enhance the competitive efficiency of banks, and(d) Strengthen the legal framework governing operations of banks. Regulatory measures taken to strengthen the Indian Banking sectors The important measures taken to strengthen the banking sector are briefly, the following: Introduction of capital adequacy standards on the lines of the Basel norms, prudential norms on asset classification, income recognition and provisioning, Introduction of valuation norms and capital for market risk for investments Enhancing transparency and disclosure requirements for published accounts , Aligning exposure norms single borrower and group-borrower ceiling withinter-national best practices Introduction of off-site monitoring system and strengthening of the supervisoryframework for banks.(A) Some of the important measures introduced to provide more operational flexibility to banks are: Besides deregulation of interest rate, the boards of banks have been given theauthority to fix their prime lending rates. Banks also have the freedom to offer variable rates of interest on deposits, keeping in view their overall cost of funds. Statutory reserve requirements have significantly been brought down. The quantitative firm-specific and industry-specific credit controls were abolishedand banks were given the freedom to deploy credit, based on their commercial judgment, as per the policy approved by their Boards. The banks were given the freedom to recruit specialist staff as per their requirements, The degree of autonomy to the Board of Directors of banks was substantiallyenhanced. Banks were given autonomy in the areas of business strategy such as, opening of branches / administrative offices, introduction of new products and certain other operational areas.(b) Some of the important measures taken to increase the competitive efficiency of banksare the following: y Opening up the banking sector for the private sector participation. y Scaling down the shareholding of the Government of India in nationalised banksand of the Reserve Bank of India in State Bank of India.(c) Measures taken by the Government of India to provide a more conducive y legal environment y for recovery of dues of banks and financial institutions are:

y y y

y y

y y

Setting up of Debt Recovery Tribunals providing a mechanism for expeditiousloan recoveries. Constitution of a High Power Committee under former Justice Shri Eradi tosuggest appropriate foreclosure laws. An appropriate legal framework for securitisation of assets is engaging theattention of the Government,Due to this paradigm shift in the regulatory framework for banks had achieved thedesired results. The banking sector has shown considerable degree of resilience.(a) The level of capital adequacy of the Indian banks has improved: the CRAR of public sector banks increased from an average of 9.46% as on March 31, 1995 to11.18% as on March 31, 2001.(b) The public sector banks have also made significant progress in enhancing their asset quality, enhancing their provisioning levels and improving their profits. The gross and net NPAs of public sector banks declined sharply from 23.2% and14.5% in 1992-93 to 12.40% and 6.7% respectively, in 2000-01. Similarly, in regard to profitability, while 8 banks in the public sector recordedoperating and net losses in 1992-93, all the 27 banks in the public sector showedoperating profits and only two banks posted net losses for the year ended March31, 2001. The operating profit of the public sector banks increased from Rs.5628 crore as onMarch 31, 1995 to Rs.13,793 crore as on March 31, 2001. The net profit of public sector banks increased from Rs.1116 crore to Rs.4317crore during the same period, despite tightening of prudential norms on provisioning against loan losses and investment valuation.The accounting treatment for impaired assets is now closer to the international best

The accounting treatment for impaired assets is now closer to the international best practices and the final accounts of banks are transparent and more amenable tomeaningful interpretation of their performance. WAY FORWARD RBI president recently recommended Indian banks to go for larger provisioningwhen the profits are good without frittering them away by way of dividends, however tempting it may be. As a method of compulsion, RBI has recently advised banks to createan Investment Fluctuation Reserve upto 5 per cent of the investment portfolio to protectthe banks from varying interest rate regime.He further added that one of the means for improving financial soundness of a bank is byenhancing the provisioning standards of the bank. The cumulative provisions against loanlosses of public sector banks amounted to a mere 41.67% of their gross NPAs for the year ended March 31, 2001. The amount of provisions held by public sector banks is not onlylow by international standards but there has been wide variation in maintaining the provision among banks. Some of the banks in the public sector had as low provisioningagainst loan losses as 30% of their gross NPAs and only 5 banks had provisions in excessof 50% of their gross NPAs. This is inadequate considering that some of the countriesmaintain provisioning against impaired assets at as high as 140%. Indian Banks shouldimprove the provisioning levels to at least 50% of their gross NPAs. There should therefore be an attitudinal change in banks policy as regards appropriation of profits and full provisioning towards already impaired assets should become a priority corporategoal.He also suggested that banks should also develop a concept of building Desirable capital over and above the minimum CRAR which is insisted upon in developedregulatory regimes like UK. This can be at, say around 12 percent as practised even today by some of the Indian

banks, so as to provide well needed cushion for growth in risk weighted assets as well as provide for unexpected erosion in asset values.As banks would have observed, the changes in the regulatory framework are now brought in by RBI only through an extensive consultative process with banks as well as public wherever warranted. While this serves the purpose of impact assessment on the proposed measures it also puts the banks on notice to initiate appropriate internalreadjustment to meet the emerging regulatory prescriptions. Though adequate transitionalroute has been provided for switchover to new regulatory measures such as scaling down the exposure to capital market, tightening the prudential requirements like switch over to90 day NPA norm, reduction in exposure norms, etc., I observe from the various quarters from which RBI gets its inputs that the banks are yet to take serious steps towardsimplementation of these measures.The Boards of banks have been accorded considerable autonomy in regard to their corporate strategy as also several other operational matters. This does not; however, seemto have translated to any substantial improvement in customer service. It needs to berecognised that meeting the requirements of the customer whether big or small efficiently and in a cost effective manner, alone will enable the banks to withstand theglobal competition as also the competition from non-bank institutions.The profitability of the public sector banks is coming under strain. Despite theresilience shown by our banks in the recent times, the income from recapitalisation bondsaccounted for a significant portion of the net profits for some of the nationalised banks.The Return on Assets (RoA) of public sector banks has, on an average, declined from0.54 for the year ended March 31, 1999 to 0.43 for the year ended March 31, 2001.Therefore, the Boards attention needs to be focused on improving the profitability of the bank. The interest income of public sector banks as a percentage of total assets has shown a declining trend since 1996-97: it declined from 9.69 in 1996-97to 8.84 in 2000-01. Similarly, the spread (net interest income) as a percentage of totalassets also declined from 3.16 in 1996-97 to 2.84 in 2000-01.A disheartening feature is that a large number of public sector banks haverecorded far below the median RoA of 0.4% for 2000-01 in their peer group. Incidentallythe RoA recorded by new private banks and foreign banks ranged from 0.8% to 1% for the same period. An often quoted reason for the decline in profitability of public sector banks is the stock of NPAs which has become a drag on the banks profitability. As youare aware, the stock of NPAs does not add to the income of the bank while at the sametime, additional cost is incurred for keeping them on the books. To help the public sector banks in clearing the old stock of chronic NPAs, RBI had announced one-time nondiscretionary and non discriminatory compromise settlement schemes in 2000 and 2001.Though many banks tried to settle the old NPAs through this transparent route, theresponse was not to the extent anticipated as the banks had been bogged down by the usual fear psychosis of being averse to settling dues where security was available. Themoot point is if the underlying security was not realised over decades in many cases dueto extensive delay in litigation process, should not the banks have taken advantage of theone time opportunity provided under RBI scheme to cleanse their books of chronic NPAs? This would have helped in realizing the carrying costs on such nonincomeearning NPAs and released the funds for recycling. If better steps are taken placed in thisconnection then the performance of the Public Sector Banks can show very good andhealthy results in the shorter period.To make the better future of the Public Sector Banks, the Boards need to be aliveto the declining profitability of the banks. One of the reasons for the low level of profitability of public sector banks is the high operating cost. The cost income ratio(which is also known as efficiency ratio of public sector banks) increased from 65.3 percent for the year ended March 31, 2000 to 68.7 per cent for the year ending March 31,2001. The staff expenses as a proportion to total income formed as high as 20.7% for public sector banks as against 3.3% for new banks and 8.2% for foreign banks for theyear ended March 31, 2001. There is thus an imperative need for the banks to go for costcutting

exercise and rationalise the expenses to achieve better efficiency levels inoperation to withstand declining interest rate regime.Boards of banks have much more freedom now than they had a decade ago, andobviously they have to play the role of change agents. They should have the expertise toidentify, measure and monitor the risks facing the bank and be capable to direct andsupervise the banks operations and in particular, its exposures to various sectors of theeconomy, and monitoring / review thereof, pricing strategies, mitigation of risks, etc. TheBoard of the banks should also ensure compliance with the regulatory framework, andensure adoption of the best practices in regard to risk management and corporategovernance standards. The emphasis in the second generation of reforms ought to be inthe areas of risk management and enhancing of the corporate governance standards in banks.

THE INDIAN BANKING INDUSTRY The origin of the Indian banking industry may be traced to the establishment of the Bank of Bengal in Calcutta (now Kolkata) in 1786. Since then, the industry haswitnessed substantial growth and radical changes. As of March 2002, the Indian bankingindustry consisted of 97 Commercial Banks, 196 Regional Rural Banks, 52 ScheduledUrban Co-operative Banks, and 16 Scheduled State Co-operative Banks.The growth of the banking industry in India may be studied in terms of two broad phases: Pre Independence (1786-1947), and Post Independence (1947 till date). The postindependence phase may be further divided into three sub-phases: Pre-Nationalisation Period (1947-1969) Post-Nationalisation Period (1969-1991) Post-Liberalisation Period (1991- till date) The two watershed events in the postindependence phase are the nationalisationof banks (1969) and the initiation of the economic reforms (1991). This section focuseson the evolution of the banking industry in India post-liberalisation. 1. Banking Sector Reforms - Post-Liberalisation In 1991, the Government of India (Gol) set up a committee under thechairmanship of Mr. Narasimaham to make an assessment of the banking sector. Thereport of this committee contained recommendations that formed the basis of the reformsinitiated in 1991.The banking sector reforms had the following objectives:1. Improving the macroeconomic policy framework within which banks operate;2. Introducing prudential norms;3. Improving the financial health and competitive position of banks;4. Building the financial infrastructure relating to supervision, audit technology and legalframework; and5. Improving the level of managerial competence and quality of human resources. 1.1 Impact of Reforms on Indian Banking Industry With the initiation of the reforms in the financial sector during the 1990s, theoperating environment of banks and term-lending institutions has radically transformed.One of the fall-outs of the liberalisation was the emergence of nine new private sector banks in the mid1990s that spurred the incumbent foreign, private and public sector banks to compete more fiercely than had been the case historically. Another developmentof the economic liberalisation process was the opening up of a vibrant capital market inIndia, with both equity and debt segments providing new avenues for companies to raisefunds. Among others, these two factors have had the greatest influence on banksoperating in

India to broaden the range of products and services on offer. The reformshave touched all aspects of the banking business. With increasing integration of theIndian financial markets with their global counterparts and greater emphasis on risk management practices by the regulator, there have been structural changes within the banking sector. The impact of structural reforms on banks' balance sheets (both on theasset and liability sides) and the environment they operate in is discussed in the followingsections. 1.2 Reforms on the Liabilities Side Reforms of Deposit Interest Rate Beginning 1992, a progressive approach was adopted towards deregulating theinterest rate structure on deposits. Since then, the rates have been freed gradually.Currently, the interest rates on deposits stand completely deregulated (with the exceptionof the savings bank deposit rate). The deregulation of interest rates has helped Indian banks to gain more control on the cost of their deposits, the main source of funding for Indian banks. Besides, it has given more, flexibility to banks in managing their Asset-Liability positions.

Increase in Capital Adequacy Requirement During the 1990s, the Reserve Bank of India (RBI) adopted a strategy aimed at all banks attaining a Capital Adequacy Ratio (CAR) of 8% in a phased manner. On therecommendations of the Committee on Banking Sector Reforms, the minimum CAR wasfurther raised to 9%, effective March 31, 2000.While the stipulation of a higher Capita!Adequacy' Ratio has increased the capital requirement of banks; it has provided morestability to the Indian banking system. 1.2 Reforms on the Asset Side 1.3 Reforms on the Lending Interest Rate During 1975-76 to 1980-81, the RBI prescribed both the minimum lending rateand the ceiling rate. During 1981-82 to 1987-88. The RBI prescribed only the ceilingrate. During 198889 to 1994-95, the RBI switched from prescribing a ceiling rate tofixing a minimum lending rate. From 1991 onwards, interest rates have been increasinglyfreed. At present, banks can offer loans at rates below the Prime Lending Rate (PLR) toexporters or other creditworthy borrowers (including public enterprises), and have only toannounce the FLR and the maximum spread charged over it. The deregulation of lendingrates has given banks the flexibility to price loan products on the basis of their own business strategies and the risk profile of the borrower. It has also lent a competitiveadvantage to banks with lower cost of funds. Lower Cash Reserve and Statutory Liquidity Requirements During the early 1980s, statutory pre-emption in the form of Cash Reserve Ratio(CRR) and Statutory Liquidity Ratio (SLR) accounted for 42% of the deposits. In the1990s, the figure rose to 53.5%, which during the post-liberalisation period has beengradually reduced. At present, banks are required to maintain a CRR of 4% of the NetDemand and Time Liabilities (NDTL) (excluding liabilities subject to zero CRR prescriptions). The RBI has indicated that the CRR would eventually be brought down tothe statutory minimum level of 3% over a period of time.

The SLR, which was at a peak of 38.5% during September 1990 to December 1992, now stands lower at the statutory minimum of 25%.A decrease in the CRR andSLR requirements implies an increase in the share of deposits available to banks for loansand advances. It also means that bank's now have more discretion in the allocation of funds, which if deployed efficiently, can have a positive impact on their profitability. Byincreasing the amount of invisible funds available to banks, the reduction in the CRR andSLR requirements has also enhanced the need for efficient risk management systems in banks. Asset Classification and Provisioning Norms Prudential norms relating to asset classification have been changed post-liberalisation. The earlier practice of classifying assets of different quality into eight`health codes" has now been replaced by the system of classification into four categories(in accordance with the international norms): standard, sub-standard, doubtful, and lossassets. On 1st April 2000, provisioning requirements of a minimum of 0.25% wereintroduced for standard assets. For the sub-standard, doubtful and loss asset categories,the provisioning requirements remained at 10%, 20-50% (depending on the duration for which the asset has remained doubtful), and 100%, respectively, the recognition normsfor NPAs have also been tightened gradually. Since March 1995, loans with interestand/or installment of principal overdue for more than 180 days are classified as non- performing. This period will be shortened to 90 days from the year ending 31st' March2004. 1.4 Structural Reforms Increased Competition With the initiation of banking-sector reforms, a more competitive environmenthas been ushered in. Now banks are not only competing within themselves, but also withnon-banks, such as financial services companies and mutual funds. While existing bankshave been allowed greater flexibility in expanding their operations, new private sector banks have also been allowed entry. Over the last decade nine new private sector bankshave established operations in the country. Competition amongst Public Sector Banks(PSBs) has also intensified. PSBs are now allowed to access the capital market to raisefunds. This has diluted Government's shareholding, although it remains the major shareholder in PSBs, holding a minimum 51% of their total equity. Although competitionin the banking sector has reduced the share of assets and deposits of the PSBs, their dominant positions, especially of the large ones, continues. Although the PSBs will remain major players in the banking industry, they are likelyto face tough competition, from both private sector banks and foreign banks. Moreover,the banking industry is likely to face stiff competition from other players like non-bank finance companies, insurance companies, pension funds and mutual funds. Theincreasing efficiency of both the equity and debt markets has also accelerated the processof financial disintermediation, putting additional pressure on banks to retain their customers. Increasing competition among banks and financial intermediaries is likely toreduce the Net Interest Spread of banks. Banks entry into New Business Lines Banks are increasingly venturing into new areas, such as, Insurance and MutualFunds, and offering a wider bouquet of products and services to satisfy the diverse needsof their customers. With the enactment of the Insurance Regulatory and DevelopmentAuthority (IRBA) Act, 1999, banks and NBFCs have been allowed to enter the insurance business. The RBI has also issued guidelines for-banks' entry into insurance, according towhich, banks need to obtain prior approval of the RBI to enter the insurance business. Sofar, the RBI has

accorded its approval to three of the 39 commercial banks that hadsought entry into insurance.Insurance presents a new business opportunity for banks. The opening up of the insurance business to banks is likely to help them emerge as financial supermarkets like their counterparts in developed countries. Increased thrust on Banking Supervision and Risk Management To strengthen banking supervision, an independent Board for FinancialSupervision (BFS) under the RBI was constituted in November 1994. The Board isempowered to exercise integrated supervision over all credit institutions in the financialsystem, including select Development Financial Institutions (DFIs) and Non BankingFinancial Companies (NBFCs), relating to credit management, prudential norms andtreasury operations. A comprehensive rating system, based on the CAMELSmethodology, has also been instituted for domestic banks; for foreign banks, the ratingsystem is based on CACS. This rating system has been supplemented by a technology-enabled quarterly off- site surveillance system.To strengthen the Risk Management Process in banks, in line with proposed Basel11 accord, the RBI has issued guidelines for managing the various types of risks that banks are exposed to. To make risk management an integral part of the Indian banking system, the RBI has also issued guidelines for Risk based Supervision (RBS) and Risk based Internal Audit (RBIA). These reform initiatives are expected to encourage banks to allocate funds acrossvarious lines of business on the basis of their Risk adjusted Return on Capital (RAROC).The measures would also help banks be in line with the global best practices of risk management and enhance their competitiveness.The Indian banking industry has come a long way since the nationalisation of banks in 1969. The industry has witnessed great progress, especially over the past 12years, and is today a dynamic sector. Reforms in the banking sector have enabled banksexplore new business opportunities rather than remaining confined to generating revenuesfrom conventional streams. A wider portfolio, besides the growing emphasis onconsumer satisfaction, has led to the Indian banking sector reporting robust growthduring past few years.It is clear that the deregulation of the economy and of the Banking sector over thelast decade has ushered in competition and enabled Indian banks to better take on thechallenges of globalisation. 1.5 Operational and Efficiency Benchmarking Benchmarking of Return on Equity Return on Equity (ROE) is an indicator of the profitability of a bank from theshareholder's perspective. It is a measure of Accounting Profits per unit of Book EquityCapital. The ROE of Indian banks for the year ended 31st March 2010, was in the rangeof 14 - 40%; the median ROE. Being 23.72% for the same period. On the other hand, theglobal benchmark banks had a median ROE of 12.72% for the year ended 31st December 2002.In recent years, Indian banks have reported unusually high trading incomes,driven mainly by the scope to booking profits that arise from a sharply declining interestrate environment. However, such high trading income may not be sustainable in future.The adjusted median ROE for Indian banks (adjusted for trading income) stands at 5.42%for Indian banks for FY2010 as compared with 11.77% for the global benchmark banks.After adjusting for trading income, the median ROE of Indian hanks stands lower than the same for the global benchmark banks, thus implying that the contribution of trading income to the RoE of Indian banks is significant.

Further, the ROE benchmarking method favors banks that operate with low levelsof equity or high leverage. To assess the impact of the leverage factor on the ROE of banks, "Equity Multiplier is presented in the next section. Benchmarking of Equity Multiplier Equity Multiplier (EM) is defined as "Total Assets divided by Net Worth". This isthe reciprocal of the Capital-to-Asset ratio, which indicates the leverage of a bank (amount of Assets of a bank pyramided on its equity capital). Banks with a higher leverage will be able to post a higher ROE with a similar level of Return on Asset (ROA), because of the multiplier effect. However, the banking industry is safer with a lower leverage or a higher proportion of equity capital in the total liability. Capital is importantfor banks for two main reasons:Firstly, capital is viewed as the ultimate line of protection against any potentiallosscredit, market, or operating risks. While loan and investment provisions areassociated with expected losses, capital is a cushion against unexpected losses.Secondly, capital allows banks to pursue their growth objectives; a bank has tomaintain a minimum capital adequacy ratio in accordance with regulatory requirements.A bank with insufficient capital may not be able to take advantage of growthopportunities offered by the external operating environment the same way as another bank with a higher capital base could. Benchmarking of Return on Assets ROA is defined as Net Income divided by Average Total Assets. The ratiomeasures a bank's Profits per currency unit of Assets. The median ROA for Indian bankswas 1.15% for FY2010. For the global benchmark banks, the ROA ranged from 0.05% to1.44% for the year ended December 2002, with the median at 0.79%.For the year ended December 2002, Bank of America reported the highest ROA(1.44%) among the global benchmark banks, followed by Citi group Inc. (1.42%). Themedian value for Indian banks at 1.15% was higher than that of ABN AMRO Bank Deutsche Bank, Rabo Bank and Standard Chartered Bank. Two banks, namely Bank of America and Citigroup Inc., posted higher ROAs as compared with the European and other banks for both FY2010 and FY2002 primarily on the strength of higher Net Interest Margins. The reasons for the Net Interest Margins being higher are discussed in the sections that follow. As with the ROE analysis, here too adjustments for non-recurringincome/expenses must be made while comparing figures on banks' ROA. Adjusting for trading income, for both Indian banks and the global benchmark banks, the median worksout to be lower for Indian banks vis-a-vis the global benchmark banks for FY 2010.I have further analysed the effect of adjustment for trading income on the ROAsof both Indian Banks and the Global Benchmark Banks. Here, it must be noted that theglobal benchmark banks have a more diversified income portfolio as compared withIndian banks, and a decline in interest rate could have increased profitability of global benchmark banks indirectly in more ways than one. However, from the disclosuresavailable in the annual reports of the global banks, it is not possible to quantify theimpact of declining interest rates on their profitability (`thus, the same has not beenadjusted for in this analysis). Nevertheless, to further analyse the profitability (per unit of assets) of Indian banks vis-a-vis the global benchmark banks, ICRA has conducted aROA decomposition analysis. 1.6 Decomposition of Return on Assets Net Interest Margin

Net Interest Margin (NIM) measures the excess income of a bank's earningsassets (primarily loans, fixed-income investments, and interbank exposures) over itsfunding costs. To the past, for banks NIM was the main source of earnings, which weretherefore directly correlated with the margin levels. But with NIM declining significantlyin many countries, banks are now trying to compensate the "lost" margins with non-fund based fee incomes and trading income. Despite these changes, net interest incomecontinues to account for a significant share of the earnings of most banks. The median NIM for Indian banks was 3.16% for FY2010 and 3.92% for FY2002. The figurescompare favorably with those of the global benchmark banks.Before drawing inferences on the NIM benchmarking results, three aspects must beconsidered, namely: (a) The external operating environment, (b) The quality and type of assets, and (c) Accounting policies followed by banks.The three aspects are explored in detail in the subsequent paragraphs. (a) External Operating Environment (b) Intermediation cost is a significant factor explaining the differences in NIMsacross countries. Interest margins tend to be higher in countries where the intermediation costs are high. Generally, the absence of a vibrant capital market results in the intermediation costs being higher. In India, the debt market is relatively less developed(as compared with the markets in USA and Europe), and therefore, most corporate entities are dependent mainly on banks for meeting their financing needs. As a result,Indian banks are able to command higher NIMs as compared with the global benchmarks banks. To make a like-to-like comparison and understand the impact of intermediationcost, ICRA has compared the NIMs of the Indian operations of the global benchmark banks with those of Indian banks. Of the six global benchmark banks, the local operationsof four banks earned higher NIMs visa-vis the median of Indian banks in FY2002 andFY2010. Of these four banks, three earned NIMs above 4%. This analysis strengthensICRA's hypothesis that the external operating environment is an important factor while benchmarking NIMs. (c) (b) Type & Quality of Assets (d)The higher NIMs of US-based banks are attributable to their sharper focus onconsumer loans and credit cards as compared with European banks. Also, the high NIMsof US banks are the cause for their comparatively high ROAs. To overcome the potentialfor higher provisions arising from its strategy of lending to riskier assets, a bank maycharge a higher rate of interest to its borrowers (with a consequently higher NIM) thananother bank. So while comparing the NIMs of two banks, the effect of asset quality must be normalised. One way of doing this is to use Total Risk Weighted Adjusts (RWA)instead of Total Assets as the denominator. However, many Indian banks do not disclosetheir RWA values in their annual reports, and therefore, ICRA has not been able to usethis method in this study. The alternative method is to adjust the NIM for provisions &contingencies. If the asset quality of a bank is relatively weak, it is likely to generatehigher Non-Performing Assets (NPAs). As a result, its provisions & contingencies arealso likely to be higher. Therefore, if the effect of asset quality is normalised by removing provisions & contingencies from the NIM, a better understanding of the efficiency of thefund based business of banks may be obtained. ICRA defined adjusted NIM as NetInterest Spread (Net Interest Income less Provisions & Contingencies)/Average TotalAssets]. The Net Interest Spread's for the global benchmark banks ranged from 0.14 to2.10% for the financial year ended December 2002, with the median at 1.54%. Thecorresponding median figure for Indian banks was 1.68%. The difference between the NIMs of the global benchmark banks and Indian bank; reduces substantially after adjusting for provisions. This strengthens ICRA's hypothesis that the type and quality of assets substantially affect NIM.

(3)Accounting Policies The Net Interest Spreads adjusted for Provisions can vary substantially,depending on the income recognition and provisioning norms. According to InternationalAccounting Standard, (IAS) provisioning for NPAs is based on management discretion,Whereas in India, the RBI defines the provisioning requirement for impaired assets asa function of time and security. An illustration of difference in accounting for NPA is thatfor Indian banks, an asset is reckoned as NPA when principal or interest are past due for 180 days as compared with 90 days for the global benchmark banks (the norms willconverge with effect from financial year 2004). Keeping in view the levels of NIM for Indian and global benchmark banks, and the three factors analysed above, ICRA believesthat the NIM for Indian banks is comparable with that of the global benchmark banks. Non-Interest Income Ratio Increased competition in the Indian Banking industry has driven the interestyields and consequently, the NIMs, southwards. Hence, banks are increasinglyconcentrating on noninterest income to shore up profits. In FY2010, the range of non-interest income for Indian banks (as percentage of average Total Assets) was between1.01 and 3.00%. The median for Indian banks showed a moderate increase from 1.63% in2002 to 1.77% in 2010. The noninterest income (as percentage of Average Total assets)of the global benchmark banks varied from 0.72 to 3.13% (with a median value of 1.62%), or the year ended December 31, 2002. The decline in interest rates in India over the last few years has helped Indian banks book substantial profits from the sale of investments, thus boosting their Non-Interest Income. As the high profits accruing fromthe sale of investments are not lively to be sustainable, ICRA has benchmarked the purefee based income (i.e. looking at Non-interest income without profits from sale of investments) as a percentage of average total income. 16 of the 21 Indian banks in thestudy had a fee based income ratio of between 0.4 and 0.8%.A comparison after similar adjustment for the global benchmark banks reveals that the fee-based income ratio of Indian banks is lower. Operating Expense Ratio The Operating Expense Ratio (operating expenses as a ratio of the average totalassets) reveals how expensive it is for a bank to maintain its fixed assets and humancapital that are used to generate that income streams, The median Operating Expenseratio for Indian banks was 2.26% in 2010, which is comparable with that for the global benchmark banks (2.09%). 1.7 Asset Quality Benchmarking Gross NPAs The median Gross NIA ratio (Gross NPA as a proportion of total advances) for Indian banks was 9.40% for FY2010 and 10.66% for FY2002. The values of the Gross NPA ratio for FY 2010 range between 2.26 and 14.68%.Many global banks do notdisclose their Gross NPA percentages in their annual reports. Net NPAs The median Net NPA ratio ("Net NPA as a proportion of Net advances) of Indian banks was 4.33% for FY2010 and 5.39% for FY2002. The values of Net NPA ratio for FY 2010 for the global benchmark banks ranged between 0.37 and 7.08%. Most of theglobal benchmark banks do not disclose their Net NPA ratios in their annual reports.From the study it can be inferred that the median Net NPA percentage for Indian banks ismarginally higher than that for the global benchmark banks. Efficiency Benchmarking ICRA studied the following parameters to assess the efficiency of Indian banksvis--vis their foreign counterparts: Profitability per employee Profitability per branch Business per employee Business per branch Expenses per employee Expenses per branchThe business

model of the global benchmark banks involves outsourcing of non-core activities. In the case of Indian banks, particularly those in the public sector, bothnon-core and core business functions are carried out in-house. The global benchmark banks display higher efficiency parameters, mainly because of the outsourcing model. Thus, the efficiency parameters are not strictly comparable, as they are affected by the business plans of specific banks and also by economy-specific considerations.ICRA has presented the analysis of the performance of Indian and international banksin the following sections. We would like to highlight that several factors influence theresults here, and caution needs to be exercised in arriving at inferences. E.g. comparingexpenses per branch (or employee) for banks across different economies involvesconversion of amounts to a common currency. The results depend on the conversion ratesof foreign exchange used (e.g. USD per rupee or Euro per rupee). In this report, ICRAhas used nominal rates of foreign currencies rather than rates based on PPP (PurchasingPower Parity). On another dimension, Indian banks and international banks operate under different business models and levels of technology. Increasingly, sophisticated banks(particularly in advanced countries) use several channels to transact business withcustomers, such as, the Internet, telephone, debit cards, and ATMs. Therefore, resultsfrom benchmarking using parameters such as business per branch or expenses per branch(which are appropriate parameters to compare across banks that operate predominantlythrough branches) need to be appropriately interpreted in an exercise when we compareheterogeneous banks across different economies. Profitability per Employee The profit per employee figure for 17 out of the 21 Indian banks was in the rangeof Rs. 0.02 crore for the financial year ended March 2010. Most Indian banks postedhigher profits per employee in FY2010 as compared with FY2002. This overall trend of increasing employee profitability may be attributed to the reduction in the number of employees following the launch of Voluntary Retirement Schemes (VRS) by some banksas well as higher profits by the banks. On an average, new private sector banks enjoy ahigher increase in profitability per employee, as compared with their public sector counterparts. This may be attributed largely to the better technology that the new privatesector banks employ, besides the advantage of carrying no historical baggage. As for theglobal benchmark banks, the profitability per employee for HSBC was robust at USD0.12 million (Rs. 0.552 crore) for FY 2002. For ABN AMRO Bank, the figure was EUR 0.02 million (Rs.l crore). On an intertemporal basis, the profitability per employee for theglobal benchmark bank also showed growth. Profitability per Branch For most Indian banks, the profit, per branch was in the range of Rs. 0-0.2 crore.However, the new private sector banks displayed the highest profits per branch, at Rs. 1.73 and 1.22 crore for the years 2010 and 2002, respectively. On an inter-temporal basis, profit per branch has been increasing gradually in the Indian banking sector. The growthin profit per branch for Indian banks is attributable to the overall increase in profitabilityin the banking industry. In the case of the foreign peer group, profitability per branchshows a small increase over the period covered by this study. As for the global benchmark banks, profitability per branch for Bank of America is at a robust USD 1.62million (Rs. 7.44 crore), while the figure for ABN AMRO Bank is EUR 0.87 million (Rs.4.36 crore) for the FY 2002. Hence, profitability per branch for the global benchmark banks is higher than that of Indian banks. Business per Employee Since different employees in a bank contribute in different ways to the revenuesand profits of a bank, it is difficult to come up with one universal metric that captures the business per

employee accurately. For' this analysis, ICRA has used the amount of deposits mobilised per employee as a measure of the business per employee. The Indian banking industry on an average mobilised Rs. 1-2 crore of deposits per employee for theyear ended March 2010. In this respect, private sector banks lead the group of Indian banks. The top bank in this category showed a deposit per employee of Rs. 7.14 crore for the year ended March 2010. As for the global benchmark banks, business per employeefor HSBC was robust at USD9.71 million (Rs. 44.66 crore), while that for ABN AMROBank was EUR 4 million (Rs. 20 crore) for the year ending December 2002.Thus, deposit mobilisation per employee for the global benchmark banks is higher than that of Indian banks. Business per Branch On an average, the banks showed a deposit of around Rs. 10-30 crore per branchfor the year ended March 2010. In recent times, the deposit mobilisation for Indian Bankson a branch basis has witnessed a steady increase. The new private sector banks in Indiahave led the way in this regard, because of the better use of technology. The highestdeposit per branch stood at Rs. 103.24 crore in 2010 for a new private sector bank, ascompared with Rs, 68.71 crore in 2002. The global benchmark banks mobilised more business per branch as compared with their Indian counterparts. Bank of Americamobilised USD 88.9 million (Rs. 408.94 crores) for the financial year ended 2002, whileABN AMRO Bank mobilised EUR 140 million (Rs. 700 crores). The higher per-bank deposit mobilisation for the global benchmark banks may be attributed to their superior technology orientation and the higher gross domestic products (GDP) of their respectivecountries. 3.5.5 Expenses per EmployeeFor this analysis, ICRA has used the employee expenses per employee as ameasure of the expenses per employee. Indian banks, on an average, expensed Rs. 0.025crore per employee in FY2002. For the new private sector banks, this figure was higher.The highest expense per employee incurred by an Indian bank for the year 2002 was Rs.0.041 crore per employee. In the case of the global benchmark banks, the expenses per employee for Citi GroupInc. was at USD 0.08 million (Rs. 0.36 crore), while for ABN AMRO Bank it was EUR 0.07 million Rs. 0.36 crore). Expenses per Branch For this analysis, ICRA has used operating expenses per branch as a measure of the expenses per branch. The expense per branch for most Indian banks was Rs. 0.56crore for FY2002. Over the years, Indian banks have reported a gradual increase in suchexpenses, with competition-prompted upgrade being the primary reason for the same. Inthe case of the global benchmark banks, expense per branch for Bank of America wasUSD 4.93 million (amount in Rs. 22.68 crore), while for ABN AMRO Bank it was EUR 4.6 million (Rs. 22.99 crore).

1.8 Structural Benchmarking Since its inception in 1980s) BIS has issued several guidance notes for banks and bank supervisors. These notes have sought to improve the integrity of the global bankingsystem and propagate best practices in banking across the world. For issues related toaccounting, BIS has relied on the International Accounting Standards (IAS) issued by theInternational Accounting Standards Committee (IASC). Banks are supposed to followthese accounting standards as part of best practices. For the structural benchmarkingstudy of the Indian banking sector, ICRA has used primarily the guidance notes issued byBIS and the relevant

IAS as the benchmarks of best practices. ICRA has also referred tostandards as mentioned under, US and UK. GAAP (Generally Accepted AccountingPractices) where they provide a good understanding of international best practices. Capital Adequacy Norms for Banks BIS introduced capital adequacy norms for banks for the first time in 1988. Toimprove on the existing norms, BIS issued a Consultative Document in January 2001, proposing changes to the existing framework. The objective of this document is todevelop a consensus on the Basel II Accord (as it is popularly known), which is expectedto be implemented in 2007. Based on feedback received from various quarters, BISissued a new Consultative Document in April 2010. In this document, BIS has proposedthe following key changes over the existing norms: Introduction (of finer grades of risk weighting in corporate credit According to the original 1988 Accord, all credit risks have a 100% per centweighting. Under the new method, grades of weightings in the 20-150% range will beassigned. Introduction of charges for operational risks: Under the proposed Basel II Accord, banks have to allocate capital for operationalrisks. BIS has suggested three methods for estimating operational risk capitals:1. Basic Approach,2. Standardised Approach, and3. Advanced Measurement Approach. Capital requirement for mortgages reduced: The risk weights on residential mortgages will be reduced to 35% from 50%.During the 1990s, the RBI adopted the strategy of attaining a Capital Adequacy Ratio(CAR) of 8% in a phased manner. Subsequently, in line with the recommendations of theCommittee on Banking Sector Reforms, the minimum CAR was further raised to 9%,effective 31st March 2000.As a step towards implementing the Basel II guidelines, the RBI in its circular of 14th May, 2010 has proposed new methods for estimating regulatory risk capital. Toestimate the impact of the proposed changes on the capital adequacy position of Indian banks, the RBI has asked select banks to estimate their riskweighted assets on the basis of the new method. As per this, the RBI has asked for the estimation of capital requirementon the basis of the external credit rating of borrowers. For nonrated borrowers, the RBIhas asked the select banks to use the existing 100% risk weights.The RBI has also asked the banks to calculate operational risk capital separatelyfollowing the Basel approach. Based on the result of the exercise, the RBI will issue newguidelines on estimating economic capital.Additionally, the RBI has asked banks to introduce internal risk scoring models. It isexpected that once the Basel II Accord is signed, the RBI will allow banks to move to theIRB approach.The Capital Adequacy norms in India are in line with the best practices as suggested by BIS. Once the Basel II Accord is implemented, the method of estimation of risk capital will undergo a significant change. RBI has already taken appropriate steps to prepare the Indian banking industry for such changes. Recognition of Financial Assets & Liabilities IAS 39 requires that all financial assets and all financial liabilities be recognisedon the balance sheet. This includes all derivatives. Historically, in many parts of theworld, derivatives have not been recognised as liabilities or assets on balance sheets. Theargument for this practice has been that at the time the derivative contract was enteredinto, no cash or other asset was paid. The zero cost justified non-recognition,notwithstanding the fact that as time pauses and the value of the underlying variable (rate, price, or index) changes, the derivative has a positive (asset) or negative (liability) value.In India, derivatives are still off-

balance sheet items and considered part of contingent liabilities. So in Indian treatment of derivatives is different from InternationalAccounting Standards. Valuation of Financial Assets IAS 39 has classified financial assets under four categories. The following tablesummarises the classification and measurement scheme for financial assets under IAS 39,Under US GAAP, marketable equity securities and debt securities are classified as under: trading, Available for sale, or held to maturity. Recognition of Non-Performing Assets (NPAs)/Impaired Assets Under IAS 39, impairment recognition is left to management discretion (its perception of the likelihood of recovery). Impairment calculation compares the carryingamount of the financial asset with the present value of the currently estimated amountsand timings of payments. If the present value is lower than. The carrying amount, theloan is classified as NPL.Under US GAAP, loans assume non-accrual statuses if any of the following conditionsare fulfilled:Full repayment of principal or interest is in doubt (in management's judgment), or if scheduled principal or interest payment is past due 90 days or more, and if thecollateral is insufficient to cover the principal and interest. In India, NPAs are classified under three categories-Sub-standard, Doubtful andLoss on the basis of the number of months the amount is overdue for. India proposed to move from 180 days to a 90-day past due classification rule for NPA recognitioneffective March 2004.The financial instrument's original effective interest rate is the rate to be used for discounting. Any impairment loss is charged to profit and loss account for the period.Impairment or "uncollectability" must be evaluated individually for material financialassets. A portfolio approach may be used for items that are individually small [IAS39.109]. Therefore, under IAS, provisioning is based on management discretion.Provision in excess of expected loan losses may be booked directly to shareholders'equity. As with IAS, under the UK, And US GAAP also, provisioning is based onmanagement discretion. Under US GAAP, when the Net Present Value of a loan is lessthan the carrying value, the difference is booked as provision.In India; provisioning norms are more explicit than they are under the IAS. RBIhas specified norms for various classes of NPL as follows:Standard Assets: 10%Doubtful Assets: 100% of unsecured portion,20-50% on secured portionLoss Assets: 100%Interest Accrual on M onperforming Loans / impaired AssetsUnder both IAS and US GAAP, there is no specific prescription for interestaccrual on NPAs. Under UK. GAAP, interest is suspended upon classification as NPL.However, suspension may be deferred up to 12 months if sufficient collateral exists.According to Sound Practices for Loan Accounting and Disclosure (1999) number 11, the BIS Committee on Banking Supervision recommends that when a loan isidentified as impaired, a bank should cease accruing interest in accordance with the termsof the contract. Interest on impaired loans should not contribute to net income if doubtsexist over the collectability of loan interest or principal. In India, accrual of interest is suspended upon classification of a loan as non performing. General Provisioning on Performing Loans Under IAS, UK and US GAAP, there is no specific prescription for general provisioning towards performing loans. However, Indian banks have a provisioningrequire; f tent of 0.2 5% on all standard assets. Conclusion The RBI norms for classification of assets, and provisioning against, bad/doubtfuldebts are more detailed and precise vis-a-vis international rules. While the internationalnorms often leave bad debt provision levels to "management discretion", Indian standardsare precise and clearly state exactly when and by how much reported earnings must becharged off for bad

debts.In India, detailed accounting standards for derivatives are yet to be introduced. As of now, derivatives continue to be considered as off-balance sheet liabilities. 1.9 Likely Future Trends and their Implications for Indian Banks Financial Disintermediation and Bank Profitability The degree of banking disintermediation and financial sophistication areimportant factors in the development of a country's economy. Disintermediation affectsthe allocation process for both savings and credits in the economy. With the introductionof sophisticated deposit products by mutual funds, pension funds and insurancecompanies, individual and corporate depositors now have more options for savings. Asimilar trend is also visible in credit offerings. More and more corporate entities are nowapproaching the capital market to raise funds either in the form of debt or equity.At the end of the 1990s, the US banking industry was facing a high level of disintermediation, as most outstanding savings were in mutual funds, pension funds, andlife insurance plans, but not in bank deposits or other liability products. However, incontinental Europe, most banking systems (as in Germany, Spain, Italy, Austria, France,etc.) are still highly bank-intermediated, although the trend is clearly towards faster disintermediation for both savings and credits. In India, financial disintermediation islikely to catch up with banks sooner than later. With the opening up of the financialsector, Indian banks are facing competition from the mutual fund and insurance sectorsfor savings. On the credit side, good quality borrowers have started raising debt directlyfrom the market at competitive rates. Changing Capital Adequacy Norms Capital adequacy norms for banks are likely to undergo a change after the Basel IIAccord is implemented. In the current system, Indian banks need to allocate 9% capital, irrespective of the credit quality of a borrower. In the new system, a bank offering creditto a better quality corporate entity is likely to require less regulatory capital. Theallocation of regulatory capital on the basis of credit quality would encourage banks toestimate their Risk adjusted Return on Capital (RAROC) rather than compute simplemargins. Similarly, banks now need to distinguish between the credit qualities of sovereign borrowings and inter-bank borrowing, as they would need to allocate capital tosovereign credit and inter-bank credit on the basis of external ratings, or using the IRBapproach.To emerge successful in the Basel II regulatory environment, banks would need tointroduce the practice of risk-based pricing of loans, which in turn would require a bank to implement advance Risk Management Systems. To implement such systems, bankswould need to implement the following key steps: Develop Credit Risk Scoring Models Generate Probability of Default (PD) associated with each risk grade Estimate Loss Given Default (LGD) for each collateral type. Calculate expected and unexpected loss in a portfolio based on correlationamongst loans. Compute the capital that would be required to be held against economic loss potential of the portfolio.Similarly, banks would have to introduce robust systems for measuring andcontrolling Market Risk and Operations Risk. .3 Management of Non-PerformingAssets The size of the NPA portfolio in the Indian banking industry is close to Rs.1,00,000 crore, which is around 6% of India's GDP. NPAs affect banks profitability ontwo counts:The introduction of scientific credit risk management systems would lower slippage of assets from the performing to the nonperforming category. Further, bankswith better NPA recovery processes would be able to reduce their provisioningrequirements, thereby increasing their profitability. To enable a fair borrower-lender relationship in credit, the Government of India has recently enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of Security interest Act 2002 (SRESAct). Due to several cases still to be

resolved in courts of law, it is. Not clear as yet, howfar this Act is set to alter the NPA recovery scenario in India. Following the announcement of the RBI's Asset Classification norms, the processof Asset Quality Management involves segregating the total portfolio into three segmentsand having detailed strategies for each. The three segments are: Standard/Performing Assets Special Mention Accounts/Sub-Standard Assets Chronic Non-Performing AssetsBanks need to vigilantly monitor Standard Assets to arrest any account slippageinto the non-performing grade. Besides, banks need to churn their credit portfolio so as tomaximise returns while keeping the risks pegged at acceptable levels.Special Mention Accounts are assets with potential weaknesses which deserveclose attention and timely remedial action. The typical warning signs exhibited by a borrower ranges from frequent excesses in the account to non-submission of periodicalstatements. Account restructuring and rehabilitation tools are best implemented duringthis stage. However, the challenges faced while restructuring include, (a) selecting thegenre of assets to be restructured, (b) quantifying the benefits to be extended, (c)determining repayment schedules, and (d) coordinating and balancing the needs of several lenders.Chronic Non-Performing Assets can now be better managed following theenactment of the SIZES Act. The Act provides the requisite regulatory framework for theforeclosure of assets by lenders, incorporation of Asset Reconstruction Companies(ARCS), and formation of a Central Registry. In the wake of this new legislation,amicable solutions may be realised for Chronic NPAs. The strategies includeEnforcement of Security Interest, Securitisalion, One-Time Settlement (OTS), and Write-off. However, a scientific approach to deciding which of these alternative routes must betaken hinges on: (a) assessment in terms of quality of the underlying assets and their realisable value, (b) alternative use of the assets, and (c) willingness of the borrower tosettle outstanding dues. conclusion The profitability of Indian banks in recent years compares well with that of theglobal benchmark banks primarily because of the higher share of profit on the sale of investments, higher leverage and higher net interest margins of Indian banks. However,many of these drivers of higher profits of Indian banks may not be sustainable. To ensure long-term profitability, Indian banks need to focus on the following parameters and buildsystemic capability in management of the same: Ensure that loans are diversified across several customer segments Introduce robust risk scoring techniques to ensure better quality of loans,as well as to enable better risk-adjusted returns at the portfolio level Improve the quality of credit monitoring systems so that slippage in assetquality is minimised Raise the share of non-fund income by increasing product offeringswherever necessary by better use of technology Reduce operating expenses by upgrading banking technology, and Improve the management of market risks Reduce the impact of operational risks by putting in place appropriateframeworks to measure risks, mitigate them or insuring them.The RBI as the regulator of the Indian banking industry has shown the way instrengthening the system, and the individual banks have responded in good measure inorienting them selves towards global best practices.

MAJOR DEVELOPMENTS IN BANKING ANDFINANCE Banking Developments The RBI allowed resident Indians to maintain foreign currency accounts. Theaccounts to be known as resident foreign currency (domestic) accounts, can be used to park forex received while visiting any place abroad by way of payment for services, or money received from any person not resident in India, or who is on a visit to India, insettlement of any lawful obligations. These accounts will be maintained in the form of current accounts with a cheque facility and no interest is paid on these accounts. With aview to liberalise gold trading, the Reserve Bank has decided to permit authorised banksto enter into forward contracts with their constituents like exporters of gold products, jewellery manufacturers and trading houses, in respect of the sale, purchase and loantransactions in gold with them. The tenor of such contracts should not exceed 6 months.The Reserve Bank of India has told foreign banks not to shut down branches withoutinforming the central bank well in advance. Foreign banks have been further advised bythe Reserve Bank of India to furnish a detailed plan of closure to ensure that their customers interests and conveniences are addressed properly.The RBI has prohibited urban co-operative banks from acting as agents or sub-agents of money transfer service schemes. The RBI has allowed banks to investundeployed foreign currency nonresident (FCNR-B) funds in the overseas markets in thelong-term fixed income securities with ratings a notch lower than highest safety. Earlier, banks were allowed to invest only in long-term securities with highest safety ratings byinternational agencies.The RBI has defined the term willful defaulter paving the way for banks toacquire assets of defaulting companies through the Securitisation Ordinance and reducetheir NPAs faster. According to the RBI a wilful defaulter is one who has not used bank funds for the purpose for which it was taken and who has not repaid loans despite havingadequate liquidity. International credit rating agency Standard & Poor has estimated thatthe level of gross problematic assets in India can move into the 35-70 per cent range inthe event of a recession. It has also estimated that the level of non-performing assets (NPAs) in the system to be at 25 per cent, of which only 30 per cent can be recovered. The Reserve Bank of India has decided to extend operation of the guidelines for the one time settlement scheme for loans upto Rs.50,000 to small and marginal farmers by public sector banks for another 3 months, i.e, upto March 31, 2010.The Reserve Bank of India, as part of its policy of deregulating interest rates onrupee export credit, has freed interest rates on the second slab - 181 to 270 days for pre-shipment credit and 91 to 180 days for post-shipment credit with effect from May 1,2010.The Cabinet cleared a financial package for IDBI and agreed to take over thecontingent liabilities to the tune of Rs.2500 crore over five years. The IDBI Act will berepealed during the winter session of the Parliament, paving the way for IDBIsconversion into a banking company.The IDBI would be given access to retail deposits, toenable it to bring down the cost of funds, but will be spared from priority sector lendingand SLR requirements for existing liabilities.The RBI has issued guidelines for setting up of offshore banking units (OBUs)within special economic zones (SEZs) in various parts of the country. Minimuminvestment of $10 million is required for setting up an OBU. All commercial banks areallowed to set up one OBU each. OBUs have to undertake wholesale banking operationsand should deal only in foreign currency. Deposits of the OBUs will not be covered bydeposit insurance. The loans and advances of OBUs would not be reckoned as net bank credit for computing priority sector lending obligations. The OBUs will be regulated andsupervised by the exchange control department of the RBI.With a view to develop the derivatives market in India and making availablehedged currency exposures to residents an

RBI Committee headed by Smt. Grace Koshie,recommended phased introduction of foreign currency-rupee (FC/NR) options. _ TheReserve Bank of India has notified the draft scheme for merging Nedungadi Bank withPunjab National Bank. This is the first formal step towards bringing about a merger between the two Banks.The Reserve Bank of India has agreed to allow capital hedging for foreign banksin India. The guidelines pertaining to capital hedging will be issued by RBI soon.The Reserve Bank of India has decided to allow foreign institutional investors (FIIs) to enter into a forward contract with the rupee as one of the currencies, with an authorised dealer (AD) in India to hedge their entire exposure in equities at a particular point of time without any reference to the cut-off date. Further, the RBI has alsoincreased Authorised Dealers overseas market investment limit to 50 per cent of their unimpaired tier-I capital or $ 25 million, whichever is higher.The Reserve Bank of India doubled the foreign exchange available under the basic travel quota (BTQ) to resident individuals from US $5000 to US $10000, or itsequivalent.The Government has decided to dispose of UTI Bank as part of restructuringUnit Trust of India.Though the details in this regard is yet to be worked out, it has beendecided that the bank will be disposed of during the course of the restructuring.The RBI has allowed tour operators to sell tickets issued by overseas traveloperators such as Eurorail and other rail/road and water transport operators in India, inrupees, without deducting the paymentfrom the travellers basic travel quota.The Reserve Bank of India (RBI) has banned banks from offering swapsinvolving leveraged structures, which can cause huge losses if the market moves the other way.The RBI constituted committee on payment system has recommended that thecentral bank, as the regulator of payment and settlement systems, should be empoweredto regulate non-banking systems. Market Developments and New Products The Hong Kong and Shanghai Banking Corporation will be bringing $150million additional capital to India in the current fiscal.The Reserve Bank of India has ordered a moratorium on the Nedungadi Bank.The moratorium effective from the close of business will be in force upto February 1,2010. During this period, the central bank is likely to finalise the plans for merging Nedungadi Bank with Punjab National Bank.ABN Amro Bank launched its Business Process outsourcing (BPO) operations,ABN Amro Central Enterprise Services (ACES) in Mumbai. It has been set up with an initial investment of 4 million euros (Rs.19 crore) and has been capacitised at 650 seats ina single shift. The Canara Bank has returned 48 per cent (Rs. 277.87 crore) of its capital to theGovernment before its Initial Public Offer.China has granted licence to Bank of India to open a representative office in thesouth Chinese city of Shenzhen.Shri A.K. Purwar is appointed as the Chairman of State Bank of India.The State Bank of India has launched SBI Cash Plus, its Maestro debit card for which it has tied up with Master Card International. SBI Cash Plus will allow customersto access their deposit accounts from ATMs and merchant establishments.The Siam Commercial Bank, having Thailand government as the major shareholder, is planning to close down its banking operations in India from November 30, 2002, as part of its global restructuring strategy.The Punjab National Bank (PNB) has got license from the Reserve Bank of Indiafor doing internet banking. The bank is likely to do the formal launch of its internet banking solution within a few weeks time.The ICICI Bank is planning to set up kiosks to offer financial services in the ruralareas. This outfit would also extend agricultural loans.

CLASSIFICATION

OF

SCHEDULED

BANKING

STRUCTURE

IN

INDIA

The scheduled banks are divided into scheduled commercial banks and scheduledco operative banks. Further scheduled commercial banks divided into the Public Sector Banks, private sector banks, foreign banks, and regional rural banks. Whereas scheduledco-operative banks are classified into scheduled urban co operative and scheduled stateco- operative.RBI has further classified public sector banks into nationalized banks, state bank of India and its subsidiaries. And private banks have been classified into old andnew private sector banks. As far as the number is concerned, total public sector banksare 27, private sector banks are 30, foreign banks are 36, and regional rural banks are196. Thus in scheduled commercial bans, the regional rural banks are on the top number.In the scheduled co-operative banks, there are 57 scheduled cooperatives and 16scheduled co-operative banks. Today the overall commercial banking system in Indiamay be distinguished into: 1. Public Sector Banks2. private Sector Banks3. Co-operative Sector Banks4. Development Banks PUBLIC SECTOR BANKS a. State Bank of India and its associate banks called the State Bank group b. 20 nationalised banksc. Regional Rural Banks mainly sponsored by Public Sector Banks

PRIVATE SECTOR BANKS a. Old generation private banks b. New generation private banksc. Foreign banks in Indiad. Scheduled Co-operative Bankse. Non-scheduled Banks CO-OPERATIVE SECTOR

The co-operative banking sector has been developed in the country to the supplimentthe village money lender. The co-operatiev banking sector in India is divided into 4components1. State Co-operative Banks2. Central Co-operative Banks3. Primary Agriculture Credit Societies4. Land Development Banks5. Urban Co-operative Banks 6. Primary Agricultural Development Banks7. Primary Land Development Banks8. State Land Development Banks DEVELOPMENT BANKS 1. Industrial Finance Corporation of India (IFCI)2. Industrial Development Bank of India (IDBI)3. Industrial Credit and Investment Corporation of India (ICICI)4. Industrial Investment Bank of India (IIBI)5. Small Industries Development Bank of India (SIDBI)6. SCICI Ltd.7. National Bank for Agriculture and Rural Development (NABARD)8. Export Import Bank of India9. National Housing Bank PUBLIC SECTOR BANKS Before the independence, the banking system in India was primarily associatedwith urban sector. After independence, the banks had to spread out into rural and un- banked areas and make credit available to the people of those areas.In 1969 the government nationalized 14 major commercial banks. Still the widedisparities continued. To reduce the disparities the government nationalized 6 morecommercial banks in 1980 government came to own 28 banks including SBI and its 7subsidiaries. Today, we are having a fairly well developed banking system with differentclasses of banks-public sector banks, foreign banks, and private sector banks-both old andnew generation.In July 1993, New Bank of India was merged with Punjab National Bank. Now, there are 27 banks in the public sector viz. State Bank of India and its 7 associates,19 commercial banks exclusive of Regional Rural.In terms of sheer geographical spread, the public sector system is the largest. Thestatistics are as follows: a network of 64000,branches-one branch for every 14000 Indianwith over 64 crores customers. This labour intensive network has built-in cost, whichmakes the public sector banks inherently uncompetitive. Reduction of branches toachieve cost saving has not received a munch thrust as it should. Public sector banks arecharacterized by mammoth branch network, huge work force, relatively lesser mechanization, and huge volume but of less value business transactions, social objectivesand their own legacy system and procedures.Improving profitability in general requires efforts in several directions, i.e.cutting in cost, improving productivity, better recovery of loan and to reduce high level of NPAs . The public sector banks have to build up the cost-benefit culture in their operations. When there is a thin margin in banking operation, the public sector banks inIndia have to increase the turnover. Previously, Indian banks were relying on high creditdeposit ratio. Now, the Indian banks have to depend on the volume of high businessturnover. The returns on assets have to be improved. Further, the PSBs in Indian have to compare them with the highly profitable bank with regards to operating expenses. They have to ensure that each every account is profitable and product should be such, while generates more profit. CHALLENGES FOR THE PUBLIC SECTOR Indian banks functionally diverse and geographically widespread have played acrucial role in the socio-economic progress of the country after independence. Growth of large number of

medium and big industries and entrepreneurs in diverse fields were thedirect results of the expansion of activities of banks. The rapid growth, forever lead tostrains in the operational efficiency of the banks and the accumulation of non-performingassets (NPAs) in their loans portfolio. The uncomfortably high level of NPAs of bankshowever is a cause for worry and it should be brought down to international acceptablelevels for creating a vibrant and competitive financial system. NPAs are serious strains onthe profitability of the banks as they cannot book income on such accounts and their funding cost provision requirement is a charge on their profit. Although S & P cited as areasons for mounting of NPAs priority sector lending, outdated legal system which notonly encourages the incidence of NPAs but also prolongs their existence by placing a premium on default and delay in finalization of rehabilitation packages by the Board for Industrial and Financial Reconstruction are some of the major causes for the rising of NPAs. The following deficiencies were noticed in the managing Credit Risk: The absence of written policies. The absence of portfolio concentration limits. Excessive centralization or decentralization of lending authorities. Cursory financial analysis of borrower. Infrequent customer contact. Inadequate checks and balances in credit process The absence of loan supervision A failure to improve collateral position as a credit deteriorate Excessive overdraft lending. Incomplete credit files The absence of the assets classification and loan-loss provisioning standards A failure to control and audit the credit process effectively.In July 1993, New Bank of India was merged with Punjab National Bank. Now, there are 27 banks in the public sector viz. State Bank of India and its 7 associates,19 commercial banks exclusive of Regional Rural. Following are the 21 public sector banks.1. Allahabad Bank 2. Andhra Bank 3. Bank of Baroda4. Bank of India5. Bank of Maharashtra6. Canara Bank 7. Central Bank of India8. Corporation Bank 9. Dena Bank 10. Indian Bank 11. Indian Overseas bank 12. Punjab National Bank 13. Punjab and Sind Bank 14. State Bank of India15. State Bank of India & its associates.1) State Bank of Hyderabad2) State Bank of India3) State Bank of Indore4) State Bank of Mysore5) State Bank of Saurashtra6) State Bank of Travancore18. Syndicate Bank 19. UCO Bank 20. Union Bank of India (UBI) Vijaya Bank Deposits Total deposits mobilized by the Public Sector Banks as at the end March 2010stood at Rs. 10,79,394crore showing a growth of 11.4% which is lower than growth rateof 12.7%

recorded at end March 2002. The State Bank of Patiala showed the highestgrowth in the deposit mobilization with 28.1%, where Orietal Bank of Commerce showedthe lowest growth rate of 4.6% at the end March 2010. During the year 2002-2010, 17Public Sector Banks registered the higher growth than the group average. Investment During 2002-2010, investment rose by Rs. 91,159crore (20%) to Rs. 5, 45,668crore as compared to an increase of Rs. 60,402 crore (15.3%) during the previous year.The rate of growth was higher than the average for 14 Public Sector Banks. State Bank of Patiala showed highest rate with 42.3%. At the other extreme, Oriental Bank of commerce registered growth rate of 7.9% during the year. Other banks which haveregistered an impressive growth in investment during 2002-2010 are Canara Bank (31.1%), Corporation Bank (32.4%), and State Bank of Saurashtra (33.0%). Credit The rate of growth in the total loan disbursement by the banking sector was lower during 2002-2010 due largely to lower economic activity. The total loans and advances position as at end March 2010 stood at Rs. 5,49,351crore registered the growth rate of 14.1% as compared to Rs. 4,80,118 crore at end March 2002 with growth rate of 15.7%.14 Public Sector Banks showed the higher growth rate than the group average. VijyaBank tops the position with 27.3% in credit disbursal. Other banks which have showedimpressive growth in advances are Canara Bank (22.1%), UCO Bank (24.4%), StateBank of Indore (21.0%),State Bank of Patiala (23.8%)and State Bank of Travancore(23.3%)during 2002-2010. the Bank which registered the lowest growth in creditdisbursement was Bank of Baroda with 5.0%. Total Assets Total Assets of the Public Sector Banks increased to Rs.1,28,5236crore as onMarch 2010 from Rs.11,55,398crore of the previous year, showing the growth rate of 11.2% as against the growth rate of 12.2% recorded during the 2001-2002. 17 PublicSector Banks registered higher than the average rate of growth recorded by the PublicSector Banks as a group. During the previous year (2001-2202), 16 Public Sector Banksregistered growth rate higher than the average growth recorded by this group. Non performing Assets Both gross NPA and net NPA at the end March 2010 were lower than the previous year. The gross NPA of Public Sector Banks decreased to Rs. 54,087crore at theend March 2010 from Rs. 56,476crore at end March 2002. Similarly the Net NPAdeclined from R.s 27,973 crore at the end March 2002 to Rs. 24,963crore at the endMarch 2010. so far as the growth is concerned, the gross NPA registered (-)4.2%at theend March 2010 as compared to 3.3% of the previous year. In the case of net NPA, it hasshown a declining trend in all the tree years. The growth in net NPA registered a (-)0.02% in 2002 and (-) 10.7% at the end March 2010. Profit The total gross profit of the Public Sector Banks stood at Rs.29,715 crore during2010-11 as compared to Rs. 21,673crore 2001-02. The net profit of the banks also wentup from Rs.8,301crore in 2001-02 to R.s12,295crore during 2010-11. highest growth ratein the net profit was recorded by the Dena Bank (905.0%) followed by the Indian Bank (468.4%) apart from these two banks, other banks which have recorded remarkablegrowth in net profit were United Bank of India (156.3%) and Allahabad Bank (106.9%).14 banks recorded higher growth in the net Public Sector Banks than the group averageduring 2010-11 Operating Expenses

The operating expenditure as percentage to total expenses moved up from 24.3%in 2001-02 to 24.8% in 2010-11. Oriental Bank of Commerce recorded the least ratiowith 17.2%. At the other extreme is Syndicate Bank with the highest ratio of 35.8%. Total Expenditure The total expenditure of the banks increased to Rs.1,16,169 crore during 2010-11from Rs. 1,08,948crore during 2001-02 showing a growth of 6.6% which is lower thanthe previous years growth of 9.9%. this moderate reduction in the rate of growth in thetotal expenditure, which recorded a lower growth of 1.0% during 2010-11 as compared to12.1% of of previous year . on the other hand, the operating expenditure of Public Sector Banks moved up from Rs.26,422crore during 2001-02 to Rs.28,897crore during 2010-11recorded a growth of 9.4% as compared to the previous years declined growth of (-)5.6%. 13 Public Sector Banks registered higher growth than the groups average growthin operating expenses during 201011. Highest growth in the operating expenses wasrecorded by Andhra Bank (32.5%), closely followed by Vijaya Bank (32.1%). TheUnited Bank of India was the only bank with lower operating expenses during 2010-11 ascompared to the previous year. Income Total income of Public Sector Banks, though increased to Rs. 1,28,464croreduring the year 2010-11 from Rs. 1,17,252crore during 2001-02, recorded lower growththan the previous year. Growth of income during 2010-11 was 9.6% which is lower than13.3% of the previous year. Both of the major components of the income, i.e, interestincome and other income, registered lower growth than the previous year. Interest incomeduring 2010-11 was Rs.1,00,711crore (10.5%) of the previous year. Similarly, the other income moved up to Rs.21,272crore (28.6%) during 2010-11 as compared to Rs.16,541crore (33.7%) of the previous year. There is not much variation in the trend in theincome pattern of the 19 nationalised banks and SBI groups during the year 2010-11.though the interest income still remain the major contributor to the total income of thegroup, the share of other income in the total income is moving up. The share of other income in the total income of the Public Sector Banks increased from 12% to 14% andfurther to 16.4% during the year 2000-01, 2001-02, and 2010-11, respectively. Theimpressive growth in the other income is largely due to the impressive growth in thetreasury income of the banks

INDIAN ECONOMY AND NPAS Undoubtedly the world economy has slowed down, recession is at its peak,globally stock markets have tumbled and business itself is getting hard to do. The Indianeconomy has been much affected due to high fiscal deficit, poor infrastructure facilities,sticky legal system, cutting of exposures to emerging markets by FIIs, etc.Further, international rating agencies like, Standard & Poor have lowered India'scredit rating to sub-investment grade. Such negative aspects have often outweighed positives such as increasing forex reserves and a manageable inflation rate.Under such a situation, it goes without saying that banks are no exception and are bound to face the heat of a global downturn. One would be surprised to know that the banks and financial institutions in India hold non-performing assets worth Rs.

1,10,000crores. Bankers have realized that unless the level of NPAs is reduced drastically, theywill find it difficult to survive.The actual level of Non Performing Assets in India is around $40 billion muchhigher than governments estimation of $16 billion. This difference is largely due to thediscrepancy in accounting the NPAs followed by India and rest of the world. TheAccounting norms of the India are less stringent than those of the developed economies.the Indian banks also have the tendency to extend the past dues. Considering the GDP of India nearly $470 billion, the NPAs are 8% of total GDP, which was better than the manyAsian countries. the NPA of china was 45%of the GDP, while Japan had NPAs of 25% of the GDP and Malaysia had 42%.The aggregate level of the NPAs in Asia has increased from $1.5 billion in 2000to $2 billion in 2002.looking to such overall picture of the market, we can say that Indiais performing well and the steps taken are looking favorable. NPA CHARACTERISTICS IN INDIA 1. Size of NPA Portfolios Reviewed On an overall basis, in comparison to the Gross NPA portfolio of the financialsector in India for the year ended March 31, 2010, approximately Rs. 452 billion from thetotal gross NPAs of Indian banking sectors Public Sector Banks cover 55% of gross NPAs Private sector banks cover 11% of gr oss NPAs Foreign sector banks cover 3.02%, and Financial institutions cover 29% 2. Sectoral Segmentation Banks in India are required to reserve a part of their lending for the priority sector.Broadly this comprises the sub-sectors such as Agriculture, Small Scale Industries, andother activities such as small business, retail trade, small transport operators, professionaland self employed persons, housing, education loans, micro-credit etc. In addition, certaininvestments in bonds issued by State Financial Corporations (SFCs), State IndustrialDevelopment Corporations (SIDCs), etc. are also recognized as priority sector lending provided such bonds have been issued exclusively to finance priority sector activities.As seen from the Chart below, around 23% of the NPA portfolio is in the prioritysector including agriculture, small scale and others. The balance 77% belongs to NPAs inthe non-priority sector which includes NPAs pertaining to public sector undertakings,corporate and retail borrowers. Within the non-priority sector, a large proportion of NPAs(more than 96%) by gross value are in the corporate segment. The largest proportionamong the corporate borrowers is private sector corporate borrowers.Since the sectoral segmentation norms are applicable to banks only the abovegraph is somewhat skewed (participant lenders included financial institutions). Given below is the sectoral segmentation in public sector banks only.Priority sector NPAs constitutes 46% of the NPA portfolio of participant public sector banks by value. In the non-priority sector corporate borrowers form the largest proportionof NPAs.

3. Industry Classification Most of the participant lenders have provided us with detailed NPA profile for large NPAs. The remainder of our analysis for NPA profiling, therefore, focuses on thelarge NPA portfolio. The total large NPA (individual gross value above Rs 10 million) portfolio of the participating banks amounts to Rs 357 billion approximately.The top 5 industries with maximum Large NPAs (by gross value) for the participant lenders included in this study are

Textiles, Iron & Steel, Chemicals,Engineering and (non ferrous) Metals. The Large NPAs of these 5 industries alonecomprise approximately half of the total Large NPA portfolio (by gross value) of the participating lenders. At 15%, the Textiles industry is the single largest contributor to thegross Large NPAs of the participating lenders. It is followed by Iron & Steel with 14%,Chemicals with 9%, Engineering with 8% and Metals with 5%.The participant lenders provided loan grading segmentation of the Large NPAs inthe top 5 industries viz. textiles, iron & steel, chemicals, engineering and metals. Onlyabout 20% of the Large NPA portfolio by gross value is in sub-standard assets. Thisindicates that the rehabilitation potential of, about 80% of the Large NPA portfolio ineach of the top 5 industries is somewhat limited Nearly 68% of the gross NPAs by gross value are in the doubtful category. Withinthis, 28% by gross value are in the C3 subcategory. It might be worth noting that C3category comprises assets that have been non-performing for at least 5 years and thatthere is no upper time limit on holding assets in the C3 category if the lender is able to provide evidence that collateral exists. Also nearly 15% to 18% of the Large NPAs ineach of the top industries (other than Chemicals) are loss assets.

4.State-wise Distribution Data was collected from participant lenders on state wise distribution of their Large NPAs. The top 5 states with maximum Large NPAs (by gross value) for thelenders included in this study are Maharashtra (including Goa), Gujarat, Delhi (includingRajasthan), Andhra Pradesh and Tamil Nadu. The Large NPAs in these 5 states alonecomprise approximately 65% of the total Large NPA portfolio (by gross value) of thelenders in the sample.Maharashtra (including Goa) with nearly 24% is the single largest contributor tothe gross Large NPAs of the participant lenders. It is followed by Gujarat with 11%,Delhi (including Rajasthan) with slightly more than 10%, Andhra Pradesh with 10% andTamil Nadu with just under 10%.

5.Region-wise Distribution The NPA portfolios of lenders covered in the study have been segmented into thefollowing regions: Northern - J&K, Himachal Pradesh, Punjab, Haryana, Delhi, Rajasthan,Uttaranchal and UP Eastern - North eastern states, West Bengal, Orissa, Bihar and Jharkhand Southern Tamil Nadu, Kerala, Pondicherry, Andhra Pradesh, Karnataka Western Maharashtra, Goa, Gujarat Central Madhya Pradesh, Chattisgarh Based on the above segmentation,the region-wise distribution of Large NPAs of the participant Lenders taken together is provided in the Chart below:The Western region (with 35%) has the maximum Large NPAs (by gross value)of the participating lenders. This is followed by the Southern and Northern Regions with24% each. Eastern and Central regions have a lower proportion of NPAs by gross valueat 10% and 6% respectively.On an overall basis, the geographical distribution of NPAs is clearly linked to thelevel of industrialization in various parts of India. The Western region in general andMaharashtra and Gujarat, in particular, are amongst the more industrialized areas of India. As a result, these areas have also attracted the maximum amount of bank credit.The slowdown in industrial activity during the past few years has also been more pronounced in these areas, which has resulted in a higher proportion of NPAs. 6. Operating Status of Assets In order to assess the rehabilitation potential of the Large NPAs, we had requested banks to provide break-down of their Large NPA portfolio between operating/non-operating and

implementation status. The table below provides a break-up of the NPA portfolio of all participating banks on the basis of operating status. As can be seen, only avery small proportion of the Large NPA portfolio (by gross value) is under implementation. The remaining is more or less equally split between assets which areoperating and those which are not. 7. Security Profile The data on break-up of the number and gross value of the Large NPAs based onthe type of security (Fixed assets/current assets) was also received from the participantlenders. It can be seen from the Chart below that 89% of the secured large NPAs aresecured against Fixed Assets, which suggests that some value might be preserved even if assets are not operating. 8. Possible Increase in Near Future Several measures are being taken both by the Government, Reserve Bank of Indiaand by the banks and institutions themselves to reduce the level of NPAs in the system.While the absolute value of NPAs has been increasing marginally, the NPA ratios (bothgross and net) have been declining over the last few years. In fact in the year ended March 31, 2010, the levels of NPAs have also declined in absolute terms also ascompared to the previous year. The Indian system is moving towards international practices which utilize significant qualitative measures in addition to quantitativemeasures. Such a change may contribute to standard loans being graded as NPAs in thefuture. Also, according to some estimates, the application of the 90 days past due criteriafrom March 31, 2004 (as proposed by RBI) will increase gross NPAs by 3-5% of grossadvances.

UNDERLYING REASONS FOR NPAS IN INDIA An internal study conducted by RBI shows that in the order of prominence, thefollowing factors contribute to NPAs. Internal Factors Diversion of funds for oExpansion/diversification/modernization oTaking up new projects oHelping/promoting associate concerns time/cost overrun during the project implementation stage Business (product, marketing, etc.) failure Inefficiency in management Slackness in credit management and monitoring Inappropriate technology/technical problems Lack of co-ordination among lenders External Factors Recession Input/power shortage Price escalation Exchange rate fluctuation Accidents and natural calamities, etc. Changes in Government policies in excise/ import duties, pollution control orders,etc.As mentioned earlier, we held discussions with lenders and financial sector experts on the causes of NPAs in India and whilst the above-mentioned causes werereaffirmed, some others were also mentioned. A brief discussion is provided below. Liberalization of economy/removal of restrictions/reduction of tariffs A large number of NPA borrowers were unable to compete in a competitivemarket in which lower prices and greater choices were available to consumers. Further, borrowers operating in

specific industries have suffered due to political, fiscal and social compulsions, compounding pressures from liberalization (e.g., sugar and fertilizer industries) Lax monitoring of credits and failure to recognize Early Warning Signals It has been stated that approval of loan proposals is generally thorough and each proposal passes through many levels before approval is granted. However, the monitoringof sometimes-complex credit files has not received the attention it needed, which meantthat early warning signals were not recognised and standard assets slipped to NPAcategory without banks being able to take proactive measures to prevent this. Partly dueto this reason, adverse trends in borrowers' performance were not noted and the positionfurther deteriorated before action was taken. Over optimistic promoters Promoters were often optimistic in setting up large projects and in some caseswere not fully above board in their intentions. Screening procedures did not alwayshighlight these issues. Often projects were set up with the expectation that part of thefunding would be arranged from the capital markets, which were booming at the time of the project appraisal. When the capital markets subsequently crashed, the requisite fundscould never be raised, promoters often lost interest and lenders were left stranded withincomplete/unviable projects. Directed lending Loans to some segments were dictated by Government's policies rather thancommercial imperatives. Highly leveraged borrowers Some borrowers were under capitalized and over burdened with debt to absorb thechanging economic situation in the country. Operating within a protected market resultedin low appreciation of commercial/market risk. Funding mismatch There are said to be many cases where loans granted for short terms were used tofund long term transactions. High Cost of Funds Interest rates as high as 20% were not uncommon. Coupled with high leveraging andfalling demand, borrowers could not continue to service high cost debt. Willful Defaulters There are a number of borrowers who have strategically defaulted on their debtservice obligations realizing that the legal recourse available to creditors is slow inachieving results EXISTING SYSTEMS/PROCEDURES FOR NPAIDENTIFICATION AND RESOLUTION IN INDIA 1. Internal Checks and Control Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance.Though most banks have Early Warning Systems (EWS) for identification of potential NPAs, the actual processes followed, however, differ from bank to bank.The EWS enable a bank to identify the borrower accounts which show signs of credit deterioration and initiate remedial action. Many banks have evolved and adoptedan elaborate EWS, which allows them to identify potential distress signals and plan their options beforehand, accordingly. The early warning signals, indicative of potential problems in the accounts, viz. persistent irregularity in accounts, delays in servicing of interest, frequent devolvement of L/Cs, units' financial problems, market related problems, etc. are captured by the system. In addition, some of these banks are reviewingtheir exposure to borrower accounts every quarter based on published data which alsoserves as an important additional warning system. These early warning signals used

by banks are generally independent of risk rating systems and asset classification norms prescribed by RBI.The major components/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 FinancialSupervision are as follows:i) Designating Relationship Manager/ Credit Officer for monitoring account/sii) Prep aration of `know your client' profileiii) Credit rating systemiv) Identification of watchlist/special mention category accountsv) Monitoring of early warning signals Relationship Manager/Credit Officer The Relationship Manager/Credit Officer is an official who is expected to havecomplete knowledge of borrower, his business, his future plans, etc. The RelationshipManager has to keep in constant touch with the borrower and report all developmentsimpacting the borrowal account. As a part of this contact he is also expected to conductscrutiny and activity inspections. In the credit monitoring process, the responsibility of monitoring a corporate account is vested with Relationship Manager/Credit Officer. `Know your client' profile (KYC) Most banks in India have a system of preparing `know your client' (KYC) profile/credit report. As a part of `KYC' system, visits are made on clients and their places of business/units. The frequency of such visits depends on the nature and needs of relationship. Credit Rating System The credit rating system is essentially one point indicator of an individual creditexposure and is used to identify measure and monitor the credit risk of individual proposal. At the whole bank level, credit rating system enables tracking the health of banks entire credit portfolio.Most banks in India have put in place the system of internal credit rating. While mostof the banks have developed their own models, a few banks have adopted credit ratingmodels designed by rating agencies. Credit rating models take into account various typesof risks viz. financial, industry and management, etc. associated with a borrowal unit. Theexercise is generally done at the time of sanction of new borrowal account and at the timeof review / renewal of existing credit facilities. 2. Management/Resolution of NPAs A reduction in the total gross and net NPAs in the Indian financial systemindicates a significant improvement in management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past which include the SRFAESIAct, one time settlement schemes, setting up of the CDR mechanism, strengthening of DRTs. From the data available of Public Sector Banks as on March 31, 2010, there were1,522 numbers of NPAs as on March 31, 2010 which had gross value greater than Rs. 50million in all the public sector banks in India. The total gross value of these NPAsamounted to Rs. 215 billion.The total number of resolution approaches (including cases where action is to beinitiated) is greater than the number of NPAs, indicating some double counting. As can be seen, suit filed and BIFR are the two most common approaches to resolution of NPAsin public sector banks. Rehabilitation has been considered/adopted in only about 13% of the cases. Settlement has been considered only in 9% of the cases. It is likely to have been adopted in even fewer cases. Data available on resolution strategies adopted by public sector banks suggest thatCompromise settlement schemes with borrowers are found to be

more effective than legalmeasures. Many banks have come out with their own restructuring schemes for settlement of NPA accounts. 2. Credit Information Bureau 3. State Bank of India, HDFC Limited, M/s. Dun and Bradstreet InformationServices (India) Pvt. Ltd. and M/s. Trans Union to serve as a mechanism for exchange of information between banks and FIs for curbing the growth of NPAs incorporated creditInformation Bureau (India) Limited (CIBIL) in January 2001. Pending the enactment of CIB Regulation Bill, the RBI constituted a working group to examine the role of CIBs.As per the recommendations of the working group, Banks and FIs are now required tosubmit the list of suit-filed cases of Rs. 10 million and above and suitfiled cases of willfuldefaulters of Rs. 2.5 million and above to RBI as well as CIBIL. CIBIL will share thisinformation with commercial banks and FIs so as to help them minimize adverseselection at appraisal stage. The CIBIL is in the process of getting operationalised. 4. Willful Defaulters 5. RBI has issued revised guidelines in respect of detection of willful default anddiversion and siphoning of funds. As per these guidelines a willful default occurs when a borrower defaults in meeting its obligations to the lender when it has capacity to honor the obligations or when funds have been utilized for purposes other than those for whichfinance was granted. The list of willful defaulters is required to be submitted to SEBI andRBI to prevent their access to capital markets. Sharing of information of this nature helps banks in their due diligence exercise and helps in avoiding financing unscrupulouselements. RBI has advised lenders to initiate legal measures including criminal actions, wherever required, and undertake a proactive approach in change in management, whereappropriate. 5. Legal and Regulatory Regime A. Debt Recovery Tribunals DRTs were set up under the Recovery of Debts due to Banks and FinancialInstitutions Act, 1993. Under the Act, two types of Tribunals were set up i.e. DebtRecovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT). The DRTsare vested with competence to entertain cases referred to them, by the banks and FIs for recovery of debts due to the same. The order passed by a DRT is appealable to theAppellate Tribunal but no appeal shall be entertained by the DRAT unless the applicantdeposits 75% of the amount due from him as determined by it. However, the AffiliateTribunal may, for reasons to be received in writing, waive or reduce the amount of suchdeposit. Advances of Rs. 1 mn and above can be settled through DRT process.An important power conferred on the Tribunal is that of making an interim order (whether by way of injunction or stay) against the defendant to debar him fromtransferring, alienating or otherwise dealing with or disposing of any property and theassets belonging to him within prior permission of the Tribunal. This order can be passedeven while the claim is pending. DRTs are criticised in respect of recovery madeconsidering the size of NPAs in the Country. In general, it is observed that the defendantsapproach the High Country challenging the verdict of the Appellate Tribunal which leadsto further delays in recovery. Validity of the Act is often challenged in the court whichhinders the progress of the DRTs. Lastly, many needs to be done for making the DRTsstronger in terms of infrastructure.

B. Lokadalats The institution of Lokadalat constituted under the Legal Services Authorities Act,1987 helps in resolving disputes between the parties by conciliation, mediation,compromise or amicable settlement. It is known for effecting mediation and counselling between the parties and to reduce burden on the court, especially for small loans. Casesinvolving suit claims upto Rs. l million can be brought before the Lokadalat and everyaward of the Lokadalat shall be deemed to be a decree of a Civil Court and no appeal canlie to any court against the award made by the Lokadalat. Several people of particular localities/ various social organisations areapproaching Lokadalats which are generally presided over by two or three senior personsincluding retired senior civil servants, defense personnel and judicial officers. They takeup cases which are suitable for settlement of debt for certain consideration. Parties areheard and they explain their legal position. They are advised to reach to some settlementdue to social pressure of senior bureaucrats or judicial officers or social workers. If thecompromise is arrived at, the parties to the litigation sign a statement in presence of Lokadalats which is expected to be filed in court to obtain a consent decree. Normally, if such settlement contains a clause that if the compromise is not adhered to by the parties,the suits pending in the court will proceed in accordance with the law and parties willhave a right to get the decree from the court.In general, it is observed that banks do not get the full advantage of theLokadalats. It is difficult to collect the concerned borrowers willing to go in for compromise on the day when the Lokadalat meets. In any case, we should continue our efforts to seek the help of the Lokadalat. C. Enactment of SRFAESI Act The "The Securitisation and Reconstruction of Financial Assets and Enforcementof Security Interest Act" (SRFAESI) provides the formal legal basis and regulatoryframework for setting up Asset Reconstruction Companies (ARCs) in India. In additionto asset reconstruction and ARCs, the Act deals with the following largely aspects, viz. Securitisation and Securitisation Companies Enforcement of Security Interest Creation of a central registry in which all securitization and asset reconstructiontransactions as well as any creation of security interests has to be filed.The Reserve Bank of India (RBI), the designated regulatory authority for ARCShas issued Directions, Guidance Notes, Application Form and Guidelines to Banks inApril 2010 for regulating functioning of the proposed ARCS and these Directions/Guidance Notes cover various aspects relating to registration, operations and funding of ARCS and resolution of NPAs by ARCS. The RBI has also issued guidelines to banksand financial institutions on issues relating to transfer of assets to ARCS, considerationfor the same and valuation of instruments issued by the ARCS. Additionally, the CentralGovernment has issued the security enforcement rules ("Enforcement Rules"), which laysdown the procedure to be followed by a secured creditor while enforcing its securityinterest pursuant to the Act. The Act permits the secured creditors (if 75% of the secured creditors agree) toenforce their security interest in relation to the underlying security without reference tothe Court after giving a 60 day notice to the defaulting borrower upon classification of the corresponding financial assistance as a non-performing asset. The Act permits thesecured creditors to take any of the following measures: Take over possession of the secured assets of the borrower including rightto

transfer by way of lease, assignment or sale; Take over the management of the secured assets including the right totransfer by way of lease, assignment or sale; Appoint any person as a manager of the secured asset (such person could be the ARC if they do not accept any pecuniary liability); and Recover receivables of the borrower in respect of any secured asset whichhas been transferred.After taking over possession of the secured assets, the secured creditors arerequired to obtain valuation of the assets. These secured assets may be sold by using anyof the following routes to obtain maximum value. By obtaining quotations from persons dealing in such assets or otherwiseinterested in buying the assets; By inviting tenders from the public; By holding public auctions; or By private treat y.Lenders have seized collateral in some cases and while it has not yet been possible to recover value from most such seizures due to certain legal hurdles, lenders arenow clearly in a much better bargaining position vis-a-vis defaulting borrowers than theywere before the enactment of SRFAESI Act. When the legal hurdles are removed, the bargaining power of lenders is likely to improve further and one would expect to see alarge number of NPAs being resolved in quick time, either through security enforcementor through settlements. Asset Reconstruction Companies Under the SRFAESI Act ARCS can be set up under the Companies Act, 1956.The Act designates any person holding not less than 10% of the paid-up equity capital of the ARC as a sponsor and prohibits any sponsor from holding a controlling interest in, being the holding company of or being in control of the ARC. The SRFAESI andSRFAESI Rules/ Guidelines require ARCS to have a minimum net-owned fund of not less than Rs. 20,000,000. Further, the Directions require that an ARC should maintain, onan ongoing basis, a minimum capital adequacy ratio of 15% of its risk weighted assets.ARCS have been granted a maximum realisation time frame of five years fromthe date of acquisition of the assets. The Act stipulates several measures that can beundertaken by ARCs for asset reconstruction. These include:a) Enforcement of security interest; b) Taking over or changing the management of th e business of the borrower;c) The sale or lease of the business of the borrower;d) Settlement o f the borrowers' dues; ande) Restructuring or rescheduling of debt.ARCS are also permitted to act as a manager of collateral assets taken over by thelenders under security enforcement rights available to them or as a recovery agent for any bank or financial institution and to receive a fee for the discharge of these functions. Theycan also be appointed to act as a receiver, if appointed by any Court or DRT. D. Institution of CDR Mechanism The RBI has instituted the Corporate Debt Restructuring (CDR) mechanism for resolution of NPAs of viable entities facing financial difficulties. The CDR mechanisminstituted in India is broadly along the lines of similar systems in the UK, Thailand,Korea and Malaysia. The objective of the CDR mechanism has been to ensure timely andtransparent restructuring of corporate debt outside the purview of the Board for Industrialand Financial Reconstruction (BIFR), DRTs or other legal proceedings. The framework is intended to preserve viable corporates affected by certain internal/external factors andminimise losses to creditors/other stakeholders through an orderly and coordinatedrestructuring programme.RBI has issued revised guidelines in February 2010 with respect to the CDR mechanism. Corporate borrowers with borrowings from the banking system of Rs. 20crores and above under multiple banking arrangement are eligible under the CDR mechanism. Accounts falling under standard, sub-standard or doubtful categories can beconsidered for restructuring. CDR is a

non-statutory mechanism based on debtor-creditor agreement and inter-creditor agreement.Restructuring helps in aligning repayment obligations for bankers with the cash flow projections as reassessed at the time of restructuring. Therefore it is critical to prepare arestructuring plan on the lines of the expected business plan alongwith projected cashflows.The CDR process is being stabilized. Certain revisions are envisaged with respectto the eligibility criteria (amount of borrowings) and time frame for restructuring. Foreign banks are not members of the CDR forum, and it is expected that they would be signingthe agreements shortly. However they attend meetings. The first ARC to be operational inIndia- Asset Reconstruction Company of India (ARGIL) is a member of the CDR forum.Lenders in India prefer to resort to CDR mechanism to avoid unnecessary delays inmultiple lender arrangements and to increase transparency in the process. While in theRBI guidelines it has been recommended to involve independent consultants, banks areso far resorting to their internal teams for recommending restructuring programs.As of March 31, 2010, 60 cases worth Rs. 44,369 crores had been referred to theCDR, of which 29 cases worth Rs. 29,167 crores have been approved for restructuring. E. Compromise Settlement Schemes One Time Settlement Schemes RBI has issued guidelines under the one time settlement scheme which will cover all NPAs in all sectors, which have become doubtful or loss as on 31st March 2000. Thescheme also covers NPAs classified as sub-standard as on 31st March 2000, which havesubsequently become doubtful or loss. All cases on which the banks have initiated actionunder the SRFAESI Act and also cases pending before Courts/DRTs/BIFR, subject toconsent decree being obtained from the Courts/DRTs/BIFR are covered. However casesof willful default, fraud and malfeasance are not covered.As per the OTS scheme, for NPAs upto Rs. 10 crores, the minimum amount thatshould be recovered should be 100% of the outstanding balance in the account. For NPAsabove Rs. 10 crores the CMDs of the respective banks should personally supervise thesettlement of NPAs on a case to case basis, and the Board of Directors may evolve policyguidelines regarding one time settlement of NPAs as a part of their loan recovery policy.As on March 31, 2010 under the OTS scheme for NPAs upto Rs. 10 crores a total of 52,669 applications amounting to Rs. 519 crores were received. Of these recoveriesaffected were for 30,888 cases amounting to Rs. 168 crores. For OTS under banks' ownscheme the corresponding recoveries were for 1.62 lakh accounts amounting to Rs. 1,583crores. Negotiated Settlement Schemes The RBI/Government has been encouraging banks to design and implement policies for negotiated settlements, particularly for old and unresolved NPAs. The broadframework for such settlements was put in place in July 1995. Specific guidelines wereissued in May 1999 to public sector banks for one-time settlements of NPAs of smallscale sector. This scheme was valid until September 2000 and enabled banks to recover Rs 6.7 billion from various accounts. Revised guidelines were issued in July 2000 for recovery of NPAs of Rs. 50 million and less. These guidelines were effective until June2001 and helped banks recover Rs. 26 billion. F. Increased Powers to NCLTs and the Proposed Repeal of BIFR In India, companies whose net worth has been wiped out on account of accumulated losses come under the purview of the Sick Industrial Companies Act (SICA)and need to be referred to BIFR. Once a company is referred to the BIFR (and even if anenquiry is pending as to whether it should be admitted to BIFR), it is afforded protectionagainst recovery proceedings from its creditors. BIFR is widely regarded as a stumbling block in recovering value from

NPAs. Promoters systematically take refuge in SICA - often there is a scramble tofile a reference in BIFR so as to obtain protection from debt recovery proceedings. Therecent amendments to the Companies Act vest powers for revival and rehabilitation of companies with the National Company Law Tribunal (NCLT), in place of BIFR, withmodifications to address weaknesses experienced under the SICA provisions.The NCLT would prepare a scheme for reconstruction of any sick company andthere is no bar on the lending institution of legal proceedings against such companywhilst the scheme is being prepared by the NCLT. Therefore, proceedings initiated byany creditor seeking to recover monies from a sick company would not be suspended bya reference to the NCLT and, therefore, the above provision of the Act may not havemuch relevance any longer and probably does not extend to the tribunal for this reason.However, there is a possibility of conflict between the activities that may be undertaken by the ARC, e.g. change in management, and the role of the NCLT in restructuring sick companies.The Bill to repeal SICA is currently pending in Parliament and the process of staffing of NCLTs has been initiated. This is expected to make recovery proceedings faster. APPROPRIATENESS OF THE EXISTING SYSTEMS Most of the participant lenders have special NPA management cells at HeadOffices for dealing with NPAs. The participants were generally of the view that thoughtime and resources were adequate for dealing with NPAs, skills needed to be improvedupon.Within the constraints of the existing legal and regulatory environment banks inIndia have done a commendable job in bringing down the levels of NPAs in recent years.However, with the tightening of NPA recognition norms, which would mean earlyrecognition and faster provisioning of NPAs, banks now need to evolve systems that helpthem identify potential NPAs and take quick action to: Prevent the potential NPA from actually becoming nonperforming, and Avoid increasing their exposure to such potential NPAs

INTERNATIONAL PRACTICES ON NPA MANAGEMENT Subsequent to the Asian currency crisis which severely crippled the financialsystem in most In addition to the above, some of the more recent and aggressive steps toresolve NPAs have been taken by Taiwan. Taiwanese financial institutions have beenencouraged to merge (though with limited success) and form bank based AMCs throughthe recent introduction of Financial Holding Company Act and Financial InstitutionAsian countries, the magnitude of NPAs in Asian financial institutions was brought to light. Driven by the need to proactively tackle the soaring NPA levels therespective Governments embarked upon a program of substantial reform.This involved setting up processes for early identification and resolution of NPAs. Thetable below provides a cross country comparison of approaches used for NPA resolution.Mergers Act. Alongside the Ministry of Finance has followed a carrot and stick policy of specifying the required NPA ratios for banks (5% by end 2010), while also providing flexibility in modes of NPA asset resolution and a conducive regulatory andtax environment. Deferred loss write-off provisions have been instituted to provide breathing space for lenders to absorb NPA write-offs. While it is too early to commenton'lhe success of the NPA resolution process in Taiwan, the early signs are encouraging.Detailed below are the some key NPA management approaches adopted by banks inSouth East Asian countries.

1. Credit Risk Mitigation As part of the overall credit function of the bank, early recognition of loansshowing signs of distress is a key component. Credit risk management focuses onassessing credit risk and matching it with capital or provisions to cover expected lossesfrom default. 2. Early Warning Systems Loan monitoring is a continuous process and Early Warning Systems are in placefor staff to continuously be alert for warning signs. 3. Asset Management Companies To resolve NPA problems and help restore the health and confidence of thefinancial sector, the countries in South East Asia have used one broad uniform approach,i.e. they set up specialised Asset Management Companies (AMCs) to tackle NPAs and put in place Debt Restructuring mechanism to bring creditors and debtors together, oftenworking along with independent advisors. This broad approach was locally adapted andused with a varying degree of efficacy across the region. For example, while in somecountries a centralised government sponsored AMC model has been used, in others amore decentralized approach has been used involving the creation of several "bank- based" AMCs. Further different countries have allowed/used different approaches (in-house restructuring versus NPA Sale) to resolve their NPAs. Additionally, the efficacy of bankruptcy and foreclosure laws has varied in various countries. A number of factorsinfluenced the successful resolution of NPAs through sale to AMCs and some of thesekey factors are discussed below Increasing willingness to sell NPAs to AMCs Bottlenecks often persist on account of reluctance of lenders to transfer assets tothe AMCs at values lower than the book value to prevent a hit to their financials. Banksin Malaysia were encouraged to transfer their assets to Danaharta - AMC in Malaysia by providing them with upside sharing arrangements and the facility to defer the write-off of financial loss on transfer for 5 years. These incentives coupled with the directive of theCentral Bank to make adjustments in the book values of the assets not transferred toDanaharta (after Danaharta identifies them) were sufficient to ensure effective sale to theAMC. In Taiwan, there is a regulatory requirement to reduce for banks to reduce NPAs to5% by the end of 2010. Consequently there is an increasing number of NPA auctions bythe banks. Effective resolution strategy A significant dimension influencing NPA resolution and investor participation isthe ease of implementation of recovery strategies. AMCs like Danaharta have been provided with a strong platform to affect the resolution of NPAs with clearly laid downcreditor's rights. Danaharta has been allowed to foreclose property without reference tothe Court and thus has been able to dispose collateral swiftly by using the tender route.Special resolution mechanisms that have involved minimal intervention of the Court havealso served to entice investor interest in the NPA market in certain countries like Taiwan.On the other hand the operations of Thailand Asset Management Corporation, the Government owned AMC, have been hindered by deficiencies in the Bankruptcy Law provisions.

Appointment of Special Administrators In Malaysia, it has been able to exercise considerable influence over therestructuring process through the appointment of special administrators that have prepared workout plans and have exercised management control over the assets of the borrower during plan preparation and implementation stages. The restructuring processaffected by the automatic moratorium that comes into place at the time of theadministrators appointment. 4. out of court restructuring Most Asian countries adopted out of court restructuring mechanism to minimizecourt intervention and speed up restructuring of potentially viable entities.Internationally, restructuring of NPAs often involves significant operational restructuringin addition to financial restructuring. The operational restructuring measures typicallyinclude the following areas: Revenue enhancement Cost reduction Process improvement Working capital management Sale of redundant/surplus asstsOnce the restructuring measures have been agreed by stakeholders, a completerestructuring plan is prepared which takes into account all the agreed restructuringmeasures. This includes establishment of a timetable and assignment of responsibilities.Usually, lenders will also establish a protocol for monitoring of progress on theoperational restructuring measures. This would typically involve the appointment of anindependent monitoring agency.As seen from the Asian experience, in general, NPA resolution has been mostsuccessful when Flexibility in modes of asset resolution (restructuring, third party sales) has been provided to lenders Conducive and transparent regulatory and tax environment, particularly pertaining to deferred loss write offs, Foreign Direct Investment and bankruptcy/foreclosure processes has been put in place Performance targets set for banks to get them to resolve NPAs by a certain deadline.

Suggestions Through RBI has introduced number of measures to reduce the problem of increasing NPAs of the banks such as CDR mechanism. One time settlement schemes,enactment of SRFAESI act, etc. A lot of measures are desired in terms of effectiveness of these measures. What I would like to suggest for reducing the evolutions of the NPAs of Public Sector Banks are as under.(1) Each bank should have its own independent credit rating agency whichshould evaluate the financial capacity of the borrower before than creditfacility.(2) The credit rating agency should regularly evaluate the financial conditionof the clients.(3) Special accounts should be made of the clients where monthly loanconcentration reports should be made.(4) It is also wise for the banks to carryout special investigative audit of allfinancial and business transactions and books of accounts of the borrower company when there is possibility of the diversion of the funds andmismanagement.(5) The banks before providing the credit facilities to the borrower comp anyshould analyse the major heads of the income and expenditure based onthe financial performance of the comparable companies in the industry toidentify significant variances and seek explanation for the same from thecompany management. They should also analyse the current financial position of the major assets and liabilities.(6) Banks should evaluate the SWOT analysis of the borrowing companies i.e.how they would face the environmental threats and opportunities with theuse of their strength and weakness, and what will be their possible futuregrowth in concerned to financial and operational performance. (7) Independent settlement procedure should be more strict and faster and thedecision made by the settlement committee should be binding both borrowers and lenders and any one of them failing to follow the decisionof the settlement committee should be punished severely.(8) There should be proper monitoring of the restructured accounts becausethere is every possibility of the loans slipping into NPAs category again.(9) Proper training is important to the staff of the banks at the appropriatelevel with on going process. That how they should deal the problem of NPAs, and what continues steps they should take to reduce the NPAs.(10) Willful Default of Bank loans should be made a Criminal Offence.(11) No loan is to be given to a Group whose one or the other undertaking has become a Defaulter.

Conclusion To The Problem A report is not said to be completed unless and until the conclusion isgiven to the report. A conclusion reveals the explanations about what the reporthas covered and what is the essence of the study. What my project report covers isconcluded below.The problem statement on which I focused my study is NPAs the bigchallenge before the Public Sector Banks. The Indian banking sector is theimportant service sector that helps the people of the India to achieve the socioeconomic objective. The Indian banking sector has helped the business andservice sector to develop by providing them credit facilities and other financerelated facilities. The Indian banking sector is developing with good appreciate ascompared to the global benchmark banks. The Indian banking system is classifiedinto scheduled and non scheduled banks. The Public Sector Banks play veryimportant role in developing the nation in terms of providing good financialservices. The Public Sector Banks have also shown good performance in the lastfew years.The only problem that the Public Sector Banks are facing today is the problem of non performing assets. The non performing assets means those assetswhich are classified as bad assets which are not possibly be returned back to the banks by the borrowers. If the proper management of the NPAs is not undertakenit would hamper the business of the banks. The NPAs would destroy the current profit, interest income due to large provisions of the NPAs, and would affect thesmooth functioning of the recycling of the funds.If we analyse the past years data, we may come to know that the NPAshave increased very drastically after 2001. in 1997 the gross NPAs of the Indian banking sector was 47,300crore where as in 2001 the figure was 63,883 andwhich increased at faster rate in 2010 with 94,905crore. The Public Sector Banksinvolve its nearly 50% of share in the NPAs.Thus we can imagine how PublicSector Banks are functioning.The RBI has also been trying to take number of measures but the ratio of NPAs is not decreasing of the banks. The banks must find out the measures to reduce the evolving problem of the NPAs. If the concept of NPAs is taken verylightly it would be dangerous for the Indian banking sector. The reduction of the NPAs would help thebanks to boost up their profits, smooth recycling of funds inthe nation. This would help the nation to develop more banking branches anddeveloping the economy by providing the better financial services to the nation.

BIBLIOGRAPHY M Y Khan and Public Sector Banks K Jain management Accounting TataMcGraw-Hill Publishing Company Limited,new Delhi 1999. Banking Finance (February 2010) Banking Finance (April 2010) IBA Bulletin (January 2004), (February 2010), Monthly journal published byIndian Banks Associations. Banking Annual (Octomber 2010) published by Business Standard. www.rbi.org.com www.google.com Search: o Indian Banking Sector o Non performing assets and banking sectors o Impact of NPAs on the working of the Public Sector Banks o Steps taken by govt. to reduce the NPAs of the banks